Living on the edge

The IMF report is a mixed bag - it narrates the short to medium term challenges owing to growing twin deficits while in the long term it expects growth momentum to sustain around 5 percent with single digit inflation.

The story is simple - the monetary policy is to be tightened to curtail demand whilst exchange rate adjustments are warranted to improve current account balance while lowering fiscal deficit is imperative for medium to long term sustainability. Reforms or adjustments would likely be done in the interim set up or in the first year of new government which will be covered subsequently in this space.

Let's attempt to dissect the Fund's projected numbers on external financing needs and impact on broader economy. The IMF estimates gross financing requirement for FY18 at $24.5 billion based on $15.7 billion (4.8% of GDP) current account deficit. This implies debt repayment of $8.8 billion in FY18 which also includes $5.5 billion of short term debt.

Barring the short term debt, which is assumed to be rolled over, the debt repayment becomes a mere $3.3 billion. The numbers of remaining period of FY18 are likely to be close to reality and are manageable. The Fund expects reserves to not fall more from the current level till June. This seems to be a little tough but not impossible.

However, the IMFs forecast beyond FY18 simply does not add up. The fund expects gross financing to grow out of bound while the current account deficit to consistently remain high. This portrays a scary scenario of debt repayment of $12.1 billion in FY19 which grows consistently every year to reach $27.6 billion in FY23.

This must include debt repayment to the IMF, CPEC, other donors and roll over debt. The important fact is missing that how much of this debt will be rolled over - it could include restructuring of Paris club debt, rolling over of China debt and of course short term debt is also part of it.

This is probably without the possible new fund programme, and to repay the debt and to finance the current account deficit, the external debt is expected to grow in tandem - to move up steadily from $93.3 billion in FY18 to $145 billion in FY23.

The surprising part is that despite heavy growth in external debt, the Fund expects reserves to keep on falling - from $12.1 billion (2.2 months of imports) in FY18 to $7.1 billion (1 month of import) in FY23. The import cover is expected to remain below 2 months of imports from FY19-23. And intriguingly, the Fund expects GDP growth to hover around 5 percent for the period and inflation to remain well in single digits.
This is a strange forecast. How can a country sustain high growth and low inflation while living on the edge in terms of external buffers? It is hard to bet on the IMF's forecast beyond FY19, as there seems to be no link of growth and inflation to reserves and debt repayment forecasts.

It is hard to forecast numbers in the long term and history suggests that IMF's forecast is not always right. In 2008, the IMF had presented a much dismal picture of current account, than reality. According to fund report in Jan 2008, the CAD was estimated at around $8 billion annually for FY10-12. On the flip, the deficit averaged at $2.8 billion per annum.

What happened back then was that currency depreciation had slowed down imports as well as the economy. Another recent example is of Egypt where even in short to medium terms, numbers were much better than IMF's projection and the IMF had to issue a modification note in Dec 2017.

The point is the fund forecast for the medium term or in fact any economic forecast in medium to long term should not be taken too seriously as numbers can change drastically by some tweaking in the model. Having said that, let's evaluate fund's forecast of baseline scenario and low capital flows for FY18 and FY19.
The IMF expects economy to grow at 5.6 percent and 4.7 percent respectively in FY18 and FY19 under baseline scenario with reserves at $12.1 billion and $10.4 billion. In case of low capital inflows, the growth is expected to taper to 5 percent and 3 percent respectively. This seems too harsh a scenario and unlikely to actualize. There are too many variables and their impact on economy is dynamic and complex.

A lot depends on oil and other commodity prices; the situation can change with generous support from friendly countries (KSA and Turkey) apart from China's help. The forecast and economic behavior is also dependant on the quantum of currency depreciation and its timings.