Stability in sight

When the going gets tough, the tough gets going. That will be the situation of Pakistan economy in the months and quarters to come. Major chunk of currency and interest rate adjustments has been taken upfront under the IMF. Other steps on energy and taxes are in the process and will be unveiled by June end, before the Fund programme is officially approved and signed.
The new imported economic team is making decisions on fast track basis, in an attempt to cover the time loss in the first three quarters by PTI's original team. This quarter and the coming two (till Dec19) are critical, and if the PM and government survive these, there will be fourteen quarters left to first let the economy stabilize along with tough reforms, and to bring growth momentum back before the next elections. In cricket lingo, it is a five day test - three sessions of first day are of opposition, but enough sessions are left to make a comeback.
Thus, coming few weeks and months are crucial. The opposition is in full swing with both parties launching their next generation and all the guns are aimed at Imran and his new economic team. At this juncture, a relatively easier way to tackle the opposition is to let go the retirees out of the country - some form of NRO. The buzz is that some power corridors are interested in this proposition, but PM Khan is not taking a U-turn on the accountability of the opposition.
It is tough to handle both accountability and bringing economic reforms, simultaneously. People are advising that Imran should pick one battle. On economic front, PTI government does not have any choice, but to comply with the IMF. And to bring reforms, it is imperative to have some form of charter of economy where government, opposition and establishment have to be on one page.
That apparently is not the case, as of now. That is why time till Dec19 is critical and the pendulum can swing either way. No matter what the outcome, the stabilization phase to continue, unless we prematurely exit the IMF programme. The Fund is showing no mercy this time, as an effective $2 billion per year funding, for a country having much higher external financing need, is peanuts.
The Fund programme is imperative for other financing avenues. WB and the ADB are on the top, followed by global capital market options, foreign portfolio investment, FDI, and other bilateral and multilateral funding. The signs are already visible such as smoothening of stuck deferred oil payment facility by KSA, some commitments from France and more to follow.
A lot depends on how Pakistan and US relations shape up in months to come. If any deal on Afghanistan exit formulates, the FDI and portfolio investment may start pouring in, and IMF may relax its conditions as well. If Pakistan plays it right, by deregulating energy sector and digitizing the financial economy, the game is on.
The other extreme is premature exit from IMF programme. But that is simply not possible any time before December, as the country needs other flows. But since most of the conditions are front loaded, it would make less sense to exit after graduating from toughest time. But we cannot ignore history, barring one or two instances; we have never completed an IMF programme.
Let's not speculate more into ifs and buts, and see what actions are to be taken and how would these impact the economy. The fiscal deficit is at an alarming level of 5 percent of GDP in 9MFY19, and the expectation is of 7.5 percent of GDP in full year.
The next budget will be full of new taxes and end of tax exemptions which will considerably lower the primary deficit - targeted at 0.6 percent of GDP for FY20 and is standing at 1.2 percent of GDP in 9MFY19, and may cross 2.5 percent of GDP in full year. The primary deficit will be lowered by having a combination of new taxes and cut in expenditure to the tune of around 2 percent of GDP or around Rs900 billion. The problem is debt servicing which has reached an alarming level with high interest rates.
On current account, recent rise in interest rates and wave of depreciation will further choke the economy and non-essential imports would be down substantially. The catch is to spur the import substituting industries which will not only serve the domestic demand but also generate much needed employment. But high interest rates increase the cost of new plants and manufacturing units.
The interest rates may start coming down in 3-4 quarters, as inflation is expected to peak by September and may start tapering thereafter. Hence, most of import substitution will come by that time. The question again is without investment and employment, how to cope in two quarters. The bottom line is that economic stability is in sight, but politics is uncertain.