The government, after trying its hand at every other alternative and failing, has finally decided to implement the IMF's conditionalities for the revival of the ninth review. However, adhering to the Fund’s demands would require deeper fiscal consolidation and realignment of macroeconomic policies including, but not limited to the exchange rate.
On the revenue front, the imposition of additional taxes on petroleum products, on imports, and a tax on foreign exchange gains of banks is likely to be part of a mini-budget. Additionally, the rationalisation of the energy tariffs and depreciation of the rupee will likely add to the inflationary pressures.
As per a report by Arif Habib Ltd, “We believe, these measures are likely to get the program back on track and pave the way for the release of the next tranche of ~USD 1.2bn in Feb 2023. With the 10th review also due in early 2023 (1Q) - combining the two reviews remains a possibility though this may further delay the IMF disbursement."
“The government is set to bring a mini-budget where a tax of 1-2% flood levy will be imposed on imports. Our estimates suggest that this will help generate additional revenue of PKR 90-100bn in the second half of the ongoing fiscal year. In addition, additional tax to the tune of 40% will be imposed on Commercial Banks’ FX income, with collection arriving at PKR 48bn,” it further adds.
Yet, the resumption of the program wouldn’t be the end of Pakistan’s economic woes. At best, the inflows will buy the country a few months before it finds itself in a similar situation again.
However, before exploring what lies ahead, one needs to understand that Pakistan’s dire economic situation stems from the deeply rooted structural flaws in its economy. The country is not fully integrated into the global economy and continues to import key commodities like fuel while exporting low value-added items like textile and rice.
Further, domestic industries aren’t globally competitive and high consumption – low savings pattern continues to deprive the local market from much-needed investment. Add the irresponsive government spending to the mix, and we have a perfect recipe for disaster in the shape of a fiscal and balance of payment deficit.
As per a 2019 research paper, A Twin Deficit Hypothesis: The Case Study of Pakistan, “trade deficits directly cause the budget deficits, and the budget deficit influences the trade deficit through different channels. The most familiar linkage is causality flowing from budget deficits to inflation to rate of interest to capital inflows to exchange rate (currency appreciation) and finally the trade deficits. In order to reduce the pressure on currency (rupee) and avoiding the trade deficits, the policymakers usually focus on the devaluation as the policy prescription rather than proper channels of lessening the un-productive and non-developmental expenditures.”
This has been the case for as long as Pakistan has existed, but because of its ability (or luck) to seek geopolitical rent, the country has always stayed afloat. This time around, however, the equation has changed drastically as there is no war in the neighborhood nor is money being pumped in through projects like CPEC.
Therefore, currently Pakistan is facing a liquidity crisis and the expected inflows from the IMF and other lenders won’t be enough to meet the near-term obligations.
“We had further highlighted that current foreign exchange (FX) crisis was mainly driven by external debt obligations and not trade unlike Pakistan’s previous foreign exchange crisis of 2008. Therefore, that despite ongoing import controls, Pakistan’s FX reserves continue to dwindle to 9-year low at US$4.6 bn only as debt repayments continue to come due and are serviced,” read a report by Topline Securities.
The report further added, “Recent monetary policy announcement of Jan 23, 2023 underscores the need for debt restructuring as US$8bn of debt still needs to be dealt with in next 5 months till June 2023 while the country’s reserves are half of that. Even if the bulk of this amount is rolled over as the SBP is alluding to, the meter will again reset on July 1 when the rollovers will restart for FY24.”
What makes the liquidity crisis even worse is the fact that avenues of inflows like remittances and exports have been badly affected by flawed exchange rate policy and import restriction on key raw materials. While the State Bank has increased the policy rate and rate of return on Naya Pakistan certificates, to attract Hot Money flows, these aren’t going to be enough.
Therefore, the only way left is to actively seek a debt restructuring arrangement. “One way out of the debt repayment conundrum will be to convert short term rollover debt into medium-long term. To note, out of US$73bn debt repayment obligations for FY23-25, US$40bn is short term debt,” read the Topline Securities research report.
