Econo-mic environment is becoming increasingly challenging and we find our economic house in disorder, not ready to face the incipient shocks building on the horizon. Let us review the dangers creeping silently around us.
First, the oil price is on the rise and is currently trading at $81.35 which is an increase of 80% increase since July 2017. Full impact of Iranian sanctions, scheduled to go into effect on 4 November is still six weeks away. The fact that it is going to be bad is evident from the way the Europeans are finding it hard to insulate Iran from its consequences. "The European Union has failed to design a workable legal shield for its companies in Iran to beat the global reach of the U.S. financial system and defy President Trump", a European diplomat confided to Reuters. The US determination to dry out Iranian oil is so aggressive it has told no country would be granted exemptions, as in the past - neither Japan nor India. JP Morgan feels oil price would hit $90 within few months.
Second, there is a considerable amount of off-budget liabilities bursting at the seam, and badly requiring an early resolution: (a) the unpaid circular debt (CD) has risen to nearly Rs.600 billion and an equal amount parked in the special purpose vehicle (SPV), Power Holding Company (PHP), requires adjustment in the books of DISCOs. While resources have to be mobilized to pay-off the unpaid CD, interest payment on the other part are mounting and would have an adverse effect on tariff as interest cost is also made part of tariff. The tariff for 2015-16 is in the field at present and the new tariff for 2017-18 is under Government consideration, which would require a fairly significant increase over the current tariff; (b) the gas price increase that required a financial impact of Rs.158 billion was only partially done to the extent of Rs.100 billion. Besides, there is an equal amount that remains to be awarded to gas companies by the regulator; (c) many announcements have yet to feature in a budgetary provision, for example subsidy on imported fertilizer, subsidy on the use of LNG in fertilizer production, the mysterious Rs.44 billion for equalization of gas prices between Punjab and Sindh and many packages for incentives to exporters. All these items would have an impact on stabilization efforts; although immediate recognition would create budgetary challenges, non-recognition would ensue more disruptive consequences as supplies would be affected.
Third, there is a chaotic scene in the government debt market. Government borrowings from SBP were registered at $4.6 trillion on 14-9-2018. After closing at Rs.3.5 trillion on 30-6-2018 and then increased dramatically to Rs.5.2 trillion a week later on 6-7-2018. This was the result of a T-Bills auction that fetched less than Rs.500 billion against a maturity of Rs.1.5 trillion. This was understandable ahead of a scheduled monetary policy committee (MPC) on 14-7-2019 where a rate hike was widely expected. The MPC did increase the policy rate by 100 bps. There was some respite afterward as borrowings returned to an average of Rs.3.5 trillion over the next few weeks but as the next MPC in September is approaching borrowings have spiked to Rs.4.6 trillion. This is a clear evidence that the money market is nearly dysfunctional. The latest TBs auction calendar shows a maturity of nearly Rs.4.8 trillion falling due in the next three months, which is more than half the outstanding amount investments in TBs. In the last two fiscal year, investment in long term securities (PIBs) have declined by Rs.1.5 trillion, which has shifted into TBs, which increased by Rs.3 trillion. So the new investment in the Government securities during this period was exclusively made in the TBs. As if this was not already a precarious situation, the only maturity that attracted investment in TBs was for three months; six months and twelve months attracted nothing. There is effectively no participation in the market except to invest in the most liquid security as the banks feel the interest rates are completely out of line. The SBP is accommodating any amount of demand from the Government. This has resulted in elevated refinancing risk and complete disruption of the money market. When the adjustments finally come, it would be very painful for the markets and without adjustments, the present chaotic conditions would continue.
Fourth, the economic data for the first two months is not very encouraging. Growth in remittances have moderated. FDI has declined. The current account deficit is up 10% compared to first two months of the last year. However, there is one silver lining in the BOP data: there was a massive decline in the deficit for the month of August which was only $600 million - significantly below the average of $2 billion it recorded in the preceding few months.
It is this backdrop that looks ominous. There is no doubt this situation has built during the last two years. The Caretakers chose to remain inactive. All hopes were pinned on a Government that would come with a fresh mandate from the people. Alas, that hope has not been realized, at least not so far. More than five weeks in the office, and after announcing a mini-budget, the Government has not succeeded in laying-out a game plan that would inspire investors' and markets' confidence.
The Government has maintained an inexplicable ambiguity on its plans to deal with immediate challenge of economic stabilization. Precious time is wasted in taking a decision that would have profound consequences. The plans to seek cash support from the friendly countries have not borne fruit despite claims to this effect just before the visit to Saudi Arabia and afterward in the conflicting versions issued by Government officials regarding the outcome. The Chinese visit has yet to take place.
Apart from uncertainty regarding the nature of friendly support, the work to repair the broken economy has to be taken in hand. Apart from fixing the macroeconomic framework, the structural issues in such important areas like privatization, SOEs, energy sector, Government borrowings and trade and exchange policies have yet to be addressed to improve the investment environment in the country. In the absence of a stable framework, the economy would be ill prepared to face an exogenous shock that looks almost a certainty.
(The writer is former finance secretary)
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