Spearhead Analysis – 22.12.2017
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
On December 15, 2017 Pakistan’s total liquid foreign exchange reserves amounted to US$20.38 Billion, down US$303.3 Million over last week as per date released by the State Bank of Pakistan (SBP). SBP reserves declined US$334 Million to US$14.33 Billion from last week, due to payments on account of external debt servicing and other official outflows. The net foreign exchange reserves held by commercial banks amounted to US$6.051 Billion, up US$30.8 Million over last week. The fact is that the reserves are continuing to exhibit a downward trend for several months now, as the Government comes under increasing strain to manage the fiscal deficits.
There has been a steady decline in the forex reserves during the current fiscal year, in the face of growing fiscal deficits and low levels of inflows in terms of Foreign Direct Investment (FDI, Export proceeds, and Inward Workers’ Remittances. As a result, there has been a continued reliance on borrowing, as was evidenced by the recent US$2.5 Billion Sukuk and Eurobond offerings. The inability of the Government to bring about real Structural and Governance reforms over the past four years have resulted in the current situation, with no appreciable revenue enhancement in the face of growing developmental and non-developmental expenditures.
Mired in one self-created political controversy after another and plagued by numerous corruption scandals the Government has effectively compromised its writ to govern. This became starkly evident with the dismissal of the Prime Minister and the Finance Minister, followed by the mishandling of the Faizabad sit-in and the eventual capitulation culminating in the dismissal of the Law Minister. Far from settling down, the political climate continues to remain volatile with demands for the dismissal of the Punjab Law Minister and even the Chief Minister in the wake of publication of the Model Town report. All this is contributing towards uncertainty and negatively impacting the economic environment within the country. A case in point is the Pakistan Stock Exchange (PSX), which has become a laggard from a star performer in the region.
PAKISTAN FOREX RESERVES
When the PML-N government took over in 2013 the total forex reserves were around US$11 Billion with around 55 per cent of reserves with SBP and 45 per cent with commercial banks. Over the past four years with unabated borrowing the government ‘built’ the reserves level to US$23 Billion by the end of 2015-16. The fact that the reserves were being bolstered through borrowing was in itself a flawed strategy. The Government was unable to initiate or implement structural changes and continued to rely on knee-jerk reactions and stop-gap fiscal measures to try and reduce the fiscal deficits. Strategies that failed miserably. Despite the fact that there is an ongoing US$50 Billion plus CPEC-related investment initiative underway, the abject lack of transparency over the terms of the agreement continued to create doubts over its actual benefits for Pakistan.
If one were to examine the trend in terms of the forex reserves, the PPP led government followed a similar pattern where they built up the reserves over their term of government and then bled these reserves at the end of their term. The PML-N led government appears to have followed a similar pattern where they artificially built up the reserves over the past four years and in their last year the reserves position has started to come under strain. With Pakistan’s external financing needs expected to touch US$32 Billion over the next 16-18 months, and with limited inflows the government has few options other than to resort to additional borrowing. This is a result of the structural fault lines within the economy which have not been addressed. In a recent write-up Dr. Hafeez Pasha has actually predicted that the reserves could fall to as low as US$3 Billion level by next year, in the face of growing fiscal pressures.
FOREX RESERVES CONVERGENCE
If one were to view the trend in terms of percentage of total reserves with SBP and Commercial Banks, in the recent past when the percentages converged towards a 50:50 equality (2012-13), the total reserves position had declined. This is the pattern which appears to be emerging yet again, with the reserve percentages converging towards equality and the actual reserves declining. This could actually be in line with what is being predicted in terms of the decline in reserves during the next year.
It is unfortunate that successive governments over the years have failed to bring about structural robust reforms to manage the fiscal inflows and outflows, and in the process the reserves of the country. Each government has burdened the country with additional debt and remained unable to bring about real improvement in the economic fault lines. It is time to re-assess the strategic and competitive advantages that Pakistan holds, and stand up to capitalize on those. Real objective reforms are required to break the cycle of incessant borrowing and create revenue enhancement opportunities from within.