As per an article in the Financial Times, ‘’The primary goals of the debtor government are to obtain an IMF loan and survive to the next election. The primary goal of the IMF is stability during the 3-7 year IMF program period. The primary goal of the bondholders is to minimise their immediate losses. The primary goal of the official bilateral lenders is to push the problem into the future.”
“The primary goals of the main actors leads to insufficient debt relief, unsustainable debts over the long term, a continuing repeat of the crisis-debt restructuring cycle, economic stagnation and poverty,” it further adds.
(Read More: Mounting Debt And Lack Of Alternatives Calls For A Debt Restructuring Of Pakistan’s Economy. But Would It Be Possible?)
https://twitter.com/MuneebASikander/status/1616960108960923648
Further, in terms of domestic debt, which forms the primary portion of the country’s public debt, needs to be re-considered. “In case of Pakistan, it is relatively easier as over 75% of the holders are domestically licensed commercial banks. The government should look at progressive taxation of income from bills and PIBs, and also aim for maturity extension,” tweets Muneeb Sikander, economist and strategy consultant.
Dr. Arshad Zaman, former World Bank Economist, in an article for the Business Recorder, suggested six steps to restructure domestic debt. These include: (i) disaggregating debt stock, (ii) identifying exactly the domestic debt to be restructured and estimating the gross debt relief target (DRT) necessary to restore debt sustainability, (iii) deducting the associated fiscal costs (recapitalisation of financial institutions, subsidies, etc.) to achieve the net DRT, (iv) assessing the wider economic costs associated with restructuring, (v) ensuring that the State Bank of Pakistan, including the payments system, can operate normally throughout and (vi) determining which claims to restructure to minimize overall costs.
However, addressing the aforementioned issues and moving towards long term economic reforms will require serious deliberation from policymakers, who will be no doubt tempted to adhere to the status quo, given that the provincial elections are upon us, and the general elections are fast approaching.
On the revenue front, the imposition of additional taxes on petroleum products, on imports, and a tax on foreign exchange gains of banks is likely to be part of a mini-budget. Additionally, the rationalisation of the energy tariffs and depreciation of the rupee will likely add to the inflationary pressures.
As per a report by Arif Habib Ltd, “We believe, these measures are likely to get the program back on track and pave the way for the release of the next tranche of ~USD 1.2bn in Feb 2023. With the 10th review also due in early 2023 (1Q) - combining the two reviews remains a possibility though this may further delay the IMF disbursement."
“The government is set to bring a mini-budget where a tax of 1-2% flood levy will be imposed on imports. Our estimates suggest that this will help generate additional revenue of PKR 90-100bn in the second half of the ongoing fiscal year. In addition, additional tax to the tune of 40% will be imposed on Commercial Banks’ FX income, with collection arriving at PKR 48bn,” it further adds.
This has been the case for as long as Pakistan has existed, but because of its ability (or luck) to seek geopolitical rent, the country has always stayed afloat. This time around, however, the equation has changed drastically as there is no war in the neighborhood nor is money being pumped in through projects like CPEC.
Yet, the resumption of the program wouldn’t be the end of Pakistan’s economic woes. At best, the inflows will buy the country a few months before it finds itself in a similar situation again.
However, before exploring what lies ahead, one needs to understand that Pakistan’s dire economic situation stems from the deeply rooted structural flaws in its economy. The country is not fully integrated into the global economy and continues to import key commodities like fuel while exporting low value-added items like textile and rice.
Further, domestic industries aren’t globally competitive and high consumption – low savings pattern continues to deprive the local market from much-needed investment. Add the irresponsive government spending to the mix, and we have a perfect recipe for disaster in the shape of a fiscal and balance of payment deficit.
