External sector reels under unceasing CSF reliance

Key policy rate kept unchanged in the wake of sector’s poor performance

ISLAMABAD: Contrary to budget managers’ expectations, Pakistan’s foreign inflows remained $1.3 billion below the anticipated value in the first half of this fiscal year, contributing towards deterioration of the country’s external sector, creating doubts over unceasing reliance on the Coalition Support Fund (CSF) despite a shift in US policy towards Islamabad.

The finance ministry had projected $1.6 billion receipts from Washington on account of the CSF when making the budget for the current fiscal year (2016-17).

CSF is the money that Washington used to disburse in return for services rendered by the country in the war against terrorism.

The minutes of the last meeting of the State Bank’s Monetary Policy Committee showed that the non-disbursement of CSF during the first half (July-December) of this fiscal year also added to worsening external sector position.

External sector’s bad performance was one of three reasons for keeping the key policy rate – the rate at which the central bank lends money to commercial banks – constant. There was a proposal to cut the rate by 25 basis points to 5.5 per cent.



According to the minutes of the MPC, the current account deficit further deteriorated on the back of surging imports, decelerating remittances and absence of budgeted CSF-related inflows of $1.1 billion.

The MPC had, therefore, decided to keep the rate unchanged at 5.75 per cent with six against three votes.

Six committee members who voted for maintaining the status quo gave more weight to challenges posed by the external account, inflationary trends and the need to maintain stability, the minutes also showed.

The three members who voted for reducing the policy rate believed that there was still room for reducing the policy rate to support growth, reduce unemployment and incentivise investment.

During the first half of the fiscal year 2016-17, the gap in official flows was around $1.3 billion, which includes inflows expected from the World Bank and CSF, according to the minutes.

Former finance ministry advisor Dr Ashfaque Hasan Khan said that Pakistan needed to realise that there was a clear shift in the US policy towards Islamabad.

The country, he said, was gradually slipping into a debt trap because of heavy reliance on foreign borrowings.

Pakistan borrowed $4.6 billion in the first seven months of this fiscal year. Islamabad will have to return a principal loan of $6.5 billion in the next 15 months.

Because of declining inflows, the central bank also failed to maintain its foreign currency reserves at the level projected by the International Monetary Fund (IMF). The fund had projected reserves at a comfortable $19.1 billion position by December last year. But the actual reserves did not rise above $18.2 billion, resulting in a deviation from the forecast, the MPC minutes noted.

In response to a query, the MPC was informed that the projected position of foreign exchange reserves by the end of current fiscal year is $20.5 billion, much below the IMF forecasts.

The central bank’s forex reserves recently fell to $16.8 billion after the government failed to create an upsurge in exports and attract sufficient foreign direct investment to meet its foreign exchange requirements.

The quantum of foreign direct investment stood at $1.04 billion during the first half of this fiscal year against $970 million in the same period last year.

The current account deficit also widened during the first half of this fiscal year to $3.5 billion, almost double the figure for the same period last year.

The January results showed further deterioration in the current account deficit which ballooned to $4.7 billion.



Decision rationale

Two factors were critical for recommending a policy to cut the interest rates – world oil price trends and normalisation of US interest rates.

Markets are anticipating a surge in US interest rates but this shift also carries adverse implications for Pakistan.

The anticipated normalisation poses few risks for Pakistan’s economy, the committee noted.

First, volatility in world currencies creates a challenging environment for a country with a stable foreign exchange market. Second, the appreciation of the US dollar will hurt export competitiveness, according to the MPC minutes.

The MPC revised downwards its average inflation forecast for the current fiscal year by half percentage point, ranging between 4 and 5 percent. A stable foreign currency exchange rate was one of the four key factors for lowering inflation projections, it was noted in the MPC minutes. Other factors included slower than an anticipated pick-up in domestic demand and less than anticipated passing on the increase in crude oil prices to domestic consumers.

Published in The Express Tribune, March 5^th, 2017.