June Issue 2019
Tough Act to Follow
Pakistan has reached a staff level agreement with the IMF on a 39-month Extended Fund Facility (EFF) of $6 billion. However, the funding will only start flowing in after its approval by the Executive Board of the IMF. This is conditional on the fulfillment of a number of ‘prior actions’ and the understanding from creditors to Pakistan that repayments due on short-term loans or deposits with the State Bank of Pakistan (SBP) are rolled over.
An assessment of how ‘tough’ the programme will be, hinges on whether the implementation of the reform agenda is concentrated in the period of prior action, or in the first year of the programme. Although these actions have not been explicitly highlighted either by the government or the IMF, conclusions can be drawn from the IMF’s staff press statement and information that has emerged during the process of negotiations in Islamabad.
The reality is that Pakistan has been implementing the so-called prior actions since November 2018, when the process of negotiations commenced. The government may have dragged the process with the expectation that following the end of successful negotiations, there would be less need for prior actions. But, unfortunately, this is not the case.
During the current fiscal year, there has been a marked deterioration in the fiscal landscape. Tax revenues have shown little growth and the shortfall by the end of 2018-19 may approach Rs. 450 billion. Current expenditures, especially on debt servicing and defence, have grown very rapidly. The cutback in development spending has not been adequate to prevent the budget deficit from reaching the record level of Rs. 2900 billion or even more, equivalent to almost 7.5 per cent of the GDP.
During the recent negotiations, it is not surprising, therefore, that primary emphasis has been placed on stabilising the economy by a quantum reduction in the fiscal deficit. Through containment of aggregate demand, this would also result in a decline in the current account deficit in the balance of payments.
Consequently, the most important set of prior actions are to be incorporated in the Federal Budget for 2019-20, to be presented on June 11. Enough taxation proposals are to be included so as to generate additional revenues of Rs. 700 billion and increase revenues of the Federal Board of Revenue (FBR) by over 34 per cent in 2019-20.
The implied ‘toughness’ of the impending Federal Budget can be assessed by the fact that the highest growth rate in revenues in the last 17 years by the FBR was just over 20 per cent in 2015-16. This was a year of ‘windfall gains’ in sales tax revenues due to the plummeting oil prices.
Based on the phenomenal increase in tax revenues, the ‘primary’ deficit is to be reduced from the likely level of 2.4 per cent of the GDP in 2018-19 to only 0.6 per cent of the GDP in 2019-20. This is only possible if the target growth rate in tax revenues is achieved and, simultaneously, there is visible austerity in civil and military expenditures.
If the fund programme breaks down after the first one or two quarterly releases, then measures may have to be taken to prevent a default. This could include the imposition of a Financial Emergency, as per Article 235 of the Constitution, and a move to a national government and the preparation of a National Economic Plan with severe cuts in imports in the short-run. The saving grace is that a crisis may be the only way to push the country on the path of self-reliance.
The fundamental question relates to the economic and political feasibility of achieving the budgetary targets for next year. The economy is likely to show a real growth rate of only three to four per cent. As such, a growth rate of 34 per cent in tax revenues appears to be next to impossible. Further, the scope for heavy additional taxation, especially of powerful vested interests, is severely limited by the razor-thin majority of the PTI Government. Also, a heavy dose of additional indirect taxation may be the ‘last straw on the camel’s back’ as far as the people are concerned.
Therefore, the next weeks are fraught with great uncertainty. Meanwhile, following the end of the negotiations, the rupee has depreciated by another 6 per cent or so, the SBP policy rate has been raised substantially by 150 basis points to 12.25 per cent; a jump in petrol prices is in the offing; a 20 to 25 per cent jump in electricity tariff is pending and an even bigger increase is anticipated in gas tariffs. Along with the hike in taxes in the forthcoming budget, there is the unfortunate prospect of a jump in the rate of inflation to double-digit rate in the next few weeks.
The result is that the combination of low income growth, rising unemployment and high inflation will have very negative economic and social consequences. There are estimates that the number of unemployed and the poor may increase by 1 million and 4 million respectively in 2019-20. Already, in 2018-19, there has been a significant worsening in the economic situation.
What then are the prospects for Pakistan in 2019-20? The big question is whether the IMF will be willing to ‘soften’ the tough prior actions it has asked for. Hopefully, the IMF also has a vested interest in ensuring that there are no big ‘negative shocks’ to the economy. Pakistan’s external debt repayment capacity will need to be sustained so that the $1 billion or so due annually to the IMF from the previous EFF loan is paid on time.
However, there is a downside scenario as well. If the fund programme breaks down after the first one or two quarterly releases, then measures may have to be taken to prevent a default. This could include the imposition of a Financial Emergency, as per Article 235 of the Constitution and a move to a national government and the preparation of a National Economic Plan with severe cuts in imports in the short-run. The saving grace is that a crisis may be the only way to push the country on the path of self-reliance.