The International Monetary Fund (IMF) staff-level agreement was reached with Pakistani authorities on 12 May 2019, a Sunday. By Thursday 16 May the State Bank of Pakistan's (SBP's) Governor, appointed only a week before on 4 May, whose appointment is the envy of most of his former Fund colleagues, implemented the market-based exchange rate mechanism, the first of two prior loan conditions he agreed on behalf of Pakistan's government.
The fact that the current account deficit has declined significantly cannot be attributed entirely to adopting the market-based exchange rate. Imports have declined considerably - from 5.49 billion dollars in July 2018 to 4 billion dollars in July 2019 or a difference of 1.49 billion dollars. The largest decline has been in petroleum products, to the tune of 815.731 million dollars - from 1.8 billion dollars in July 2018 to 987.9 million dollars in July 2019 or a decline of 45 percent. However the Saudi oil facility up to three billion dollars for three years has kicked in which implies that actual payment under this head has been simply deferred. In other words, 58 percent of the decline in imports in July is due to the deferred oil facility and not attributable to the IMF agreement signed by Messrs Sheikh and Baqir.
Machinery imports, sourced to China under the China Pakistan Economic Corridor, declined from 618.4 million dollars in July 2018 to 585.3 million dollars in July 2019 - a decline of 5 percent.
Food group, textile group and agri and other chemicals also suffered a decline in imports that can be attributed to the rupee depreciation as well as decisions taken by the Federal Board of Revenue (raising regulatory duties/customs).
On 22 May, the SBP implemented the second prior agreed condition by increasing the SBP's benchmark interest rate by 150 basis points to 12.25 per cent, effective from May 21. This decision was revealed through a press statement which warned of more increases to come: "The monetary policy committee noted that further policy measures are required to address underlying inflationary pressures from higher recent month-on-month headline and core inflation outturns, recent exchange rate depreciation, an elevated fiscal deficit and its increased monetisation, and potential adjustments in utility tariffs." And acknowledged the slowdown in the economy attributing it "mostly due to lower growth in agriculture and industry. More than two-thirds of real GDP growth in fiscal year 2019-20 expected to come from services. Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported programme." Disturbingly, there has been no improved market sentiment with exports rising marginally (factors like higher utility rates in relation to our competitors, high cost of borrowing and rising sales tax refunds which are expected to be dealt with by FBR policy to make refunds promptly out of its revenue stream) and industrial and small and medium enterprise output down due to high inflation and a contraction of the domestic value of each rupee earned.
In its meeting on 16 July the Monetary Policy Committee (MPC) decided to raise the policy rate further by 100 basis points to 13.25 percent maintaining that this "decision takes into account upside inflationary pressures from exchange rate depreciation since the last MPC meeting on 20th May 2019 and the likely increase in near term inflation from the one-off impact of recent adjustments in utility prices and other measures in the FY20 budget. The decision also takes into account downside inflation pressures from softening demand indicators. Taking these factors into consideration, the MPC expects average inflation of 11 - 12 percent in FY20, higher than previously projected. Nevertheless, inflation is expected to fall considerably in FY21 as the one-off effect of some of the causes of the recent rise in inflation diminishes."
Three major disturbing elements from the last MPC observations need to be highlighted. First, the one off impact of recent adjustments in utility prices referred to in the statement is as one off as the raising of the discount rate twice since 22 May. Utility prices are bound to rise not only when the international price of petroleum and products rise, an input into sizeable domestic power generation, but also as and when the government fails to generate the target revenue agreed with the Fund (5.5 trillion rupees) which, if past precedence is anything to go by, would lead the government to raise taxes on oil and products, the easiest and quickest way to generate money. The power sector, irrespective of extremely ambitious goals to eliminate the flow and then the stock of over 1.3 trillion rupee circular debt, continues to borrow with the rate of return passed onto the consumers though the recent intent to issue sukuk remains stalled as it would have surpassed the allowed government guarantee as a percentage of GDP.
Secondly, the 16 July statement notes that the "....MPC expects inflation to average 11 to 12 percent in FY 20. The MPC is of the view that real interest rates implied by these inflation projections and today's policy rate decisions are appropriate levels considering the cyclical weakening of aggregate demand." The inflation projection by the MPC is one percent less than what has been projected by the IMF as well as in the budget for the current fiscal year; however independent economists maintain that inflation may well be in excess of 15 percent in the current year on the back of geopolitical considerations especially with respect to conflict in the Middle East that would further fuel price of petroleum and products, emerging security concerns in the region particularly on our Eastern and Western borders as well as domestic political constraints. And of course the inflation cause in Pakistan on which the SBP has no control is the raise in customs and other indirect taxes on imports as well as domestic output to meet the Fund target which in turn would render products from across our porous borders very attractive for smuggling. In other words yet another rate raise maybe on the cards this month which would further raise capital costs for the private sector further compromising its capacity to be the engine of growth.
Thirdly, the three key developments in the July MPC statement are (i) a budget that seeks to credibly improve fiscal sustainability by focusing on revenue measures to widen the base. The SBP Governor and the Advisor to the Prime Minister on Finance, the two signatories to the agreement with the Fund, are perhaps the only two economists currently working in the country who are optimistic about achieving the tax target and this in spite of the fact that in the first month of the current fiscal year there was a shortfall of 14 billion rupees due to reduction in customs collections which in turn can be attributed to lower imports due to the rupee erosion - a reduction that was predicted given the adoption of the market based exchange rate; (ii) external financing has strengthened with the disbursement of the first tranche of the IMF's EFF however apart from other mulitlaterals accounting for less than 5 billion dollars pledged during the IMF programme duration the rest of the 38.6 billion dollars required during the next thirty nine months would have to be through government efforts. While a Fund programme normally does generate assistance/loans from other multilaterals yet given that the Fund required specific assurances of continued bilateral support (from friendly countries) before approving the loan this automatic support may not be available; and (iii) an inane MPC comment notably that on the international front the sentiment towards emerging markets, though Pakistan is not quite defined as one, has improved with greater expectations of a policy rate cut in the United States. President Trump is openly supporting a rate cut however it is unclear whether the Fed Chairman would support that call.
To conclude, the prior conditions agreed by Messrs Baqir and Sheikh have had limited success to date.