Pakistan’s economy: False comfort

A full-blown economic crisis may well be not too far down the road.

It seems that one reason why Pakistani authorities seem so glib and nonchalant about reviving financial relations with the IMF (and other external donors) is the false comfort that is being derived from a balance of payments position that was in surplus in December 2010 and the rising level of foreign exchange reserves, which now provide a reserve cover equivalent to about five months of projected imports. Experience teaches, however, that a seemingly comfortable cushion of reserves can vanish with astonishing speed. Global prices for food and oil are beginning to surge, reminding us of Pakistan’s last balance of payments crisis in 2008. With no agreement on a pass-through mechanism for oil prices in Pakistan and oil prices in world markets headed higher, Pakistan’s fiscal deficit and import bill are set to soar, the former because of oil subsidies and the latter due to the rising unit price of oil. It is true that exports and workers’ remittances have performed exceptionally well so far and reimbursements from the Coalition Support Fund have also helped shore up the external position. However, it is not clear whether these favourable developments will be sustained in the remaining five months of 2010-11 and beyond, and/or whether they will be overwhelmed by adverse developments on the fiscal and import front. Should the latter transpire, we could see a repeat of the economic cataclysm experienced in 2008.

A small IMF mission has come and gone. News reports say the mission failed to persuade our worthy representatives on the urgent need for fiscal reforms. The mission members met with the prime minister and he informed them that the government was following its reform agenda. One wonders who wrote that brief because it seems that the government has decided to do nothing until the budget for 2011-12. Meanwhile, as the media reports it, the IMF has demanded additional measures, including the removal of exemptions and concessions, which have been doled out to the powerful and well-connected over the years. Removing these exemptions, variously estimated to cause a revenue loss of approximately Rs150-200 billion does not require approval of parliament and can be done through a notification. In any event, this is not an additional demand of the IMF; these are the same exemptions which were to be removed as part of the RGST and, to some observers, was the genesis of the opposition to the RGST since it included, removing the tax exemption on agriculture inputs.

Even if this were to happen, it is unlikely that the IMF staff would recommend to the body’s executive board that the next tranche of the stand-by arrangement be released. The board would want to see a more comprehensive and well-articulated set of reforms not only on the fiscal side but also with respect to public enterprises, the power sector, improving governance and embarking on a clear path to resolving the interlocking problem of circular debt. A piecemeal approach will simply not fly.

This recurring pattern of ‘start-stop’ adjustment, which has sadly been the hallmark of our relations with the IMF grievously hurts the economy. Not only does it cause a loss of reform momentum, it dissipates any benefits that reforms may have conferred. The government loses credibility and market confidence is diminished invariably, resulting in a downgrade of our debt, as has happened recently. This downgrade elevates country risk which manifests itself in higher spreads. Just recently, plans for the Oil and Gas Development Corporation to float a bond in the international market have been put on hold in light of widening spreads. Confidence, once lost, is painfully difficult to regain.

While one may have reservations about whether it is apt to describe the economy as being in ‘crisis’ at present, as most economic analysts suggest, a full-blown crisis may well be not too far down the road, unless we can find resources from somewhere to finance our sharply rising budget deficit and imports. Given the improbability of that happening, another economic crisis marked by stagflation and rising poverty levels would be the horrible price the Pakistani people will have to pay because the government is unconvincing, bewildered and stupefied.

Published in The Express Tribune, February 10^th, 2011.