IMF tenth review

The IMF Executive Board has approved the release of $502 million to Pakistan following the successful completion of the tenth review under the three year EFF. The Ministry of Finance must be commended for not requiring any waivers this time, as all the quarterly quantitative performance criteria and indicative targets were successfully met. However, IMF has exhorted the Government at the far end of the Program to prepare and implement wide-ranging structural reforms to generate 'strong and inclusive growth'. The performance has been tardy to date in improving the business climate, increasing export competitiveness, reducing losses of state enterprises and raising the quality of tax administration.
In fact, the economy has unravelled somewhat in recent months. Earlier, in January, the IMF had projected a growth rate of 4.5 percent in 2015-16, despite a big cotton crop failure and falling exports. Now, it has preferred to remain silent on the likely growth performance of the economy.
The PBS has reported a growth rate of 4.1 percent in the Quantum Index of Manufacturing up to January. However, it is actually significantly lower at below 3 percent, when the full impact of decline in manufactured exports and fall in production in the iron and steel sector, following the closure of Pakistan Steel Mill, are allowed for. Electricity generation has, in fact, increased by only 3 percent in the first seven months of 2015-16.
The current account deficit in the balance of payments has also deteriorated. It was only $351 million in the first quarter, which has increased to $1.9 billion by February. Imports showed a big decline of 15 percent in the first quarter. Since then non-oil imports have demonstrated buoyancy and by February the decline in imports is down to only 5 percent. Meanwhile, exports continue to fall by almost 14 percent monthly. Perhaps for the first time during the tenure of the IMF program, foreign exchange reserves have started falling. They increased by almost $2.4 billion in the first six months of 2015-16, but have declined somewhat since then. The receipt of the IMF tranche will essentially be used for retiring Eurobonds of $500 million by end March. Meanwhile the capital flight from the stock market continues putting some further pressure on reserves.
The same unravelling is observed in public finances. FBR revenues performed exceptionally well in the second quarter, with a growth rate of almost 24 percent. However, in January and February 2016, the growth rate has plummeted to 14 percent, despite the holding back of some refunds. A growth rate of over 27 percent will be required in March if the IMF indicative target for FBR revenues for the first nine months is to be met.
One of the primary reasons for meeting the fiscal deficit target for end-December was the low PSDP spending of Rs 156 billion at the Federal level versus the annual budgetary target of Rs 700 billion. Other reasons included a delay in releases for defence spending and accumulation of a large cash surplus by the Provincial governments.
However, developments in the last two months have been ominous. Not only has the growth rate of FBR revenues faltered but also borrowings from the banking system have reached Rs 580 billion by the middle of March. This is almost Rs 400 billion above the end-December 2015 level. According to the IMF performance criteria, the fiscal deficit should increase by less than Rs 387 billion this quarter. As such, it is likely that this criterion will also not be met at the time of the eleventh review.
The deterioration in macroeconomic indicators in the last few months is hopefully only temporary in character. It is ironic that as the present IMF program comes close to completion some of the gains in stabilisation have begun apparently to be lost already.
The IMF Press Note highlights explicitly for the first time the extent of over-valuation of the Rupee of 17 percent over the last two years. But overnight this has been deleted from the Press Note. Clearly, the exchange rate appreciation acting as a hindrance to exports has become a major policy issue and could require some action prior to the next review.
The present IMF Program comes to an end in September 2016. The key question is whether the Authorities will seek an extension or allow the Program to gracefully end. There are arguments on either side. The recent unwinding of the stabilisation process could be further accelerated after the Program ends. Given the lack of robustness of the world economy and overriding uncertainty in global capital markets, the glow of external funds into Pakistan may diminish in the absence of the umbrella of a Fund Program.
The Medium Term Debt Strategy (MTDS) finalised recently by the Debt Policy Co-ordination Office, envisages flotation of $3 billion of Eurobonds in the next three years, in lieu of retirement of existing bonds. The risk premium on Pakistan is already high and without the IMF cover it may not be feasible to obtain such financing. This is what happened after the end of the IMF Program during the tenure of the last PPP government. Foreign inflows dried up and foreign exchange reserves fell by almost $9 billion in two years.
However, a politically expedient strategy is to pursue higher growth from 2016-17 onwards, with elections approaching in 2018. But the present agreement with the IMF is to restrict the fiscal deficit to only 3.5 percent of the GDP next year. This does not provide the necessary 'fiscal space' to pursue higher development spending and provide tax incentives to stimulate growth. Also, more resources are required for the implementation of CPEC projects.
Given that the next review is due in early June, the negotiations could be rendered more difficult by not only the failure to meet some performance criteria up to March 2016 but also by the need to get the IMF to agree on the parameters of the next year's budget. It will, therefore, be of considerable importance to see the outcome of the penultimate review of the Fund Program.
(The writer is a Professor Emeritus and former Federal Minister)