The IMF completed the penultimate (eleventh) quarterly review of the Extended Fund Facility to Pakistan recently. The cumulative loan from IMF under this programme has reached $6 billion. The Staff Report on the eleventh review has been released on the 5th of July 2016, soon after the end of the financial year, 2015-16.
The report has an optimistic perspective on the outcome in 2015-16 and on the outlook for 2016-17. Clearly, the IMF wants to declare victory as the three-year Programme comes to an end in September 2016. However, it must be recognised that the report does try to qualify the optimism by identifying several risk factors in the short- and medium-run. Also, it highlights the unfinished agenda of structural reforms which will need to be implemented beyond the Programme if the growth process is to be sustainable and inclusive.
Detailed comments on the review are presented below.
Higher Growth Rate of the GDP in 2015-16 despite major cotton crop failure, fall in exports and no big jump in investment
At the start of the financial year, 2015-16, the IMF Eighth Review had projected growth rate for the year at 4.5 percent. This was based on a growth rate of 8 percent in investment and export growth of over 2 percent. The eleventh review now projects that the outcome will be a smaller 5 percent increase in investment and a big decline in exports of over 9 percent..
Nevertheless, the IMF has opted to raise the growth rate in 2015-16 of the GDP from 4.5 percent to 4.7 percent in line with the Government's estimate. What are possibly the hidden factors which may have contributed to the higher growth? Is it higher CPEC infrastructure investments? However, these aggregate to less than 0.2 percent of the GDP in 2015-16. Is it a boom in construction activity? Here also, according to the PBS, investment in housing has increased in 2015-16 by only 4 percent. Clearly there is need for the IMF to explain the upward revision in its GDP growth rate estimate for 2015-16, when independent estimates are that it is between 3 and 3.5 percent only.
Inflation could be higher in 2016-17 due to monetary overhang, higher oil prices and a low base effect
The IMF projects the inflation rate in 2016-17 at 5.2 percent. It could be significantly higher due to, first, a strong monetary overhang with almost 28 percent increase in currency in circulation and 27% growth in reserve money, second, because of the large 37 percent increase in the global price of oil last quarter and the possibility of further increases and, third, due to a low base effect of low inflation in 2015-16. It is possible that the rate of inflation may approach the average of 7 percent in 2016-17.
Budget deficit of 4.4 percent of GDP in 2015-16 is possible only with significantly lower PSDP spending.
The MoF reported in the budget documents of 2015-16 to the Parliament a combined PSDP spending of the Federal and Provincial Governments of Rs 1393 billion. The IMF has since been informed that the actual development spending is Rs 1040 billion. This implies a more or less, last minute cutback of 353 billion, equivalent to 25 percent. It is important that such inconsistency in reporting be avoided.
Budget deficit target of 3.8 percent of GDP in 2016-17 will also imply much lower size of PSDP
The budgets presented by the Federal and Provincial Governments target a total PSDP of Rs 1840 billion in 2016-17. However, according to the IMF, limiting the consolidated fiscal deficit will require restricting the overall size of the PSDP to 1236 billion, over Rs 600 billion less than budgeted. This highlights the restricted `fiscal space` today for achieving higher economic growth in Pakistan by pushing up the level of development activity.
Inconsistent estimates of inflows from Coalition Support Fund
The IMF reports Federal non-tax revenues of Rs 823 billion in 2015-16. These include Rs 170 billion of defence receipts (from the CSF). But in the balance of payments statistics, IMF indicates CSF receipts at $937 million (Rs 97 billion). Therefore, non-tax revenues have been overstated by Rs 73 billion. This implies that the fiscal deficit is higher by over 0.2 percent of the GDP in 2015-16.
Similarly, the CSF inflow is also potentially overstated in 2016-17. The IMF includes Rs 171 billion as the CSF inflow in projected non-tax revenue but about Rs 100 billion ($900 million) in the balance of payments. This implies that the fiscal deficit could approach 4 percent of the GDP in 2016-17. It could be even higher as inflows of even $900 million in 2016-17 from CSF are uncertain at this time.
Big decline in official project and programme assistance in 2016-17
The government has highlighted in its budget documents that gross bilateral and multilateral project and programme assistance will decline from $6 billion in 2015-16 to $3.2 billion in 2016-17. Almost $3.5 billion will have to be raised externally by flotation of bonds and borrowing from commercial banks.
However, the IMF balance of payments projections ignore this likely development. As much as $8.7 billion is estimated to become available from official sources in 2016-17. This is over 140 percent above the projection by Government. The IMF also assumes that there will be no flotation of bonds in 2016-17.
The bottom line is considerable uncertainty about the level and nature of external borrowing in 2016-17. If the full targeted amount does not materialise then foreign exchange reserves could come under pressure.
Budget Projections for 2016-17 do not incorporate costs of the agriculture relief package and salary hike
The IMF has largely accepted the Government budget estimates on current expenditure at the Federal level. However, no provision has been made for the cost of the agricultural relief package of Rs 50 billion and of Rs 57 billion due to the salary hike. This will take the fiscal deficit to the even higher level of 4.3 percent of the GDP.
Further, the same level and pattern of salary increase has been granted by the four Provincial Governments in 2016-17 and an agricultural package of Rs 50 billion by the Government of Punjab. As such, generation of a combined cash surplus of 1 percent of the GDP by these Governments looks unlikely.
Revenue target of FBR is ambitious
The IMF has endorsed the FBR revenue target of Rs 3621 billion for 2016-17, representing a growth rate of 17 percent. But this does not allow for the payment of outstanding sales tax refunds by end-August 2016. Also, the sales tax per liter of petroleum products is tending to fall as international prices rise. Further; a growth rate of 21 percent in direct taxes is unlikely. As such, the FBR revenue target looks ambitious.
