The financing dilemma

Pakistan finds itself today between the devil and the deep blue sea. The external balance of payments position has greatly worsened over the last two years. The combined current account deficit for these two years has risen sharply to $30 billion. This has required much more external borrowing, especially of a commercial as opposed to a concessional nature. On top of this, foreign exchange reserves have been used to cover partially the financing gap. They were at a peak of $19 billion in 2015-16. There has since been a 46% decline and reserves were at $9.8 billion on end-June 2018. This is not even adequate to provide for two months cover of imports. Normally, a three months cover is considered the minimum safe level.
The perilous position that the country now finds itself has historically led to an effort to seek support from the International Monetary Fund (IMF) for stabilizing the balance of payments position. During the last 10 years, this has already happened two times.
The first time was after 2007-08 following a very big oil price shock when by October 2008 reserves had fallen to only $4 billion. Pakistan was able to negotiate a Standby Facility with the Fund of $11 billion. However, the program ended prematurely in September 2011.
The second time was after 2012-13 when reserves fell once again to a low level of $5 billion by September 2013. The new Government of PML (N) proceeded to seek support from the IMF this time for an Extended Fund Facility of $6.3 billion. This program came to an apparently successful end in September 2016.
The balance of payments problem this time and the consequential depletion of reserves have been caused largely by four factors. First, there has been the persistent fall in exports since 2013-14 up to 2016-17. Second, home remittances have lost their historical buoyancy and been, more or less, stagnant since 2015-16. Third, imports have jumped up due to machinery imports for CPEC power projects and a relative cheapening of imports generally due to a, more or less, stable nominal exchange rate up to the end of 2017. Fourth, the rapid accumulation of external debt, especially of shorter duration, has implied a big increase in debt servicing obligations.
Like the last two times, the normal expectation is that Pakistan will go back once again to the IMF for balance-of-payments support. This is the role that was given to it as a Bretton Woods institution by the United Nations in 1944. Developed countries are expected to contribute funds to the IMF to facilitate its role as the global lender of last resort generally for developing countries. More recently, it has made large loans even to developed countries like Greece. In addition, low to middle income countries like Egypt, Argentina, Iraq, Jordan, Sri Lanka and Kenya all have on-going programs with the Fund.
The normal process of approaching and then negotiating a new program by Pakistan with the IMF has been put in question by the recent statement by the Secretary of State of the USA. He has said that there is no rationale for a bailout of Pakistan by the IMF that pays off Chinese loans to Pakistan. In effect, the US may be opposing a new IMF program for Pakistan.
What should Pakistan do now? There is the risk that the process of implementation of CPEC could either be jeopardized or slowed down by the IMF, under pressure from the largest member of its Executive Board, the USA. One option, of course, is to seek a re-scheduling of the repayment of Chinese loans for the duration of a Fund program, possibly up to three years. The interest rates on the loans could, of course, be adjusted upwards to ensure that the present value of the debt servicing of Chinese debt remains the same. All efforts need to be made to protect CPEC which is vital for Pakistan's future.
There is also a growing realization that besides the focus on CPEC, the IMF will not be as 'soft' and benevolent as it was last time in terms of imposition of conditionalities and their fulfillment during the tenure of the Program. The likelihood is high that a number of prior actions could be asked for, along with tough program criteria and structural benchmarks to be met at different stages of the Program.
This could include a large up-front devaluation of the rupee, hike in electricity tariffs, enhancement in tax rates (especially withdrawal of the concessions granted in income tax in this year's Budget), fast-paced privatization of entities like PIA, PSM and some DISCOs, transfer of functions and expenditures to Provincial Governments in conformity with the 18th Amendment, big jump in interest rates and severe limits to Government borrowing from the SBP, cut in development spending and austerity in other expenditures including cost of civil administration, defense, grants and subsidies.
The new government will, no doubt, have to weigh the economic and political cost of these actions, especially in light of its somewhat slender majority and in contrast to its relatively populist agenda.
On top of all this, there are two big unknowns. First, there is uncertainty about the quantum of support that will be made available. Estimates of the Program size range from $6 to $12 billion. The latter is more in the range of what is needed given the large magnitude of the financing gap. Second, behind the scenes there could be non-economic steps like a change in the Afghan Policy asked for by the USA, which may be unacceptable.
Therefore, the prospects of a sizable Fund programme like the 2008 Standby Facility have receded. This means that Pakistan must now prepare a Contingency Plan. How will the external financing requirement of up to $28 billion be covered this year? This will become even more difficult in the absence of access to the international financial markets without the IMF program.
No doubt, increased funding from China and other friendly countries can be sought. Also, efforts can be made to recover illicit funds abroad of Pakistanis. Attractive schemes can be designed to encourage larger inflow from our workers abroad. However, there is need to recognize that over next two quarters there will be heavy pressure on the sparse reserves, which may lead to a run against the rupee.
Therefore, soon after the takeover, the new Government may wish to proceed to negotiate with the Fund to 'test the market.' If the stated apprehensions prove to be true then there should be quick implementation of the Contingency Plan.
This plan could include the imposition of a Financial Emergency under Article 235 of the Constitution. Similar to the political consensus reached on the National Action Plan against terrorism among the political parties, a united front will need to be developed on the hard economic steps in the greater national interest.
The prime target will have to be reduction in the current account deficit this year. In a 'business as usual' scenario this could approach $19 billion. It will need to be brought down to almost $9 billion, for financing to become possible without a significant decline in the already low reserves. Near draconian measures will have to be taken to compress imports and strong incentives given for boosting exports. In addition the fiscal deficit will have to be brought down to below 5% of the GDP, to contain the pressure of rising aggregate demand on imports.
The next few months are crucial. Time will tell who the real friends of Pakistan are and the level of maturity and the collective will of our overall political leadership in the larger national interest. We hope and pray that the deep economic quagmire that the country is in will be overcome without too much cost being imposed on the less privileged segments of our population.
(The writer is Professor Emeritus at BNU and former Federal Minister)