The IMF Stand-By Facility (SBF) of $3 billion has been in operation for two weeks now. Already, there is a big increase in external inflows. Foreign exchange reserves now stand at $8.2 billion, almost twice the level at the end of 2022-23.
The SBF has the usual memorandum of economic financial and financial policies, performance criteria, indicative targets and structural conditionalities. Periodic reviews are targeted for end-December 2023 and end-March 2024. Successful completion of these reviews will lead to the release of $720 million and 1,130 million, respectively.
The macroeconomic projections for 2023-24 indicate the continuation of ‘stagflation’, but with less intensity. The GDP growth rate is expected to rise somewhat from negative 0.5% in 2022-23 to 2.5% in 2023-24. The inflation rate is projected to decline modestly from 29.2% in 2022-23 to 25.9% in 2023-24.
Two projections, in particular, appear to be optimistic. First, the unemployment rate is projected to decline from 8.5% to 8%. This is unlikely. A GDP growth rate of only 2.5% will not enable full absorption of the incremental labor force in 2023-24, and the unemployment rate could rise to above 9%.
Second, the level of gross capital formation is projected to increase from 13.5% of the GDP to 14.7% of the GDP. This is also unlikely, given the continuation of extremely high interest rates, with the SBP policy rate already at 22%.
Turning to the two deficits, the IMF has projected the budget deficit in 2023-24 at 7.5% of the GDP, same as the level last year. However, a primary surplus of 0.4% of the GDP is anticipated. The Ministry of Finance had projected the budget deficit at 6.5% of the GDP. The higher deficit estimate by the IMF is due to much larger debt servicing with the continuation of extremely high interest rates in 2023-24.
The current account deficit in 2023-24 is projected by the IMF at 1.8% of the GDP, equivalent to $6.5 billion. This is in comparison to the actual deficit of $2.5 billion in 2022-23. Foreign exchange reserves are expected to rise to $9 billion by the end of 2023-24, due largely to big increases in exports, remittances and external disbursements which not only will finance the opening up of imports, leading thereby to their increase by 24%, but also lead to near doubling of foreign exchange reserves.
The containment of the trade deficit is also expected to be achieved by transition to a market-based exchange rate policy. The IMF expects that the difference between the open-market and the inter-bank exchange rate will need to be restricted to only 1.5%. This policy is now being implemented by the SBP and despite the big improvement in foreign exchange reserves the rupee has depreciated by 4% last week.
The other major reforms and steps proposed in the SBF are as follows:
(i) Further increases in the SBP policy rate, if necessary.
(ii) No financing by the SBP of the government deficit.
(iii) Publication of the Annual Financial Report on the SOEs and steps towards privatization of selected units, like HBFC.
(iv) Full operationalization of the Single Treasury Account.
(v) PPRA to pilot the e-procurement system.
(vi) Phasing out of SBP’s involvement in concessionary refinancing schemes.
(vii) Addressing undercapitalized financial institutions.
(viii) No introduction of a fuel subsidy.
(ix) Measures to address the drivers of the circular debt flow in the power sector.
(x) Ensuring cost recovery from electricity tariff and reduction of subsidy to agricultural tubewell users.
(xi) Undertaking medium-term cost reducing reforms in the power sector and similar steps in the gas sector.
(xii) Enhancing the SOEs legal and regulatory framework.
(xiii) Undertaking steps to improve the business environment, especially for foreign direct investment.
(xiv) Addressing structural deficiencies in the housing and construction sector.
(xv) Focusing on mitigation and transition management in climate change.
(xvi) Ensuring continuation of implementation of AML/CFT.
(xvii) Construction of quarterly GDP estimates by the PBS.
The above comprehensive list of reforms and measures clearly indicates the pressure by the IMF for achieving major structural changes in the economy. However, the process of implementation will initially be the responsibility of the caretaker government, which is likely to take over in early to mid-August.
There are three critical areas which will determine the success of the SBF. These are measures, first, to raise the level of exports and home remittances by almost 20% and 24% respectively, to finance the upsurge in imports. The next risky area relates to achieving the high targeted growth of federal and provincial revenues in 2023-24. The third area is receiving almost $15 billion new loans inflow in 2023-24.
The IMF has projected that the required rate of depreciation in the value of the rupee is 20.4% in 2023-24. This is significantly less than the actual fall in the value of the rupee of almost 40% in 2022-23. Exports are projected to increase rapidly in dollar terms by 20%, as compared to a fall of 14% in 2022-23.
However, all export incentives, except the 1% income tax, have been withdrawn during the tenure of the last IMF programme. The electricity tariff is to be raised substantially shortly. Further, international commodity prices are likely to be lower. Therefore, there is the risk of a significant shortfall in meeting the export target.
Further, in the event of a lower than target growth in exports, the exchange rate will need to be used much more intensely to reduce the rise in imports, in the absence of physical restrictions. Inevitably, a faster decline in the exchange rate will further accelerate the rate of inflation.
The other major risk factor is achievement of the extraordinarily high growth rate in federal and provincial revenues combined of almost 40%, which has never been achieved before. The targeted growth rates of different revenue sources are as follows:
Targeted Growth Rate in 2023-24
Federal Revenues 38.2
Tax Revenues 33.4
Non-Tax Revenues 92.9
Provincial Revenues 30.6
Tax Revenues 30.1
Non-Tax Revenues 32.5
Total Revenues 40.0
Federal tax revenues are expected to rise by over 33%, as compared to 17% last year. Taxation proposals are expected to yield an additional Rs 500 billion. However, with 2.5% GDP growth, there is likely to be limited growth in corporate profits and in their revenue yield. Some of the larger withholding taxes like those on contracts, services and energy bills are unlikely also to show fast growth.
A primary area of concern is the outlook for provincial finances. The IMF programme expectation is that the provincial cash surplus will rise to Rs 900 billion and make a significant contribution to limiting the size of the combined budget deficit. However, with two caretaker governments in Punjab and Khyber-Pakhtunkhwa there was no scope for new tax measures. Sindh and Balochistan have focused on balancing their respective budgets only in the presence of a big increase in pay and pensions.
The third area of risk is the expectation by the IMF that with the presence of the SBF in the first nine months of 2023-24 there will be success in raising external disbursements of new loans into the government account from $9.9 billion in 2022-23 to $14.7 billion in 2023-24, an increase of almost 49%.
This will hinge particularly on a general improvement in Pakistan’s credit-rating and success, thereby in raising new loans by flotation of bonds and from international commercial banks of up to $6 billion. Otherwise, here again, larger depreciation of the rupee will have to be resorted to achieve the require surplus in the balance of payments.
Overall, there is the risk that implementation of the wide-ranging reforms in the SBP will be slow in the presence of caretaker governments, especially in terms of achieving the required high growth rate in revenues. The newly-elected government will have to take a number of measures to get the IMF programme back in track before the end of December 2023, including mini budgets both at the federal and provincial levels. Stronger actions will have to be taken by the SBP from the end of the first quarter onwards on the exchange rate and interest rate fronts.
Copyright Business Recorder, 2023