Big financing risks

The IMF Staff Mission has left Pakistan after a series of meetings on the next Fund Programme in the form of an Extended Fund Facility (EFF) for the next three years.

Apparently, detailed discussions have been held on the reform agenda with a special focus on the comprehensive set of measures both on the revenue and on the expenditure side in the forthcoming budget of 2024-25.

The IMF is testing if the present political dispensation is willing to implement the tough budgetary reform agenda for 2024-25, before a move is made to finalize the three-year EFF.

The Staff Mission had earlier released a report at the successful completion of the Stand-by Facility for Pakistan on the 10th of May.

This report contains a detailed set of projections of key macroeconomic magnitudes from 2024-25 to 2028-29.

These projections clearly highlight the severe constraints on external financing in the presence of large such financing needs in 2024-25 and thereafter.

The external financing requirements for 2024-25, for example, are based on a relatively small current account deficit of $4.5 billion, equivalent to only 1.2% of the GDP.

Total amortization requirements, including IMF repurchases, add-up to the large magnitude of $16.5 billion. Consequently, the total external projected financing requirement is $21 billion.

The report estimates on the financing side an inflow of foreign direct investment of only $1.3 billion in 2024-25. This is a clear reflection of the lack of confidence of the IMF with efforts by the SIFC (Special Investment Facilitation Council) to mobilize substantial foreign investment in Pakistan.

Hopefully, the claim that the UAE has committed to invest $10 billion in Pakistan should greatly increase the likelihood of the financing of $21 billion required in 2024-25. Will we still require an IMF Programme or is the commitment by the UAE still very tentative?

However, the IMF Programme may still be required because the foreign investors want the assurance that there will be full repatriation of profits to them. In the absence of an IMF Programme this is unlikely as we saw in 2022-23.

The big question mark with the IMF projections of the sources and magnitude of external financing in 2024-25 relates to access of Pakistan to private creditors, including new borrowings from international commercial banks and flotation of Euro/Sukuk bonds.

The assumption is of access to these two sources of as much as $6.9 billion in 2024-25.

During the current financial year, given the very low credit rating of Pakistan, there has been no access to these two private sources despite the presence of the IMF Programme. This is unlikely to change in 2024-25.

Therefore, despite the valorous efforts of the SIFC, the likelihood is that Pakistan will require the umbrella of a functional IMF Programme.

Without such a programme, the flow of funds from official multilateral and bilateral creditors may also fall sharply. The requirement from these sources is estimated at $5.2 billion in 2024-25, along with roll-over of over $5.5 billion.

The three-year Extended Fund Facility from the IMF is likely to be one of the toughest programmes in the 24 Programmes that Pakistan will have had with the IMF.

Not only is there a need for exceptionally large external financing but Pakistan will also have to implement wide-ranging reforms on multiple fronts to establish credibility as a borrower with the ability to repay by achieving a sustainable external balance of payments and budgetary position.

The immediate focus must be on the budgets for 2024-25 by the Federal and the Provincial governments. There is need, first, for a credible target for the primary surplus. This is likely to be set at 1% of the GDP, as compared to the target of 0.4% of the GDP in 2023-24.

Currently, there are indications that the target for this year will be difficult to achieve in the face of some shortfalls both in tax, non-tax revenues and the Provincial cash surplus. It could actually end up at negative 0.2% of the GDP by end-June 2024.

The fundamental implication is that an extraordinary growth rate will be required in Federal and Provincial revenues in 2024-25 if the target of a primary surplus of 1% of the GDP is to be achieved.

The media reports are that in discussions on the Federal Budget of 2024-25 the IMF has asked for a FBR revenue target of almost Rs 12.9 trillion.

This will represent a jump in the FBR revenue-to-GDP ratio from the likely 8.6% of the GDP in 2023-24 to 10.3% of the GDP in 2024-25, based on IMFs own projections of the size of the nominal GDP in 2024-25.

The increase of 1.7% of the GDP in FBR revenues has never been achieved before. It is even more difficult in an economy with a sluggish rate of growth. Apparently, tax measures like restoration of the full sales tax on POL products, even in the presence of a large petroleum levy, enhancement of sales tax rate on a wide range of items, effective reduction of slabs in the personal income tax and enhancement in withholding tax rates are under consideration.

This is tantamount largely to higher taxation of existing taxpayers. The fundamental question is whether the federal and provincial governments will be willing to effectively enhance their respective tax bases by bringing traders, large farmers and big property owners more effectively into the tax net.

The reform agenda will also include other strong measures like privatization and scaling down of losses of State-Owned Enterprises, transfer by the Federal government of functions and projects to the Provincial governments along with the expenditure liabilities, pension reforms, etc. The year, 2024-25, will truly have to be a year of major reforms.

The fundamental question is whether there will be political consensus on the wide-ranging reforms?

Also, will the Provincial governments to be motivated to develop their revenue sources? In the presence of big increase in the tax burden and in utility prices, is there the risk of an uprising by the people?

Further, given the likely ambitious targets in the impending IMF Programme, each quarterly review may reveal shortfalls and the need for corrective actions. The Ministry of Finance will undoubtedly face pressures of the type seldom seen before. We hope that the big financing risks in 2024-25 will not culminate in an economic or political meltdown.

Copyright Business Recorder, 2024