The new government is in place both at the Federal level and in the Provinces. Despite allegations of vote rigging, the transition has been peaceful and orderly. A general commitment to democracy has been demonstrated. This augurs well for the future of Pakistan.
A credible economic team has been put in place. The Finance Minister, Asad Umar, is a leader from the corporate sector. The Advisor for Commerce, Industry and Investment, Razzaq Dawood, is an innovative entrepreneur who held the portfolio of Commerce in Gen Musharraf’s government. The Advisor on Institutional Reforms is Dr Ishrat Husain, former Governor of the SBP, also during the Musharraf era, and an expert in governance. Therefore, this team can hopefully contribute to and take fast and rational economic decisions in the larger public interest.
Unfortunately, the new Government has come in the backdrop of even more bad economic news. The large-scale manufacturing sector has witnessed a major downturn in the last four months of 2017-18. During the first eight months, the growth rate was exceptionally high at 6.2%, which has slumped to 3.8% in the last four months of the year. The buoyancy shown earlier by sectors like food, beverages and tobacco, pharmaceuticals and cement has largely been lost. Industries like chemicals and fertilizers have demonstrated a negative growth rate in production throughout in 2017-18.
There has also been a recent upsurge in the rate of inflation. The year-to-year inflation in the Consumer Price Index in the last two months has risen to above 5%. In particular, the inflation in the month of July 2018 is as high as almost 11% in the Wholesale Price Index. This is ominous and the CPI will correspondingly rise with a lag. After over three years of very low inflation it is back again on the radar screen of economic problems.
Probably the worst news is on the balance of payments front. The monthly current account deficit has consistently exceeded $2 billion over the last four months. The deficit in July 2018 was $ 2.2 billion, showing an increase of 14% over the level in July 2017.
Imports in July on an f.o.b. basis have exceeded $ 5.5 billion for the first time, with a growth rate of 20%. Clearly, actions taken earlier in the form of depreciation of rupee, levy of regulatory duties and 100% cash margin on non-essential goods have not yielded the desired results in terms of containing imports. The Caretaker Government also failed to strengthen the measures to restrict imports.
Based on these trends, there is a high level of risk that the current account deficit in 2018-19 could even exceed $ 20 billion, as compared to $ 18 billion last year. Consequently, with external debt repayments approaching $ 9 billion, the total external financing requirement this year could be as much as $ 29 billion or perhaps even more.
Last year, the external financing requirement was close to $ 24 billion. This could only be financed by a drawdown of foreign exchange reserves of as much as $ 6.3 billion. How then will an even larger requirement in 2018-19 be met when reserves have plunged to a very low level, not even enough to provide import cover of two months?
Overall, there are unambiguous multiple indications that the economy is sick and the country faces an incipient financial crisis. The economic team must expeditiously start the process of stabilization of the economy. At all costs, a future run against the rupee must be averted.
What are the tasks and decisions to be taken by the team on an emergency basis? The first perhaps is the need for a presentation, latest by the end of the second week of September, of a revised Budget for 2018-19. The Budget presented by the PML (N) Government in its last days was very defective. It was based on revised estimate of the budget deficit for 2017-18 of 5.5% of the GDP. The actual deficit has turned out to be much higher at close to 7% of the GDP.
Therefore, the benchmarks of projections for 2018-19 are wrong. FBR revenues have been lower, current expenditures higher and hardly any cash surplus has been generated by the Provincial Governments in 2017-18, in comparison to the original estimates for the year. On top of this, budgeted revenues in 2018-19 have been consciously over estimated, while expenditures have been understated so as to produce a low budget deficit estimate for this year of only 4.9% of the GDP. Further, in an exercise in unbridled populism, huge income tax breaks were given to individuals and companies in the latest budget.
The Ministry of Finance in Islamabad has demonstrated a veritable lack of capacity and inability to anticipate negative developments. The design and implementation of tax, expenditure, debt management and trade policies has been inadequate. Other economic Ministries have not been allowed to play their due role.
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The new government has to take immediately key decisions for incorporation in the Revised Budget for 2018-19, if it is decided to present it. First, to what extent should the income tax breaks be withdrawn? Second, what are the areas and the extent to which economy in expenditures can be achieved? Third, should import tariffs be scaled up to help in containment of imports, since they are low in comparison with tariffs in India and Bangladesh? Fourth, how can the liquidity constraints of exporters begin to be tackled by speedy payment of refunds?
Fifth, the high level of circular debt in the power sector is constraining electricity supplies and leading to high levels of load shedding. How can these problems be addressed? Sixth, the PSDP has given very low priority in allocations for the water and power sectors. How should the sectoral allocations be changed to reflect this priority? To what extent, if any, should the overall size of the PSDP be reduced?
Perhaps, the single most important question that needs to be resolved on an emergency basis is how the very big external financing requirement for this year will be met. The first indications are that the gap is far too large to be met by FDI and normal sources of borrowing.
As such, the issues are as follows: First, to what extent should an attempt be made to reduce the current account deficit in 2018-19 and what should be the strategy for achieving this objective? Second, a decision has to be taken as to whether the IMF should be approached or not for balance of payments support. The question is that if strong actions have to be taken anyway to achieve stabilization then why not do this as part of an IMF programme which can perhaps soften and provide more time for achieving the adjustment?
The new economic team and the Federal Cabinet will have to finalize the overall policy posture and the actions to be taken. If the IMF is to be approached then this should be done immediately. Delays will only weaken the negotiating position and lead to a tougher Program. Also, meanwhile uncertainty will be at its peak.
The litmus test for performance of the new Government in the first 100 days will largely be how it moves and with what speed to tackle the imminent financial crisis.
The writer Dr. Hafiz A Pasha is Professor Emeritus at BNU and former Federal Minister.
(This news/article originally appeared in Business Recorder on August 28th, 2018)