The IMF programme is finalized. In Naya Pakistan, it was announced in an old fashioned way by a technocrat FM in PTV 9 PM bulletin. No press conference, no burning questions from journalists, and the announcement came on Sunday night to ease investors’ anxiety and to avert a run on dollar, yet the stock market plummeted yesterday.
The negotiations of the 22nd Programme in 72 years were perhaps the toughest. Without delving into the disagreement of local authorities and IMF - sacking of Asad and Bajwa, and not letting Dagha sit in the final round of negotiations, the Fund is by and large signing on its conditions.
The agreement is subject to timely implementation of prior actions. The actions are market based exchange rate, const recovery in the energy sector and fiscal consolidation to reach primary deficit of 0.6 percent of GDP in FY20. On discount rate, IMF has not said anything explicitly. Thus, the IMF programme is implied to be signed after the presentation of budget and revision in energy prices.
On the exchange rate, Pakistan may not see similar adjustment to what Egypt experienced at the time of entering programme in November 2016. The REER there was around 125 and its 104.4, and if it has to take to 100, the level would be around 150. This space had written six months back that the REER based equilibrium would be around Rs150/USD. But in Egypt, REER came down to 75-80, so one cannot say about the quantum of currency adjustment, but some correction is surely warranted.
Assuming steep adjustment in currency may not be a pre-condition, but parity could depreciate once the inflation creeps in after new taxes. The two issues that delayed the programme for many months are energy and fiscal. There is nothing done in the past nine months to show IMF that Pakistan has any other plan to bring energy subsidies down or to lower fiscal deficit without simply increasing tariff and imposing new taxes.
On fiscal side the primary deficit was 0.3 percent of GDP in FY16, and right after the conclusion of the Fund programme, it started slipping, reaching 2.2 percent of GDP in FY18, and is expected to be around 2.8-3.0 percent of GDP in FY19. Taking it back to 0.6 percent of GDP in one year is a herculean task and may require additional revenues or cut in expenditure to the tune of Rs800-1,000 billion. With, increase in BISP or Eshsas programme allocation, the onus is falling on revenues.
Majority of this would be budgeted in the form of new taxes or by ending tax exemptions. Thus, around Rs600-800 billion new taxes are to be imposed as some room will be given for improving tax administration. The fact that the government still has kept room for higher electricity subsidies, having also phased out the tariff increase, limiting to a few categories, one gets the impression that privatization proceeds may well be a big chunk to bridge the fiscal gap and work towards achieving the ambitious primary deficit target. If that is indeed the case, the need to impose new taxes can reduce by a couple of hundred billions, if not more.
The additional taxes will still bring inflation home. Although, the direct impact on CPI would not be massive, as 78 percent of domestic sector is insulated from the proposed tariff increase. Inflation in general will surely pick up, as fresh taxes are levied. To counter rising inflation, the interest rates may go up. Higher inflation could also lead to higher REER, and that could mean another round of adjustment in nominal exchange rate.
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