Contours of new IMF programme

Prime Minister Shehbaz Sharif has reiterated recently the need for moving ahead with a new IMF (International Monetary Fund) programme for a longer period. Therefore, it is likely that after the conclusion of the present nine-month Stand-by Facility, negotiations will commence with the IMF on a new Extended Fund Facility (EFF) of three years.

There is a general apprehension that in view of the extremely vulnerable position of Pakistan with regard to the making of timely external payments, the programme will be extraordinarily tough in terms of the speed of adjustment and degree of rigidity of the agenda of structural reforms.

The objective of this article and the next article is to identify the likely targets in the EFF of key macroeconomic variables over the three-year period, 2024-25 to 2026-27. This will include targets related to the achievement of stabilization of the economy through the containment of the current account deficit in the balance of payments and the budget deficit. This will enable Pakistan to build up its foreign exchange reserves to a ‘safe’ level by the end of the programme.

The methodology adopted to identify the likely targets includes, first, examination of the targets in the previous EFF of Pakistan from 2019-20 to 2022-23, which remained largely unimplemented. Second, we look at the programme targets in the on-going IMF programme of a country like Sri Lanka, which is emerging from a default situation.

Third, the leading party, PML-N (Pakistan Muslim League-Nawaz), which has formed the federal government in a coalition with PPP (Pakistan People’s Party) and other parties, had included a set of macroeconomic targets for five years to be implemented in the event of success in formation of the government. An analysis will be undertaken to judge the adequacy of these targets.

The most critical set of targets relates to the external balance of payments. The previous EFF of Pakistan was based on the process of reforms and adjustments leading to a quantum jump in the level of foreign exchange reserves. At the start of the programme, reserves were $7.3 billion, equivalent to import cover of 1.5 months. The expectation was that by the end of the programme they would rise to over $20 billion, thereby providing import cover for over 3.5 months.

There is a coincidence that at the start of the next EFF Programme reserves are likely to be at, more or less, the same level as at the start of the previous programme. Fortunately, at the end of 2023-24, the size of the current account deficit will be much smaller. It stands at $1 billion after the first eight months and is likely to be significantly below 1% of the GDP by the end of the year.

Therefore, relatively small targets can be set for the size of the current account deficit during the tenure of the programme, ranging from 1% of the GDP in 2024-25 to 1.5% of the GDP in 2026-27. This will require limiting the annual growth rate of the dollar value of imports of goods and services to 6%. The trade deficit will be kept at the target level with the annual growth rate in the value of exports approaching 8.5%. Simultaneously, the growth rate in workers’ remittances will have to be at least 5%. In absolute terms, the target for the size of the current deficit will need to be limited close to $4 billion in 2024-25, $5 billion in 2025-26 and $6 billion in 2026-27.

Turning to the required financial account surplus to help in the targeted buildup of foreign exchange reserves there is need to first assess the likely size of the IMF funding. It is assumed that the amount, given the SDR quota of Pakistan, will be close to $6 billion. In addition, there is the possibility of additional funding linked to a Climate Adaptation Plan of up to $2 billion. The IMF programme of Bangladesh includes this type of funding.

Based on the net inflows from the IMF the net surplus in the financial account are likely to range annually from $8 to $9 billion. The annual external financing requirement is estimated at $16 to $18 billion, net of the likely rollovers. The non-debt creating inflows are expected to range from $2 to $2.5 billion.

Overall, the balance of payments surplus plus the net inflow of IMF funds can lead to an increase in the reserves of up to $4.5 to $5 billion annually. This will imply that the foreign exchange reserves will be over $20 billion by the end of 2026-27, equivalent to an import cover of three months.

The above scenario will require strong reforms and policy moves over the programme period. Pakistan’s exports of goods and services have performed poorly with an annual growth rate of only 1% over the last decade. Therefore, raising the exports growth rate to over 8% will be very challenging.

There will be a need for incentivization through lowering the real effective exchange rate index to significantly below its currently artificially high level of near 100. Pakistan must also be able to adopt an export incentive scheme possibly of the Bangladesh type.This scheme effectively offers a higher exchange rate to value-added and emerging exports and on exports to emerging markets. Further, large cost-push pressures leading to loss of competitiveness in the form of escalation in power and gas tariffs must be avoided.

The policy regarding imports will have to change from physical controls by resort to the market-based exchange rate policy described above. The SIFC (Special Investment Facilitation Council) will need to demonstrate greater success through appropriate steps in increasing the inflow of foreign direct investment. Towards the end of 2025-26, Pakistan should ideally have built up its reserves for an improved credit rating and diversification in the financing sources. It is also hoped that our migrant workers will help by an annual increase in remittances of at least 5%.

The target for the size of the current account deficit is an average of 1.1% of the GDP in the on-going Sri Lanka EFF. Reserves are expected to rise sufficiently by the end of the IMF programme to provide import cover of almost 3.5 months. The macroeconomic targets in the PML-N manifesto include limiting the current account deficit to 1.5% of the GDP every year, over the next five years.

However, it will need to be closer to 1% of the GDP in the first two years.

The next article will focus on the likely budgetary targets and the macroeconomic projections of the GDP growth rate, rate of inflation and level of investment in the likely next IMF Program with Pakistan.

Copyright Business Recorder, 2024