Primary deficit of 0.6 percent with singular lack of focus on the fiscal deficit (7.2 percent was set as the target for 2019-20 - identical to what the authorities erroneously claimed was the projected deficit for 2018-19) was an International Monetary Fund (IMF) condition met by Pakistan by the first mandatory review report uploaded on the Fund's website in December 2019.
This achievement, so claimed Dr Hafeez Sheikh, was a milestone in the country's economic history reflecting the soundness of government's policies focused on reducing expenditure and raising revenue. He did not mention that this achievement was due to (i) less than 8 percent total releases under the Public Sector Development Programme (as opposed to the usual practice of 20 percent releases during the first quarter), (ii) social sector disbursements were less than one percent of the total 190 billion rupees budgeted for the year due to an ongoing survey, and (iii) revenue was shored up by not releasing pending refunds.
To add to the confusion the actual budget deficit for 2018-19 on which the target for the current year was agreed was 8.9 percent (data released in August 2019 data) and not 7.2 percent.
Sheikh has rightly held the previous administration responsible for the massive rise in government debt - domestic debt rose from 9.5 trillion rupees in 2013 to 18 trillion rupees March 2018 (90 percent rise) while external debt rose from 4.3 trillion rupees to 9.6 trillion rupees (123 percent) - a rise that is nonetheless understated as the rupee was deliberately (and disastrously) kept over-valued (between 5 to 20 percent as per a footnote in the IMF's quarterly review under the previous Extended Fund Facility programme 2013-2016.
However what Sheikh conveniently ignores is the fact that the IMF gave a reprieve to the Khan administration by focusing on the primary deficit (without debt servicing charges added on) instead of the budget deficit. This, in turn, accounted for Pakistan's two economic team leaders - Governor State Bank of Pakistan Dr Reza Baqir and Dr Hafeez Sheikh Advisor to the Prime Minister on Finance - to agree to a set of monetary and fiscal/expenditure policies and projecting the country's prohibitive 38.6 billion dollar external financing needs for the next 39 months - the programme period - in the Letter of Intent Memorandum of Economic and Finance Policies dated July 2019. What is further extremely disturbing is the fact that the economic team leaders used the IMF focus on primary deficit instead of the budget deficit to ratchet up their reliance on hot money inflows (through a very high economically unviable discount rate) - a policy no longer supported by J Azour Director of the Middle East and Central Asia Department at the IMF who wrote (post-Coronavirus pandemic) in a blog uploaded on the Fund's website: "sharp spikes in global risk aversion and the flight of capital to safe assets have led to a decline in portfolio flows to the region by near 2 billion dollars since mid-February, with sizable outflows observed in recent weeks-a risk I underscored in a recent blog. Equity prices have fallen, and bond spreads have risen." He advised oil importing countries "should try to strike a balance between easing credit conditions and avoiding vulnerability to capital outflows, and, where possible, allow the exchange rate to cushion some of the shocks."
Pakistan's reliance on borrowing from domestic and foreign commercial banks that had surpassed borrowing in previous years is likely to rise significantly due to the virus as the country's political leadership attempts to grapple with the impact of the pandemic on the general public and the poor and vulnerable in particular.
The servicing costs for the current year indicate two disturbing elements. Firstly, the rupee was undervalued at the time the new economic team leaders agreed to adopt a market based exchange rate thereby raising debt servicing costs further. In January 2020, as per the SBP website, the rupee was undervalued by 3.5 rupees against one dollar. As each rupee loss to the dollar adds around 100 billion rupees to the treasury's cost of servicing debt this implies that 350 billion rupees additional would be required for debt servicing.
The SBP argues that the real effective exchange rate (REER) it tabulates monthly does "not suggest in any way an under valuation of the exchange rate and that SBP has not expressed any such view in its statements.....It is worth noting that while the concept of REER is simple, users often face difficulties in understanding its construction and interpretation. Often, appreciation or depreciation of REER is confused with the concept of currency overvaluation or undervaluation although these are two separate concepts. Neither can overvaluation nor undervaluation be deduced from comparing the numbers to 100...The REER number merely shows a comparison relative to the 'chosen' base year. The extent of exchange rate under/over valuation is computed through a medium-term analysis using sustainable norms for the current account balance, fiscal balance, demographic condition, debt, etc." Previous SBP governors have cited REER as a yardstick for determining the rupee valuation and if the new team is redefining REER then it needs to publicly acknowledge it and respond to the query as to why it continues to bother with this exercise at all.
Falling export orders, lower remittances, hot money outflows are further eroding the value of the rupee prompting the SBP to extend its support to the local currency. However in spite of the intervention the rupee continues to lose value vis a vis the dollar putting further pressure on debt servicing costs.
Secondly, if one takes out the rise in servicing costs in the current year's budget, grossly understated due to the Coronavirus by now, then the actual increase in current expenditure is 214,465 million rupees (2,343,910 million rupees in the revised estimates of last year to 2,558,375 million rupees in the current year). Given that the 190 billion rupee Ehsaas programme (including its largest component Benazir Income Support Programme) is subsumed in grants to others rather than under other than PSDP development expenditure as in the past it raises serious questions about the actual economies in the budget document. Expenditure items with higher allocations in the current year compared to the year before include: (i) pensions by 79 billion rupees, (ii) subsidies by 16.5 billion rupees, (iii) contingency payment of 115 billion rupees allowing for a small adjustment against expenditure allocations for Coronavirus of 1.2 trillion rupees.
Reduction in the budgeted current expenditure consists of 29 billion rupees lower non salary civilian government outlay which may or may not be achieved but on the face of it looks rather a challenge.
Public Sector Development Programme was raised by 200 billion rupees, no doubt more indicative of the past practice of the finance ministry to use it as a contingency fund of sorts by trimming it mercilessly as and when required, a need which has clearly arisen post-Coronavirus onslaught, while being able to appease the administrations' political considerations. However as far as slashing PSDP expenditure is concerned the window is no more than: (i) 234 billion rupees - 467.1 billion rupees authorized as of 27 March 2019 for PSDP out of the total budgeted 701 billion rupees; and (ii) 115 billion rupees contingency money. It is unclear how much of the brunt of the virus would be borne by the revenue collecting agency which has already suffered serious shortfalls relative to the unrealistic target agreed by our economic team leaders.
To conclude, there is an urgent need for the Ministry of Finance and SBP to come up with realistic projections of revenue and expenditure requirements for the rest of the year to be able to take more informed decisions for next fiscal year's budget, identify sources of generating additional revenue including borrowing from the domestic and international market, revisit the need to provide an indicative level to banks treasuries within which the rupee dollar parity would be free to fluctuate while ensuring that the rupee is not overvalued, and for the discount rate to reflect core as opposed to headline inflation and identify desirable foreign exchange sources shying away from reliance on hot money inflows.
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