No room for complacency

The balance of payments (BoP) data for the month of February is a breath of fresh air. There is an improvement of $2.6 billion during the 8-month period Jul-Feb in the current account, which is significant and something the policy makers were struggling to achieve for quite sometimes. The marginal performance of the month of February was remarkable as the deficit amounted to $356 million, only a fraction of $2 billion registered in later part of 2017-18 and early months of 2018-19.
But some policymakers and commentators are portraying this as a major policy success and a first step in the comprehensive revival of the economy. While this is a success there is no reason to become complacent. It is important to carefully examine what this success is actually saying and for this purpose we carefully analyze the sources of this improvement.
There are two major sources from where this improvement has come, namely, remittances and imports. Remittances showed an exceptional growth of nearly 12% during the period and contributed an improvement of $1567 million, compared to last year. The source is imports of goods, which have decreased by $500 million together with a much larger decrease in imports of services (not many details are available here). Both are a welcome development. But what is most disappointing and worrying is the performance of exports, which actually declined by a small margin of $10 million. Thus the trade account on goods declined by less than 3%. Thus policy contributed impact is somewhat limited on the crucial trade account.
One wonders what has been the impact of nearly 40% depreciation of rupee in the last about 14-15 months. It seems remittances have responded to higher exchange rate than anything else. On the other hand, there is no exportable surplus in the country and thus supply elasticity of exports is negligible. Some desirable impact has been exerted on imports, but it is paltry compared to the sizable depreciation as well as the need of contraction, where at least halving of the current account would have been the target of adjustment.
The other instrument of adjustment used for correction is the SBP policy rate, which has been increased by 450 basis points (bps) during the same period of 14-15 months. Apparently, this was entirely focused on fighting inflationary pressures rather than to expect any corrective role in the balance of payments, since the country has limited capital flows that could be affected by the policy rate.
The real culprit that continues to afflict the macroeconomy and which has not seen any serious adjustment efforts is the fiscal deficit. The government had inherited a high fiscal deficit of 6.6% for 2017-18 and a budget that has significantly underestimated the underlying deficit at 4.9%. Despite giving two mini-budgets, the government has not fixed the underlying weaknesses of the budget estimate. Curiously, the mini-budget increased the budget target to 5.1%. We give a brief account of where the fiscal deficit is headed during the current year.
The most discouraging aspect of fiscal performance is the poor tax collections. The FBR revenues for Jul-Feb showed a meager growth of less than 4% as opposed to the required growth of about 15%. The target for the year is Rs 4.4 trillion. At this rate even Rs 4 trillion appears daunting. We estimate that there could be a shortfall of as much as Rs 350 billion, which is close to 1% of GDP. The non-tax revenues were estimated at around Rs 1 trillion. In the first six months of the year, collection was barely 25%. Under the circumstances, even a final shortfall of Rs 200 billion in non-tax revenues at the close of the year, would be a reasonable performance. The combined shortfall of tax and non-tax revenues appears to be around Rs 550 billion or 1.5% of GDP. Now, this revenue performance alone would take the deficit during the year to 6.6%. And we have not yet considered the expenditure over-runs.
The expenditure side looks highly precarious. The 450 bps hike in the SBP policy rate is way beyond the assumption made in the estimation of debt servicing. In the Miftah Budget, debt servicing was pitched at Rs 1622 billion. In the first mini-budget, it was revised upward to Rs 1842 billion, a sizable adjustment of Rs 224 billion. But much of the increase of 450 bps has come after this adjustment. Therefore, an overrun on this head is inevitable. Regarding its size, reportedly the finance minister has stated before the NA Finance Committee that as much as Rs 400 billion would be needed additionally to meet the debt servicing obligations. This is more than 1% of GDP. Then there is the rising defense expenditure, even prior to the recent tensions, which of course would further strain the expenditure side. Note that we are only talking about current expenditures. No amount of cutting development expenditure would help avert the above expenditure over-runs.
Then there are a number of unrecognized expenditures resulting from not implementing the prices determined by the regulators. The IMF program hinges on such recognition or passage of these prices to end-users. If all is passed to consumers, there would be adverse implications for inflation. In the alternative, deficit would further go up and need for corrective actions would consequently increase. There are other subsidies not provided in the budget and hence in the final count they would add to the deficit. Taking all these together, it is estimated that a minimum of 1% over-run in expenditures looks realistic to expect, taking the fiscal deficit in the range of 7.4-7.6 percent. This is an unsustainable level of deficit.
With such high fiscal deficit, external account would continue to remain under pressure. It is not surprising that the foreign exchange reserves remain dangerously low. In August 2018, SBP reserves was $8.9 billion. After the friendly support, $5 billion were added, which would mean $13.9 billion. The reserves stood at $8.1 billion on 8 March 2019. Clearly, we are losing reserves by roughly a $1 billion a month. The foreign debts are rising in the process. Nothing signifies the precarious nature of our economy more than the phenomenon of loss of reserves. The green shoots on the BOP are there, but the chances for them spawning a beautiful garden of economic stability are limited.
The start of an IMF programme would be the real harbinger of a credible turnaround. Unfortunately, we have allowed imbalances to grow by not doing so at the outset. These imbalances would be removed if the Fund program is carried through its full cycle with diligence and commitment. There are difficult times ahead. The earlier we face them the less painful they would be.
(The writer is former finance secretary)
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