Direct tax expenditure is substantially understated
The IMF has accepted the Federal tax expenditure estimates given in the Pakistan Economic Survey of 1.3 percent of the GDP. These include only 0.2 percent of the GDP as the cost of exemptions and concessions in income tax. According to the estimate by the World Bank in 2014, tax expenditure in income tax is substantially higher at 1.2 percent of the GDP.
Major tax expenditures in direct taxes which have not been included in the PES/IMF estimate are the revenues foregone due to accelerated depreciation allowance, limited coverage of capital gains on shares and property, concessionary tax rate on export income, regional/sectoral tax holidays, tax deduction against loan provisioning by banks, various personal tax deductions and so on. Most of these provisions benefit the rich and powerful.
The IMF has rightly supported the reduction of SROs in indirect taxes. But the elite is largely immune from any pressure for elimination of tax concessions to them. This is yet another reason why the country's tax system has become more regressive over time.
The VAT features of the General Sales Tax have been badly affected
The Eleventh Review report claims that the Authorities aim to modernise the GST regime on goods and services in close co-ordination with the Provinces. In fact, the opposite has happened in the Budget of 2016-17. The federal government has taken unilaterally the decision not to accept the input tax invoices of services in the Provincial tax base against the GST on goods. The consequence is 'cascading' of the tax burden on goods. If the Provinces retaliate by not honouring input tax invoices of goods in services, this will then contribute to further increase in the tax rate by up to two percentage points of the GST from 17 percent to 19 percent.
The other move is the ingenious method devised by FBR to zero-rated exports of five sectors without the need for refunds. This is to be achieved by exempting input into these sectors from sales tax. This mechanism is potentially subject to leakages. Also, a 5 percent non-invoiceable GST has been introduced. One such case is fertiliser. In fact, this is one item which is subject simultaneously to taxation and also enjoys a subsidy. This again testifies to the creativity of FBR.
The balance of payments position is increasingly fragile due to a large number of risk factors
The IMF review has rightly identified a number of risk factors including further appreciation of the already 20% overvalued rupee due to the rising dollar; lower growth in China and the GCC affecting exports and remittances; lower non-China foreign direct investment; faster-than-expected rise in oil prices; growing debt repayment obligations and profit repatriation related to the CPEC; political uncertainty and security conditions.
The list is actually even longer. It includes uncertainty about inflows from the CSF; implications on exports, remittances and grant assistance due to Brexit and growth in imports of LNG and coal for new power projects.
It is indeed a relief to see that despite the above risk factors, the IMF expects the foreign exchange reserves to continue increasing to almost $23 billion by 2019-20, compared to $18 billion currently.
External debt and external financing needs will rise exponentially
The IMF has revised upwards its projections of the external debt of Pakistan in the latest review. It is now likely to reach $88 billion by 2018-19 from the present level of under $72 billion. This is a conservative estimate as it is based on relatively limited borrowing for the CPEC projects from Chinese banks. It could exceed $93 billion in 2018-19 if the proposed big expansion in power generation capacity is to be achieved. At this level, external debt could exceed 300 percent of exports by 2018-19.
Simultaneously, external financing needs are expected by the IMF to rise exponentially from $7.3 billion in 2015-16 to $15.1 billion in 2018-19. These amounts are needed to finance the current account deficit plus amortisation of external debt. The financing needs could be even larger. The big question is whether gross external borrowing and foreign non-debt creating inflows will be adequate to cover these large financing needs.
Overstatement of improvements in the power sector
The IMF commends the Government for major improvements in the power sector including a decline in power blackouts and distribution losses, enhancement in tariffs and introduction of surcharges. Consequently, the tariff differential subsidy has been reduced substantially.
The State of Industry reports by Nepra reveal a different story. Despite much hype, electricity generation capacity has expanded by 4 percent only between 2012-13 and 2014-15. Distribution losses have remained, more or less, unchanged at 20 percent up to 2014-15. The electricity consumption per industrial consumer is up by only 1 percent annually between 2010-11 and 2014-15. This is unlikely to have eliminated load shedding fully in the industrial sector.
The billing recovery rate has remained stagnant at 89 percent. In one year, 2014-15, arrears in payment were as high as Rs 123 billion. Tariff increases have been largely neutralised by the appropriate policy of NEPRA to transfer the benefit of lower fuel costs to consumers through negative fuel charges adjustment on a monthly basis. Consequently, the circular debt has continued to accumulate and currently stands at over Rs 650 billion. No concrete plan has been put in place to retire this debt.
Pending agenda of structural reforms remains wide ranging after the end of EFF
The IMF has rightly emphasised that many structural reforms remain to be implemented. These include broadening the tax base and elimination of tax expenditures in income tax; restructuring and/or privatising loss-making public sector enterprises; completion of energy sector reforms; implementation of business climate reform and a reduction in costs of doing business.
Other necessary reforms which have not been emphasised by IMF upfront are full implementation of the 18th Amendment; finalisation of the 9th NFC award; achieving greater economy in non-salary expenditure and full autonomy to the SBP and other regulatory agencies. Prime importance must be placed on design and implementation of an effective Trade Policy for at least doubling exports by 2020-21. Otherwise, the sustainability of external debt will be doubtful.
In conclusion, the IMF must be thanked for its sympathetic approach to monitoring performance under the EFF. This was not the case in previous programmes, especially in the decade of the 90s. Over twelve waivers have been given by the Executive Board of IMF in eleven reviews. However, based on the above risk factors, there remains the possibility that the incoming government in 2018 after the elections may have to invite back the Fund once again.
(The writer is Professor Emeritus and former Federal Minister)