Parting ways with the IMF: The govt’s math does not add up

How the government is making fiscal decisions based on highly flawed logic and even worse arithmetic.

ISLAMABAD:

Pakistan’s eccentric decision to damage its relations with the International Monetary Fund has resulted in the suspension of development loans from other multilateral financial institutions – a consequence that is likely to have both short and long-term repercussions for the economy.

The Asian Development Bank – a Manila-based lending agency that has a history of extending loans to Pakistan in times when Western-dominated institutions had refused to help out the country – was the first to say that it would not give lend any more money to Islamabad unless it receives the IMF’s Letter of Assessment, a certificate of the soundness of a country’s economic indicators and of progress on promised reforms.

The Washington-based World Bank has not yet publicaly announced its intentions, but there is little doubt that it will join the ADB’s bandwagon.

For their part, the country’s economic managers seem to think that the country can continue to make do without external budgetary support.

Finance Minister Abdul Hafeez Shaikh has claimed that, not only will Pakistan be able to meet all of its debt repayment obligations in 2012, but it will also be able to do so while maintaining foreign exchange reserves above $16 billion. The arithmetic of this claim, however, does not quite add up.

Assumptions versus reality

According to the finance ministry’s economic affairs division, despite the suspension of the programme loans, Pakistan will receive gross inflows of $3.8 billion.

However, these numbers include an assumption that the government will be able to raise $500 million from auction of exchangeable bonds backed by shares in the state-owned Oil and Gas Development Corporation. The government estimates it will get another $500 million from the Islamic Development Bank while the remaining $2.8 billion is likely to come from multilateral institutions for the funding of projects.

Given the volatility in international debt markets due to the European sovereign debt crisis, however, Pakistan may not be able to complete the OGDC bond offering, or else be forced to pay an exorbitant interest rate, an action which most capital markets experts consider bad financial planning.

As for the project loans, international financial institutions have said they are more than willing to fast-track the disbursement of those loans – provided Islamabad undertakes measures it has been promising for decades, including setting up project management units, addressing land settlement and environmental concerns as well as introducing greater transparency in the bidding process for contractors.

The challenge for the federal government, however, will be to get the notoriously slow-moving provincial governments to move forward with these requirements, since most of the time, the provinces are the executing agencies for the project loans.

A failure to address these concerns costs the government money: financial institutions charge the government even for loans that have not been utilised. In addition, the government will still have to arrange for some local financing, since the international institutions only provide their funding at the completion of the project. The higher local borrowing costs are likely to add to the deficit.

Repayment assumptions

The government estimates that it needs to pay back $3.3 billion in principal and about another $900 million in interest on its foreign debt, including $1.4 million in repayments to the IMF.

The government seems to feel it can continue to do this, though it is counting on the continued high international commodity prices that have fuelled an export boom, as well as a continuation of record-high $11 billion in expatriate remittances and $2 billion in foreign direct investment.

Officials say they expect these three factors to help keep the economy stable, though they seem to overlook the fact that the rest of the world – including most of Pakistan’s major trading partners – are going through a recession.

The government is also underestimating the risk of capital flight, which experts say has already begun. The State Bank of Pakistan already had to pump in about $130 million into the foreign currency markets last week to help stabilise the sharply dropping rupee, bringing foreign exchange reserves down to $17.3 billion.

Yet most experts agree that the pressure on the rupee is only likely to increase till March 2012, when the government must begin repaying the IMF.

Implications for the budget and the economy

The government is highly unlikely to meet its already optimistic target of a budget deficit equalling Rs850 billion, or about 4% of the total size of the economy.

Among its other faulty assumptions are receiving about Rs75 billion by auctioning 3G licences to mobile telecommunications companies, despite not having settle a claim from Etisalat, the UAE-based buyer of Pakistan Telecommunications Company, that the government would not do so until 2013. The Rs70 billion that Etisalat owes the government for its purchase of PTCL are also unlikely to be paid this year.

In addition, the government is unlikely to receive much of the Rs118 billion owed to it by the United States under its Coalition Support Fund programme, due to strained ties between Islamabad and Washington.

All these factors come to 1.3% of GDP, taking the budget deficit to 5.3%.

In addition, the government has been delaying power sector reforms that are adding between Rs22.5 billion to Rs30 billion per month to the deficit.

The government also wants to pick commodity financing overdue subsidies this year, adding another Rs120 billion.

All of these will take the deficit to around 6.5% of GDP or Rs1,381 billion.

During the last fiscal year ending June 30, 2011, the budget deficit was 6.6% of GDP or Rs1,314 billion. Out of that, Rs1m206 billion were raised from the domestic market.

In absence of external financing, the government will have to borrow this entire amount either from domestic sources or print more money. This will not only take away private sector credit but also result in double-digit inflation for the fourth consecutive year.

Published in The Express Tribune, October 3^rd, 2011.