As per a 2019 research paper, A Twin Deficit Hypothesis: The Case Study of Pakistan, “trade deficits directly cause the budget deficits, and the budget deficit influences the trade deficit through different channels. The most familiar linkage is causality flowing from budget deficits to inflation to rate of interest to capital inflows to exchange rate (currency appreciation) and finally the trade deficits. In order to reduce the pressure on currency (rupee) and avoiding the trade deficits, the policymakers usually focus on the devaluation as the policy prescription rather than proper channels of lessening the un-productive and non-developmental expenditures.”
This has been the case for as long as Pakistan has existed, but because of its ability (or luck) to seek geopolitical rent, the country has always stayed afloat. This time around, however, the equation has changed drastically as there is no war in the neighborhood nor is money being pumped in through projects like CPEC.
Therefore, currently Pakistan is facing a liquidity crisis and the expected inflows from the IMF and other lenders won’t be enough to meet the near-term obligations.
“We had further highlighted that current foreign exchange (FX) crisis was mainly driven by external debt obligations and not trade unlike Pakistan’s previous foreign exchange crisis of 2008. Therefore, that despite ongoing import controls, Pakistan’s FX reserves continue to dwindle to 9-year low at US$4.6 bn only as debt repayments continue to come due and are serviced,” read a report by Topline Securities.
The report further added, “Recent monetary policy announcement of Jan 23, 2023 underscores the need for debt restructuring as US$8bn of debt still needs to be dealt with in next 5 months till June 2023 while the country’s reserves are half of that. Even if the bulk of this amount is rolled over as the SBP is alluding to, the meter will again reset on July 1 when the rollovers will restart for FY24.”
What makes the liquidity crisis even worse is the fact that avenues of inflows like remittances and exports have been badly affected by flawed exchange rate policy and import restriction on key raw materials. While the State Bank has increased the policy rate and rate of return on Naya Pakistan certificates, to attract Hot Money flows, these aren’t going to be enough.
Therefore, the only way left is to actively seek a debt restructuring arrangement. “One way out of the debt repayment conundrum will be to convert short term rollover debt into medium-long term. To note, out of US$73bn debt repayment obligations for FY23-25, US$40bn is short term debt,” read the Topline Securities research report.
As per an article in the Financial Times, ‘’The primary goals of the debtor government are to obtain an IMF loan and survive to the next election. The primary goal of the IMF is stability during the 3-7 year IMF program period. The primary goal of the bondholders is to minimise their immediate losses. The primary goal of the official bilateral lenders is to push the problem into the future.”
“The primary goals of the main actors leads to insufficient debt relief, unsustainable debts over the long term, a continuing repeat of the crisis-debt restructuring cycle, economic stagnation and poverty,” it further adds.
(Read More: Mounting Debt And Lack Of Alternatives Calls For A Debt Restructuring Of Pakistan’s Economy. But Would It Be Possible?)
https://twitter.com/MuneebASikander/status/1616960108960923648
Further, in terms of domestic debt, which forms the primary portion of the country’s public debt, needs to be re-considered. “In case of Pakistan, it is relatively easier as over 75% of the holders are domestically licensed commercial banks. The government should look at progressive taxation of income from bills and PIBs, and also aim for maturity extension,” tweets Muneeb Sikander, economist and strategy consultant.
Dr. Arshad Zaman, former World Bank Economist, in an article for the Business Recorder, suggested six steps to restructure domestic debt. These include: (i) disaggregating debt stock, (ii) identifying exactly the domestic debt to be restructured and estimating the gross debt relief target (DRT) necessary to restore debt sustainability, (iii) deducting the associated fiscal costs (recapitalisation of financial institutions, subsidies, etc.) to achieve the net DRT, (iv) assessing the wider economic costs associated with restructuring, (v) ensuring that the State Bank of Pakistan, including the payments system, can operate normally throughout and (vi) determining which claims to restructure to minimize overall costs.
However, addressing the aforementioned issues and moving towards long term economic reforms will require serious deliberation from policymakers, who will be no doubt tempted to adhere to the status quo, given that the provincial elections are upon us, and the general elections are fast approaching.