Our fiscal cliff?

When the countrys financial managers met with senior officials of the IMF, there was a little that may be considered a commendation for Finance Ministry. The Fund warned that the foreign currencies reserves are "under $10 billion in October 2012, below adequate levels;" and that headline inflation, though declining will still end the year in double digits.
But neither persistent inflation nor the deteriorating external position is the cause of concern. The elephant in the room is the high fiscal deficit followed by power woes.
The Fund has rightly highlighted that the fiscal deficit mushroomed to 8.5 percent of GDP in FY12 against a target of 4 percent In FY13; this deficit will once again shoot past the budgeted 4.7 percent to 6.5 percent of GDP, according to the SBP.
To make matters worse, the actual fiscal deficit will be even higher considering that the GoP has spent about Rs.475 billion on power sector subsidies, and another Rs.37 billion on subsidies to other sectors in FY12. The cumulative handout of Rs.512 billion is a staggering amount considering that only Rs.200 billion out of this was budgeted at the beginning of the previous fiscal year.
Given the lack of progress in terms of power sector reforms, the subsidy head is once again expected to rival the countrys defence budget, which hovers around Rs.490 billion.
IMF officials are expected in Islamabad soon to discuss the possibility of a new Stand-By Arrangement for Pakistan. Well placed sources reveal that among the options on the table for Finance Ministry is an improvement in the tax to GDP ratio by one percent in each of FY13, FY14 and FY15. The spending on subsidies will also have to be curtailed to hit the brakes before the economy plunges over the fiscal cliff.
According to the State Bank of Pakistan, the countrys GDP tallied Rs.19.44 trillion in FY12, according to provisional data posted on the SBP website. In its First Post-Programme Monitoring Discussion with Pakistan; the IMF has contended that the real GDP growth rate will hover at 3.25 percent. The Fund has also predicted that inflation will crawl into double digits by end-FY13. That would mean a nominal GDP growth of 13.25 percent, taking national income to Rs.22.01 trillion.
Assuming that FBR is able to meet the mandated target of improving tax collection to 10.9 percent of GDP; it will gather an additional Rs.346 billion in taxes, compared to the total tax revenues in FY12.
However, even after achieving this goal the fiscal deficit will be in the vicinity of Rs.1,408 billion, while the countrys financial managers have to rein this gulf to Rs.1,188 billion, to achieve the slated IMF target. Obviously, this curtailment mandates a drastic reduction under the subsidies head. In fact, the remaining gulf will require GoP to cut its spending on subsidies to about half of last years level.
The thin silver lining in the GoPs recent dialogue with the Fund is that for now, the Fund is not averse to the accommodative monetary stance of SBP. Also, while the foreign exchange reserves are falling, they are still relatively better poised than what may come to pass, if pressures on the external account continue.
Reading between the lines reveals that the Fund has given a green signal to the continuation of dovish monetary policy stance. So a further 100bps cut in upcoming Monetary Policy cannot be ruled out.
The writing is on the wall. The longer GoP waits to enter into an IMF Programme, the worst will be the state of the external account, in addition to the already woeful domestic debt situation. When the IMF team arrives in Islamabad, the best Finance Ministry can do, under the circumstances, is to get a lifeline from the Fund, before the economy rummages off this looming fiscal cliff.