This is the first of a two part series analyzing the IMF third staff report as well as the Letter of Intent submitted by the government. Next week's article would focus on provincial surplus as a means to meet the budget deficit target and new structural benchmarks agreed by the government and their likely impact on sectors and the general public.
The third International Monetary Fund (IMF) staff review was uploaded on its website and immediately created a furore with three distinct points of view: the report is favourable to the one-year performance of Ishaq Dar at the helm of the Finance Ministry, the report is at par with those released by the IMF staff in the first year of a new programme loan by the perennial borrower Pakistan, and the report indicates we are worse off than before. Needless to say publicly at least PML-N and the opposition is on either end of the spectrum while economists claim that the performance has been at par with the first year of an IMF programme.
But what does IMF really think about the economy? Prior to responding to this query it is relevant to note that none of the multilaterals are in the business of embarrassing a government or challenging its data with the overarching philosophy to remain engaged with a time-bound reform agenda with the debtor nation. It is only complete disengagement with the reform agenda after several notices by the Fund staff that lead to the suspension of a programme as Pakistan experienced in 2010. Be that as it may, the Fund staff - in its third mandatory review under the 6.64 billion dollar Extended Fund Facility approved by the IMF Board in September 2013 - was compelled to challenge the growth data that the Federal Finance Minister Ishaq Dar insists on to this day. The IMF third review states that the economy showed signs of improving with a 3.3 percent growth rate instead of the earlier projection of 3.1 percent. Much has been written on the Dar-led Pakistan Bureau of Statistics (PBS) maintaining an implausible growth rate of 4.4 percent of Gross Domestic Product (GDP) - a growth rate that can easily be challenged. It is relevant to note that the IMF's growth estimate is based on later data with the third staff review report dated July 2014 while the PBS data is for the first nine months of the year. One example of why projecting the growth rate for the first nine months onto the entire year may not be appropriate is that of large-scale manufacturing (LSM), which registered a growth rate of 4 percent for the first nine months of 2013-14 but independent research indicates that in February and March there was negative growth in this sub-sector; it is not yet known whether the negative trend continued for the remaining three months of last fiscal year.
The recently-released World Bank report titled Doing Business Report 2014 lowered Pakistan's ranking in ease of doing business from 106 in 2012-13 (the last year of the PPP-led coalition government's tenure as well as the three months of the caretakers) to 110 in 2013-14. Frequent claims by the incumbent government that promoting private sector is its forte and that business activity has picked up since it took over the reins of government in the first week of June 2013 can therefore be legitimately disputed.
The World Bank's Doing Business Report 2014 and local reports that have not been contradicted by the government indicate that the country performed very poorly in terms of improving electricity supply in 2013-14 relative to 2012-13. The World Bank in its third review rated supply 3 points lower than the year before - from 172 ranking in 2012-13 to 175 in 2013-14. It has recently surfaced that the two projects that Prime Minister Nawaz Sharif himself inaugurated amid much fanfare are not generating any electricity: Nandipur because its generation cost is as high as 22 rupees per unit, and the economic rate of return does not justify production, while Guddu developed a technical fault in the turbine a few days after Prime Minister Nawaz Sharif inaugurated the plant. Demand as is the norm each year rose by 800 MW last year - data which explains why loadshedding duration has increased during first year of the Nawaz Sharif administration. In addition the IMF staff review also points out that foreign direct investment "continued disappointingly weak." This factor alone would account for lower industrial output thereby rendering the government-determined growth rate even more suspect.
The balance of payment position has improved, the IMF report acknowledges, boosted by bilateral inflows, including grants (and one would assume this latter addition relates to the 1.5 billion dollar gift by the Saudis though Ishaq Dar refused to discuss either the modalities of the gift, if any, in parliament or to clarify why the donor country was so reticent about the parliament being informed of its largesse), Eurobond issue and official disbursements from development partners. But the IMF qualified Ishaq Dar's euphoria by making two rather disturbing statements. First that the bullet structure of the Eurobonds (defined as fixed coupon bullet securities) has been widely used because of their secondary market liquidity but it increases repayment and rollover risks. Secondly, the IMF urged the government to publicly announce the intended use of these bonds especially if the purpose of the bond issuance is to fund projects, budget support, or increasing the efficiency of the local yield curve by benchmark securities. The June 2014 budget speech was silent on this.
Inflows, the IMF report, maintains, contributed to the rupee appreciation by almost 7 percent during the third fiscal quarter despite accelerated spot market purchases by the SBP. The report recommends that greater willingness to accommodate downward exchange rate flexibility could play an important role in accelerated reserve accumulation while helping boost exports over time; and adds that "authorities do not share staff's view that the exchange rate is somewhat overvalued and place greater priority on the nominal exchange rate stability." Unfortunately, both the Prime Minister and the Finance Minister have declared that the rupee would not be allowed to slide beyond 100 to a dollar. And in spite of these inflows as well as the rupee appreciation the report adds that "the reserve position remains insufficient, covering less than two months of imports". The current debt profile: from short-term domestic financing and borrowing from the SBP to longer term domestic bond and external financing. This policy would enamour few nationalists or economists if one refers to the caution in the IMF report namely costs of repayment may rise as well as rollover risks.
And finally a look at the risks highlighted by the Fund: (i) balance sheets of commercial banks are highly exposed to public sector (representing 46 percent of bank's total assets and included in this is around 400 billion rupees of circular debt cleared on the 29th June, 2013 by Dar - a debt that has since resurfaced); (ii) external vulnerabilities include low reserves in spite of recent improvements, oil price volatility in the international market, which could also impact on remittance inflows and a weakening global economy with implications on our exports; and (iii) security conditions are challenging and the IMF has added street violence and urban criminal activity to the terrorist threat but this critical sector has not received sufficient funding and reform efforts either at the federal or the provincial levels have therefore been compromised.