Budget shortcomings and the IMF

The same day as the board of directors of the International Monetary Fund (IMF) approved the staff-level agreement, 3 July 2019, a summary of the objectives of the programme and recent economic development and outlook, attributed to David Lipton, IMF's First Deputy Managing Director and Acting Chair, were uploaded on the Fund website, tailed by targets/projections of key macroeconomic data.
Details of the programme conditions including structural benchmarks and the time-bound quantitative conditions have yet to be released with the Letter of Intent signed by the Advisor to the Prime Minister on Finance Dr Hafeez Sheikh and Governor State Bank of Pakistan Reza Baqir committing this country to a set of reforms that, if the prior conditions are anything to go by, would be extremely challenging - politically and from the perspective of the common man's kitchen budget.
The very same day Dr Hafeez Sheikh, flanked by Hammad Azhar, Minister for Revenue, and Shabbar Zaidi, Chairman of the Federal Board of Revenue, held a press conference where he gleefully itemized the inflow of concessional loans of 9.4 billion dollars to Pakistan during the 39 month Extended Fund Facility programme: (i) IMF would release one billion dollars in the current year (total programme loan 6 billion dollars) at 3 percent repayable in 10 years; disturbingly the budget documents itemize IMF budgetary support at 2.38 billion dollars for the current year; (ii) the Asian Development Bank would release 2.1 billion dollars in the current year though again the budget documents place total programme/budget support loans at 1.8 billion dollars in the current year (ADB would release an additional 1.3 billion dollars by the end of the IMF programme); and (iii) World Bank assistance has clearly not been firmed up with Sheikh claiming that it would also extend budgetary support.
Total loans during the 39 months of the IMF programme would be 38 billion dollars, (inclusive of 8.7 billion dollars of project loans - non-budget support - out of which 1.4 billion dollars would be disbursed in the current fiscal year as per the budget) and the remaining 29.3 billion dollar programme support, so revealed Dr Sheikh though nearly all of his claims do not match the budget documents: (i) roll-over loans from friendly countries 14 billion dollars with the budget documents noting that for 2019-20 roll over from friendly countries would be 750 billion rupees plus 480 billion rupees Saudi oil at deferred payment and 165 billion rupees from Islamic Development Bank or 9.3 billion dollars given the rate of rupee dollar parity used is 150; reports indicate that the executive directors of the IMF were informed that Saudi Arabia and China have agreed to roll over the loans, a prior condition that is against IMF's usual practice as loans from other sources are not a precondition but an outcome of a Fund programme; it is therefore ironical that in its programme summary the IMF notes that "the Fund supported programme is expected to coalesce broader support from multilateral and bilateral creditors in excess of US$38 billion which is crucial for Pakistan to meet its large financing needs in the coming years;" (ii) the documents claim sukuk/Eurobonds of 300 billion rupees in the current year (the rate of return and the maturity period have not been worked out yet - decisions that would impact on the country's mark-up payments); and (iii) extremely disturbing was Sheikh's contention that loans from commercial banks would range from between 0 to 8 billion dollars - a typical Sheikh ploy that would preempt specific queries given that loans from this source are procured at a market rate of return with a very short amortization period - a source of funding much denigrated by Prime Minister Khan with reference to the previous administration. The actual amount of commercial loans procured would depend on the success of borrowing from other sources including incurring debt equity through the issuance of sukuk/Eurobonds.
With 38 billion dollar inflows the gross reserve position would improve to 11.1 billion dollars against 6.8 billion dollars in the year just past and 9.7 billion dollars in 2017-18, so reveals the IMF. The foreign exchange reserves would be enough for 2.2 months of imports which is a big improvement from the 1.4 month of imports the year before though data suggests that it would be backed by higher indebtedness reminiscent of the Dar years.
The debt position of the government this year would be considerably worse relative to previous years as indicated by the IMF's projections: (i) external general government debt would rise to 32 percent of GDP this year as opposed to last year's estimate of 26.5 percent and 24.3 percent in 2017-18; (ii) domestic general government debt (one may assume that the 1.4 trillion rupees of circular debt is not included), is estimated at 44.9 percent in the current year against 48.4 percent in 2018-19 (the Pakistan Tehrik-i-Insaaf government relied on incurring domestic debt to meet the more than budgeted disbursement for current expenditure last year as it dithered on whether to go on a Fund programme or not; and (iii) debt service to rise to 45.7 percent of GDP this year against 37.9 percent in 2018-19 and 26.23 percent in 2017-18.
The question is why does the budget 2019-20 envisage higher external debt in spite of claims to the contrary by the Khan administration? Two reasons account for this. First and foremost the current account deficit is targeted as per the IMF to decline to negative 2.6 percent of GDP this year as opposed to negative 4.6 percent in 2018-19 and negative 6.3 percent during the last year of the PML-N administration. This requires exports to rise by 8.2 percent, a grossly unrealistic target as in 2018-19 exports grew only by 0.2 percent in spite of exemptions (textile sector would pay 17 percent sales tax as per budget 2019-20 on local sales which it claims would further compromise its liquidity position given that massive refunds on exports remain pending), and special treatment (cheaper electricity would now be available for only four hours a day instead of 24 hours, a decision taken by Dr Hafeez Sheikh).
Imports on the other hand are expected to decline by negative 4.7 percent in the current year as opposed to negative 4.2 percent in the preceding year. The decline in imports last year is attributed to the completion of the mega electricity projects under China Pakistan Economic Corridor though other imports would decline as the rupee dollar parity makes them unattractive; however if the international oil price continues to rise the oil bill, which is a significant component of our total imports, would undercut the decline in other imports. At best around 2 to 2.5 percent decline in imports maybe projected for the current year. Hence the target for the current deficit would not be reached through desired foreign exchange earnings/remittances and the government would have to rely on higher borrowing to meet the target, possibly through higher than projected borrowing from commercial banks.
Secondly, irrespective of extremely tall claims with respect to reducing expenditure the budget documents reveal: (i) a rise in total current expenditure to 7.28 trillion rupees as opposed to 5.589 trillion rupees as per the revised estimates of last year - a massive rise of 30 percent. Unlike last year this includes allocation for Ehsaas programme that Dr Hafeez Sheikh credited under current expenditure though Benazir Income Support Programme, the major component of Ehsaas, was in previous years credited under development expenditure outside public sector development programme. This enabled the government to show a reduction from 162.9 billion rupees in last year's revised estimated under other development expenditure to 85.79 billion rupees this year; if the Ehsaas programme of around 200 billion rupees is subtracted from current expenditure even then the increase in current expenditure in the current year compared to the revised estimates of last year are around 1.4 trillion rupees which is around 27 percent; and (ii) a rise in federal development expenditure to 701 billion rupees is year compared to 500 billion rupees according to the revised estimates of last year - a rise of nearly 29 percent.
The foregoing reveals why some executive directors of the IMF asked the staff during the Board meeting whether they had contingency plans in the event that the adjustment process does not proceed as planned. Reports sadly indicate that the Pakistan economic team has no home grown contingency plan in place or indeed under preparation and one can only hope that this is rectified in weeks and months to come. Next week's article would focus on IMF's other macroeconomic indicator projections.