IMF's optimism

Pakistan has been able to get access recently to the IMF's Rapid Financing Facility in light of the adverse impact of the Covid-19 on the 'lives and livelihoods' of the people in the country. This quick support from the IMF must be appreciated. The amount received is $1.4 billion, equivalent to 50 percent of the SDR quota of Pakistan. It can also be used in the form of budgetary support.

The inflow from the IMF has partly compensated for the large and very fast outflow of 'hot money'. The amount received in the form of investment in short-term treasury bills was over $3.6 billion. By the end of April, almost $2.9 billion had exited from Pakistan.

The consequence had been a visible dip in the foreign exchange reserves from $12.8 billion at the end of February 2020 to $10.9 billion by the middle of April 2020. Following the receipt of the IMF loan, reserves are back to $12.1 billion. The rupee which had depreciated by almost 9 percent in the immediate aftermath of the epidemic has recovered most of its lost value.

However, there remains some lack of clarity about the status of the program with the IMF of over $6 billion under the Extended Fund Facility (EFF). The IMF Executive Board was expected to review the case for release of the second tranche linked to the successful completion of the Second Review. But this has not happened and the EFF to Pakistan is effectively in a state of suspension.

The result of this suspension is that there will be no release of the second and third tranches until after June 2020, probably after the presentation of the Federal Budget for 2020-21. Therefore, in effect, Pakistan has received only approximately $500 million extra from the IMF up to June 2020, as each tranche is of $450 million.

The IMF Staff have prepared a report on the request for purchase under the Rapid Financing Instrument along with a statement by the Executive Director for Pakistan. This statement highlights the fact that 'the economic situation in Pakistan has changed dramatically and the external and fiscal position of the country has come under stress. Therefore, while the authorities remain committed to the policies and reform agenda agreed under the EFF, the sudden and massive impact of the pandemic has understandably shifted their near-term priorities more towards combating the pandemic'. The statement also recognizes the urgent need to increase public spending to contain the outbreak and support the economy.

The Staff Report also contains projections of the likely economic outcome in 2019-20 and the medium-term projections up to 2024-25. This includes the projections of the macroeconomic framework, balance of payments, general Government budget and the monetary survey.

The primary objective of this article is to assess these projections. Do they adequately reflect the negative macroeconomic impact of COVID-19 in the last quarter of 2019-20 and the consequential changes in the earlier projections for 2019-20 by the IMF? How do they capture the speed of recovery subsequently? These projections are important because they could become the basis for setting of future performance criteria following the resumption of the EFF.

The short-term projections for 2019-20 by the IMF Staff do partly reflect the large negative consequences of COVID-19. First, the GDP growth rate is likely to fall to a negative 1.5 percent in comparison to the original projection of a positive 2.4 percent. In effect, this implies that the GDP will fall massively in the last quarter of 2019-20 by over 13 percent. Second, the inflation rate projection has been reduced from the average of 11.8 to 11.3 percent for 2019-20. Third, a big drop is also seen in private investment.

However, the tendency towards optimism is visible in the balance of payments and budgetary projections for 2019-20. In particular, the issue is with the expected magnitude of the drop in exports and remittances in the last quarter of 2019-20. The anticipated drop in exports by the IMF staff is 11 percent. First indications are that it could even exceed 40 percent. Consequently, the current account deficit for the year could be higher by almost $1.8 billion.

Further, for reasons that are not clear, inflow of assistance to the Government in the financial account of the balance of payments is expected to go up from $2.3 billion in the fourth quarter of 2019-20 to over $11 billion, an increase of 379 percent. Some of it reflects the net additional inflow of $500 million from the IMF in the 4th quarter. However, at a time when inflows into developing countries are falling, the question is where are the large inflows to Pakistan going to come from?

The result is that the IMF staff projections indicate that at the end of June 2020 the foreign exchange reserves will be in a relatively comfortable position at over $11 billion, equivalent to a reserve cover of 2.7 months of imports. However, if exports fall more or inflow of assistance is lower, then Pakistan could be at a near crisis level with reserves below $8 billion, providing import cover of less than two months.

The same optimism has been displayed in the government budgetary projections. There is, of course, the recognition that the budgetary position would be significantly affected by the big contraction in the tax bases and the resulting loss of tax revenues in the last quarter of 2019-20. However, it is not clear if the fiscal and monetary implications of the existing and proposed relief interventions have been taken fully into account.

The total public expenditure is expected to be only 0.2 percent of the GDP higher than the original pre-Covid-19 projection. The level of national PSDP spending, in particular, is expected to be lower by Rs 484 billion. Federal development spending has been projected at Rs 488 billion when releases of over Rs 560 billion have already taken place. Further, grants and subsidies are expected to be higher by Rs 297 billion only when the budgetary impact of the relief interventions has been estimated by the IMF staff at almost Rs 500 billion. Therefore, the likelihood is that the budget deficit could approach 10 percent of the GDP in 2019-20 as compared to the IMF projection of 9.3 percent of the GDP.

