Spearhead Analysis – 20.06.2017
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
“Macroeconomic stability gains made under the 2013-16 EFF-supported programme have begun to erode and could pose risks to the economic outlook.” [International Monetary Fund (IMF)]
The Pakistan Economic Survey 2016-17 showed an abysmal failure on many fronts, as the Government was unable to achieve most of the economic targets it had set for itself. The Survey was followed up with the Federal and Provincial Budgets for 2017-2018, which can at best be described as Election Year Budgets, focused on maintaining the status quo. This at a time when the country is facing a severe financial deficit due to rapidly falling exports; lower remittances; eroded Foreign Direct Investment (FDI); rising imports; and, higher repatriation and repayment requirements. In addition, there are glaring anomalies regarding the scale of Public Debt and the ballooning issue of Circular debt. The apparent lack of implementation of structural and institutional reforms, are a manifestation of continued ad-hoc policies.
In the recently concluded first Article-IV consultation review between Pakistan and the Executive Board of the IMF after the end of the three-year US$6.2 Billion Extended Fund Facility (EFF), it appears that all is not well, in stark contrast to the optimistic outlook portrayed by the Ministry of Finance. It comes as no surprise that the IMF has categorically stated that the macroeconomic stability gains achieved during the past four years are starting to unravel with the potential to threaten any positive economic outlook for Pakistan.
The IMF made the following key observations:
- The government’s debt is equal to 66.6% of GDP (Ministry of Finance 59.3%).
- Pakistan’s debt is stated to be above Rs.21.2 Trillion (Ministry of Finance Rs18.9 Trillion).
- Evidence of weakened policy implementation and re-emergence of macroeconomic vulnerabilities.
- Slowing fiscal consolidation with a likelihood that the revised 2016-17 budget deficit target of 4.2% of GDP would not be met.
- Widening current account deficit expected to touch 3% of GDP in 2016-17 or over US$9 Billion.
- Decline in the foreign exchange reserves, which could impact the stability of the rupee-dollar exchange rate.
- The issue of Circular debt in the power sector and the financial losses of public-sector enterprises exerting fiscal pressures.
It is intriguing that the IMF has put Pakistan’s foreign exchange reserves at US$18.5 Billion by the end of this fiscal year. Given that the reserve position as per SBP as at June 09, 2017 stood at US$15.3 Billion and only two weeks remain till the end of the year, it is highly unlikely that US$18.5 Billion is an achievable target. The current reserves at US$15.3 Billion are also below the estimates of the 12th IMF review report estimates. As per some, such variations put the credibility of the IMF estimates into question.
In a recent Cabinet meeting it emerged that the circular debt has touched a level of Rs.400 Billion plus, after the Government made payments of Rs.480 Billion in 2013 and vowed to eliminate the menace of such accumulations in the future. With no meaningful resolution of the energy crisis the Asian Development Bank (ADB) has approved a US$300 Million loan for the power sector under the Sustainable Energy Sector Reforms Programme that began in April 2014. This is expected to bolster the sliding foreign currency reserves. To date the ADB has given US$1.1 Billion, while the World Bank has given US$1.1 Billion for the power sector, which continues to flounder. The funds appear to have been diverted towards meeting budget and balance of payments support. The Ministry of Water and Power in its recent monitoring report on the Energy Sector Reform Programme revealed that during first half of FY17, the electricity bill recoveries dropped to 92.2% (94.6% in June 2016), while the line losses fell from 17.9% to 17.2% in the first half of FY17, higher than the limits prescribed by the power sector regulator. The lower recoveries coupled with higher-than-approved line losses have led to accumulation of Rs.400 Billion plus in circular debt.
Under the IMF programme the government had committed to phasing out the concessionary tax regime. However, in the outgoing fiscal year the government sustained losses of almost Rs.415 Billion due to tax breaks, 5.4% higher than the previous year. This amount excludes the cost of income tax exemption granted to independent power producers (IPPs), which stood at Rs.50 Billion. The total accumulated cost of tax breaks in the FY2016-17 were Rs.465 Billion. In an ideal situation the cost of tax breaks should have been reduced to Rs.130 Billion by June 2017. This performance puts into question the government’s resolve towards a phased withdrawal of tax exemptions under the IMF programme.
The public debt continues to rise and with it the cost of debt servicing. The government used approximately 45% of total revenues for repayment of debt and interest payments in the first nine months as per the Pakistan Economic Survey 2016-17. Debt servicing was Rs.1,410 Billion in July-March FY17 versus an annual budgeted estimate of Rs.1,945 Billion. Interest payments on domestic debt accounted for about 72%, with the higher share of domestic borrowing in the public debt portfolio. External public debt servicing dropped to US$4,340 Million in 2015-16 compared to US$4,475 million in 2014-15, mainly due to lower principal repayment to the IMF. According to the Economic Survey 2016-17, the external debt repayment obligations for Pakistan are not more than an average of U$4.3 Billion per annum until 2022 based on the outstanding debt at the end of March 2017. Keeping in view the track record, these repayments should not raise any concern as Pakistan has successfully met higher repayment obligations of US$4.8 Billion and US$5.2 Billion in 2013 and 2014, respectively, even with a smaller foreign exchange reserves base.
In addition to the above risk factors the IMF has identified certain key external risks elements, which could impact the macroeconomic stability of Pakistan:
- Lower trading partner growth,
- Tighter international financial conditions,
- Rise in global oil prices,
- Inability to enhance exports to meet rising external obligations from large-scale foreign-financed investments.
At the same time the IMF has identified the positives, achieved by the government, but which could be at risk:
- Real GDP estimated at 5.3% in the outgoing fiscal year, strengthening to 6% over the medium term on the back of the China-Pakistan Economic Corridor (CPEC) initiative. Expected improvement in availability of energy
- Potential growth-supporting structural reforms.
- Managed inflation and a sound financial sector.
The risks identified by the IMF are real and it is essential for Pakistan to ensure that the macroeconomic ‘gains’ are not eroded. For this there is a need to implement sound policies, and devise structural reforms for higher and more inclusive growth. For this there is a need to increase tax revenues through broadening of the tax base and strengthened tax administration, and better management of public spending. IMF have proposed reductions in electricity subsidies, and recommended strengthening of the national fiscal federalism framework and public debt management. While estimates could be questioned, there is no denying that the macroeconomic risks are real and there is some sane and sound advice that needs to be heeded to ensure that the potential economic success is not eroded by hidden losses.