After a tumultuous week following the staff level agreement for an IMF program, rudimentary signs have started emerging for a stable macroeconomic framework. Since the start of the week, the stock market is not only calm it has signaled a cautious welcome to the program. Despite a larger than expected adjustment of 150 pbs in the policy rate on Monday, the market showed a robust rally on Tuesday and gained an impressive about 1200 points, which were further consolidated on Thursday. The market values were up more than 6%.
To be sure, there may still be many ups and downs, but most likely, the march would be toward stability as the program has brought clarity and direction in government's economic policy. A shot in the arm was the announcement of Saudi oil facility on deferred payment basis worth $3.2 billion for three years. This would go a long way in easing the balance of payments (BOP) outlook as it would allow reserve build up which would be a critical target of the program. What was noticeable was the broad-based welcoming messages issued on the occasion by all the important leaders of the government. At a time when government looked a bit confused and unsure of getting into the program, an unqualified assertion that the oil facility will help lessen BOP difficulties would build market confidence. These leaders should also come forward and make similar statements about the Fund program and exhort people that the painful initial actions would pave the way for much needed reforms in the economy for realizing its true potential.
It may also be pointed out that a long process of reforms has yet to start. The new budget would be the occasion when these measures would be announced. On the other hand, the new economic data released in past few days paints an awful picture of the state of economy; the repair job would be messy and painful. Let us briefly review the two key pieces of information namely fiscal data for nine months and BOP numbers for ten months.
The fiscal data reveals that the country is all set to register perhaps the worst fiscal year in several decades. The nine-month deficit was recorded at 5.0%, which is unprecedented in nearly three decades. How does this compare with last year for the same period. Last year, the nine-month deficit was 4.3%. If we assume the same final outcome for this year, as for last year, after nine-month performance, then an additional 2.3% deficit was incurred in the fourth quarter to take the total deficit to 6.6%. If we add the same amount of marginal deficit for the last quarter, the deficit for the year would be 7.3%. However, there are estimates that go as high as 7.6%, which look more credible given the recent hike in the policy rate and phenomenal correction in SBP borrowing that was witnessed as the government picked up Rs 3.1 trillion in TB auction on Tuesday at a fantastic rate of 12.75%, a full 150 bps higher than the last auction.
Based on these numbers one can also gauge the extent of fiscal adjustment that would be required under the first year of program. Unlike in the past, the IMF has envisaged adjustment of primary deficit (PD) rather than the overall deficit. The press release indicated that the PD would be brought down to 0.6% of GDP. Last fiscal year, the PD was 2.2% of GDP. With a higher deficit, would the PD also rise. There is no guarantee for this to happen since the PD depends on interest payments, and with rising interest payments, PD would not be necessarily increasing. If, therefore, we assume the same level, an adjustment of 1.6% would be needed. In our view this is a fairly accommodating condition. This translates into a fiscal adjustment of Rs 720 billion (at a GDP of Rs 45 trillion). Much of this, if not all, has to come from tax measures. Accordingly, the next budget would be tough.
We now turn our attention to balance of payments (BOP), where current account has improved by 27% (or about $4.3 billion), which has declined from $15.8 billion to $11.5 billion. It is now for some time that this outcome is exhibited as a major achievement of economic policy. Let's examine how realistic is this claim. The improvement in current account is from three sources: remittances ($1400 million), reduction in imports of goods ($2300 million) and import of services ($1750). These gains were partly tempered by a significant reduction of $1473 million in the foreign direct investment.
We make the following observations: First, and evidently, as the mainstay of BOP is trade account, we see highly tentative signs of any significant adjustment in imports, whereas exports are down 2% (this should be an eye opener for those who favor devaluation for export promotion). Second, these modest gains in imports reduction could well be due to price adjustments (oil prices had massively declined at the beginning of the year before recovering to present level) rather than the more desirable quantitative adjustment. Third, the dollar-GDP has declined because of massive devaluation. Consequently, as percentage of GDP, CA has not undergone the same level of reduction as one would like. Finally, the protagonists of improved BOP performance think that BOP is a separable box in the macro framework with no response and feedback mechanism. This is not true. The fiscal deficit, discussed above, is the primary cause of the weak BOP. Unless one achieves a major reduction in fiscal deficit, there is not hope that BOP would become manageable anytime soon.
The upshot of our discussion is that there are nebulous signs of economic recovery but the dangers lurking in the background are fearsome. If on the one hand, the government should work to inspire people's confidence in the program, it must keep them fully abreast of more difficult measures that would soon be unfolded. The economic data has shown that economic conditions obtaining at the beginning of the program are precarious and their correction would require concerted efforts and sacrifices by all sections of the society.
As we have been stressing now for some time, communication with people, markets, business and investors has to be a policy in itself. The prime minister should address the nation and give them the rationale behind his decision to go for the program. He should give hope to the people that after a series of painful measures, they can expect an economic turnaround where inflation would be tempered and growth would be revived.
(The writer is former finance secretary)
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