The IMF Staff projections for 2020-21 are even more optimistic. They indicate a very sharp process of recovery in the economic growth process in the country, big moves towards stabilization of the economy and significant rise in foreign exchange reserves.

This picture of emerging trends is in sharp contrast to the perception of the economy of Pakistan being relatively more vulnerable to financial crisis. It also runs counter to global projections by multilateral agencies that negative economic growth, decline in world trade and high unemployment will persist till the end of 2020 and possibly even thereafter for some more time.

The first questionable projection is that the GDP growth will rise from a negative 1.5 percent in 2019-20 to a positive 2 percent in 2020-21. As highlighted above, the last quarter of 2019-20 is likely to witness negative GDP growth of over 13 percent. With the world economy in a state of recession, Pakistan's exports are likely to remain depressed. Further, private investment will remain shy, both domestic and foreign, and private consumption spending constrained by the high level of unemployment. It is more likely that negative growth of the GDP will persist for at least the first two quarters of 2020-21 and that the GDP increase in 2020-21 could be near zero or even marginally negative.

The inflation rate has been projected at 8 percent in 2020-21. It has already fallen to 8.5 percent by April 2020. Further, there has been a big precipitate drop in domestic oil prices. The rate of inflation is likely to be significantly lower in 2020-21 also due to the overall depressed level of aggregate demand in the domestic economy (especially owing to a crippling of private investment and consumption) and continuation of low import prices. It will, therefore, not be surprising if the rate of inflation falls to between 5 and 6 percent in 2020-21.

The degree of optimism is even more pronounced in the balance of payments and government budget projections for 2020-21. First, exports are projected to increase by almost 5 percent despite the lack of buoyancy in world trade, and the private sector's own estimates of the contraction of its exports. Exports of textiles, leather and products, sports goods, etc., are expected to continue declining by at least 40%, going by projections of orders and estimates of future capacity utilization.

Second, the IMF staff projection anticipates that remittances will stop falling sharply and stay, more or less, at the same level as in 2019-20. This will be despite the sharp decline in oil prices and the associated compression in spending on infrastructure projects or on the maintenance of existing setups (a significant number of Pakistanis have already lost their jobs in Saudi Arabia and the Gulf states).

Third, foreign direct investment is expected to rise by almost 30 percent in a highly uncertain environment. Overall, the current account deficit is projected to increase by only $2 billion but somehow the financial account inflow will rise by 17 percent and lead to an overall balance of payments surplus of $2.5 billion and with the resumption of the IMF EFF, foreign exchange reserves will jump to $15.6 billion, equivalent to 3.3 months of imports by June 2021. This will happen despite the drying up globally of outflows to developing countries and in the case of Pakistan an exponential increase in debt servicing liabilities next year, unless, of-course, there are large rollovers of the debt servicing obligations due in 2020-21.

The outlook for the Government budget of the IMF staff is also similarly sanguine. Tax revenues are expected to show unprecedented growth of 34 percent despite nominal GDP growth optimistically of 10 percent. This will imply additional taxation of Rs 800 billion in the forthcoming budget. Whatever residual life there is left in the economy will be crushed. No lessons are being learnt from the experience of over-targeting tax revenues in 2019-20 even prior to COVID-19.

Simultaneously, non-debt servicing related Federal current expenditure is projected to actually fall by 3 percent, contrary to the expectation of the IMF Executive Director. The interest rate on domestic debt is expected to remain high at close to 11 percent. Clearly, the IMF staff does not see any significant relief interventions, either on the fiscal or monetary side in 2020-21, not even in the initial months of the year. Consequently, the amount for grants and subsidies combined has been reduced by 18 percent in 2020-21.

Overall, the budget deficit is expected to fall by almost 3 percent of the GDP and the primary deficit by 2.5 percent of the GDP; seemingly even after accounting for the power sector obligations for capacity payments and 2019-20s unpaid liabilities pertaining to the circular debt which are overdue and need settlement. All the above projections by the IMF staff are clearly well beyond the realm of possibilities.

What could be the motivation for such projections which, more or less, completely ignore the potentially large and lingering negative impacts of the Covid-19? One possible explanation is that the projections have been consciously kept on the positive side to create the perception in the IMF Executive Board that Pakistan remains creditworthy and that the risk in approving emergency assistance to the country of $1.4 billion is not worrisome.

Also, the projections may have been made as a bargaining ploy to compel the Authorities in Pakistan to undertake strong and wide-ranging reforms even in a difficult economic environment to achieve ambitious targets as part of the Program under the EFF following its resumption.

The unfortunate consequence of these optimistic projections for 2019-20 and 2020-21 is that they may convince the international community and the multilateral agencies that Pakistan does not warrant any further special support for Covid-19 relief, post-relief stimulation or debt relief. This runs counter to the appeal by the Prime Minister that Pakistan needs sizeable debt write off or deferment of its external debt repayment commitments at this time.

(The writers are former Federal Minister and Governor of the SBP, respectively)