The Fitch Solutions claims that Pakistan and International Monetary Fund (IMF) will reach an agreement over a bailout soon, with a potential bailout size of about $12 billion. Fitch Solutions in its latest report titled "Pakistan: What to Expect in the Next IMF Bailout Package", states that the bailout package will focus on fiscal consolidation, a review of monetary and exchange rate policy, financial reforms, and structural reforms-the same measures implemented in the previous loan agreement.
Given the positive statements following the latest meeting of Prime Minister Imran Khan and International Monetary Fund (IMF) Chief Christine Lagarde in Dubai on 10th February 2019, Fitch Solutions maintained that an agreement is likely to be reached in the near future. Early indications suggest that Pakistani authorities requested aid of $12 billion, which is almost twice as large as the previous bailout package of $6.6 billion in 2013.
The report states that details of the discussions on the bailout package are yet to be released, Fitch Solutions maintains that the conditions and targets will focus on key areas such as fiscal consolidation and debt management, a review of monetary and exchange rate policy, financial and banking sector reforms, as well as implementation of key structural reforms.
The 2013 package was reasonably successful at improving Pakistan's macroeconomic fundamentals over the three-year timeframe before fiscal and monetary management started to slip again in late 2016 and 2017.
Fitch Solutions further states that measures to strengthen the country's fiscal and debt dynamics will likely be a major cornerstone of the IMF deal, with the end goal of narrowing the budget deficit and stabilizing the debt-to-GDP ratio through austerity measures. These policies will likely be aimed at reducing the budget deficit from an estimated 6.6 percent in 2018 to approximately 4 to 5 percent, or even lower, over the next one to three years [with the budget fiscal year 2018-19 (July - June) already targeting a deficit of 4.9 percent].
This would be roughly in line with the consolidation programme implemented in 2013 that set out expectations for a reduction in the fiscal deficit by an annualized 1% per year for three years. With public debt currently at 71.4 percent of GDP, fiscal consolidation will help to stabilize, and potentially lower, the debt load.
The IMF previously targeted to lower the debt-to-GDP ratio from 63.9 percent in 2013 to 60.5 percent over a period of three years. However, this was not achieved and the ratio eventually rose to 67.6 percent in 2016.
Fitch Solutions expects the IMF to request Pakistan to strengthen tax administration, broaden the tax base, and raise its tax-to-GDP ratio. Following tax reforms implemented under the three-year IMF Extended Fund Facility (EFF) Arrangement implemented in September 2013, Pakistan's tax to GDP ratio increased from 9 percent in fiscal year 2013-14 to 11.2 percent in fiscal year 2017-18.
Fitch Solutions argues that Pakistan would still be expected to reduce fiscal expenditures in the later years of the programme. The reduction in public spending would likely involve further reductions to energy subsidies, as the target of reducing the subsidies to 0.4 percent of GDP under the previous package was not met given that subsidies stood at around 0.9 percent in 2016.
There is likely to be a focus on reducing transfers to provinces so as to better align federal and provincial responsibilities in expenditures as pointed out by the IMF in its 2017 Article IV document, the document further states.
Fitch Solutions expects the IMF to call for a review of Pakistan's monetary and exchange rate policy, given the accelerating inflation (which rose to 7.2 percent y-o-y in January 2019 from 4.4 percent y-o-y in January 2018), the large current account deficit (estimated at 6.4 percent of GDP in 2018) and the low levels of foreign reserves (with the import cover currently standing at about three months in December 2018).
In 2013, Pakistan agreed to strengthen the independence of the State Bank of Pakistan (SBP) in its pursuit of price stability, and successfully lowered inflation from 9.2 percent in 2013 to 3.7 percent in 2016. It is believed that Pakistan would be expected to further enhance the autonomy of the SBP and credibility of monetary policy by gradually reducing government borrowing from the central bank. To be sure, outstanding net SBP credit to the government sector rose by 105.8 percent in 2018 to Rs 4.9 trillion (about 14 percent of GDP), from Rs 2.3trillion in 2017, according to the report.
Under the EFF in 2013, Pakistan began net purchases of foreign exchange in the inter-bank spot market, tightened its Net International Reserves (NIR) targets, and increased exchange rate flexibility. These efforts helped to raise reserves from $9.8 billion in September 2013 to $23.6 billion in September 2016, equivalent to an import cover of 2.6 and 7.2 months, respectively.
Given the low levels of foreign reserves at present, it is expected that reserve accumulation would be one of the main objectives of the bailout package to be achieved through same measures to those in 2013.
Following the bailout talks in November 2018, it was reported that Pakistan had declined the IMF's proposal of implementing a free-float exchange rate regime. In the event of an agreement, the IMF will likely request for a wider managed-float policy band to increase the flexibility and reduce the need for policy intervention, which would help to improve the sustainability of the current account and rebuild foreign reserves.
Financial sector reforms enacted since 2013 aimed at improving the legislation and regulation of the sector will likely see further progress. Reforms which have already been implemented include the introduction of a new bankruptcy law, the implementation of legislation on deposit insurance scheme, and a revision of regulatory and supervisory laws. Combined these reforms have succeeded in aligning local standards with that of best international practices.
There have also been successful efforts to improve the capital adequacy ratio of the banking sector to bring it above prudential minimums and reduce non-performing loans to an 8-year low of 10 percent by 2016. While these measures are important for continued growth in the financial sector, Fitch Solutions expects the IMF to have a strong focus on improving Anti-Money Laundering (AML) laws and Countering Financing of Terrorism (CFT) efforts, given the poor regulations in these areas.
Structural reforms will be another pillar of the IMF deal and these will likely focus on the privatisation of loss-making public sector entities (PSEs) and measures to improve the domestic business environment.
In 2013, the Sharif Administration identified 31 state-owned enterprises slated for privatization, and hired transaction advisors for the first several transactions that were expected before the end of 2015.
However, according to local media reports in March 2018, the IMF estimated the aggregate losses of PSEs in Pakistan to be more than Rs 1.2 trillion (4 percent of GDP) as of March 2018, which suggests that more can still be done to improve the operational efficiency of these entities. Given Pakistan's high debt-to-GDP ratio, privatization will be a key prerequisite for the bailout package.
The ease of doing business remains low relative to other countries, with the country falling to 136 position among 190 countries in 2018 compared to 110 in 2013 according to World Bank's Ease of Doing Business Index. Fitch Solutions states that measures to enhance business environment would be included in the coming package, given the large room for improvement.
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