Vagaries of Consciousness
Nation’s coffers would be nearly empty by the time the new government starts
While election frenzy is griping the country, few indications are available if the political parties are abreast of the challenges they would be facing if they get a chance to form the government, and what policies they plan to adopt to deal with them. The election manifestos of most parties have not yet to be announced and, therefore, no public pronouncement is in the field. One exception is the 100 day program announced by the Pakistan Tehrik Insaf (PTI). However, there is hardly any indication in this program that directly addresses the macroeconomic challenges.
It would be useful to enumerate the challenges that would call for immediate action as the new government assumes office. Many analysts have exaggerated the enormity of the challenges, painting a doomsday scenario waiting to unfold. This is not true. The country also offers considerable opportunities of redemption and hence while it would be painful to overcome challenges, these opportunities could quickly herald a new era of prosperity.
Our foremost challenge is to restore the macroeconomic stability. It has many parts but its ultimate manifestation is the untenable balance of payments (BOP). Last week we had reviewed in detail the eleven-month BOP position, which indicated a very high deficit likely to touch 6pc of GDP ($18 billion) – highest in more than a decade. In the last five years, the external debt has risen by $22 billion while there is an increase of only $4 billion in country’s reserves ($10 billion versus $6 billion). Reserves are barely sufficient to cover two months of imports. So, proverbially, nation’s coffers would be nearly empty by the time the new government starts its term. Accordingly, inescapable and most pressing issue would be to mobilise foreign resources to ward-off an imminent default on foreign obligations.
To this end, it would be near impossible to get any outside support unless an IMF program is put in place. Patchwork is always possible, which even the caretakers are also doing by picking one loan or the other, from this lender of that lender, and moving from week to week. An arrangement that would signal the dawn of a new era would only be possible when accompanied with a credible program of reforms with international buy-in. This is essential to meet the growing financing gap and begin to build reserves to stabilise macroeconomic situation and to avert default.
Let us also answer whether it will be possible to do without the outside help. Frankly, that would be exceedingly painful and politically too costly. It would essentially require abandoning the current regime of current account convertibility, a covenant that we have agreed to that requires freedom of import of goods and services and access to foreign exchange from the competitive inter-bank market. We may have to revert to import controls that we have left behind more than two decades ago. There would be shortages, unusual price increases and loss of competitive environment that has developed since the time we moved to a deregulated economy. Accordingly, the new government would be ill-advised to venture into such experiments.
Our foremost challenge is to restore the macroeconomic stability. It has many parts but its ultimate manifestation is the untenable balance of payments (BOP)
Therefore, we recommend the government should follow the familiar course of reforms work to build a credible plan. We briefly outline what should be its elements. First, a sharp fiscal adjustment would be required. The likely deficit of 7pc has to be brought down to 5pc during the next fiscal year. This would call for both an increase in tax collections as well as a major cut in development spending because current expenditures – except subsidies – would require deeper analysis to right size the government. Equally importantly, given that 57.5pc of divisible taxes are transferred to provinces, their cooperation in cutting expenditures would be critical through the build-up of surpluses. On the tax collection side the momentum of first three years of the last government that saw a 60pc increase in revenues would have to be relaunched. The tax collections in the last two years have dropped to no more than 12pc.
The second area of reform would be the monetary policy, which is the responsibility of the State Bank. The policy was too lax and accommodated widespread fiscal indiscipline. The policy rate actions were delayed – only two adjustments totaling 0.75pc were made since January – despite huge decline in foreign reserves. The policy rate would require significant adjustment to signal a tight monetary policy in the immediate future.
The third area of reform would be the exchange rate. It is hard to predict what would happen to the rate once a reform program is put in place but given the precariously low levels of reserves, the need to build reserves would call for intervening in the market for purchases, which inevitably would bring pressure on the rate.
The fourth area of reform would be to fix the power and gas sectors. The circular debt (CD) requires settlement as well as stopping future accumulation. It is reported that CD has reached Rs570 billion, despite a cash payment of Rs200 billion during the year. There is also the non-cash settlement of the previously paid CD parked in the power holding company (PHC) to individual distribution companies. Efforts to pay CD debt would pose a challenge as it would run counter to the need for containing the fiscal debt. However, an adjuster may be sought in the interest of improving the efficiency of the power sector that is impeded by a high level liquidity stuck up in CD. But the more formidable task would be to stop future accumulation of CD. The previous CD settlement plan was abandoned both in amending the law as well as implementing the divestment plans that would have enabled payment of such debts. There is an additional CD surfacing in the area of LNG payments. So far it is estimated to be around Rs30 billion, but could soon balloon to a very high level unless settled immediately.
On the structural side, nothing is more important than the revival of the privatisation program, which was also abandoned halfway by the previous government. Without a serious effort to put a plug on further accumulation of losses by public sector enterprises, neither fiscal viability would be ensured nor the continuing losses of efficiency in their operations recouped. The straight forward plan of inducting strategic investors stands the highest chance of success and would be welcome by international partners.
Finally, an unusual situation is created in country’s anti money laundering and countering financing for terrorism (AML/CFT) regime by FTAF decision to place the country yet again in the grey list. Reportedly, a new plan of action spread over 15 month has been approved by FATF plenary. This is an odious plan literally imposed by International Cooperation Review Group (ICRG) as opposed to Asia Pacific Group (APG) that Pakistan has been working with in the past. We have to make good of it as much as possible and seek relief wherever we find it impossible to implement. The IMF program may also contain provisions that may link progress on the plan as part of its reviews.
The new government, evidently, would be bargaining a very tortuous road to navigate the economy. Only a leadership with vision and foresight would be able to stabilise the economy and set it on the road to prosperity. The leaders must sacrifice more than what they would be asking from the people. Austerity and frugality in public lifestyle should be the catchword in the new economic regime.
By: WAQAR MASOOD KHAN