Of the IMF and the (political) capital

The rumor mill is churning in Islamabad. Markets are confused. Starching the surface, inflation is hurting common man. In turn, PTI government is losing political capital. The resolve is in to negotiate with the IMF on indicative targets to counter inflation. There is no issue at all in meeting the six key performance criteria. It is six out of six for Dec-19 review. The result would be same in Mar-20. In some cases, Sep-20 targets are already met. The problem could come in primary fiscal deficit target for Jun-20.

Two targets hovered around external accounts – Net international Reserves (NIR) and net foreign currency swaps/forward position. These targets are directly linked to SBP performance. Back in Jun-19, no one was expecting such improvement and IMF targets were set on than ground realities. The hawkish stance of SBP flipped the market thinking. The market determined exchange rate brought unprecedented portfolio flows (hot money). Today, the external account is in comfortable position.

NIR moved up from minus $15.5 billion in Jun-19 to estimated $8.6 billion in Dec-19. An improvement of $6.8 billion. IMF Dec-19 target was minus $16.0 billion, and Sep-20 target is minus $8.8 billion. It is becoming irrelevant now. The other target (linked to NIR) is net foreign swap/forward positions. The liabilities reached $8.0 billion by Jun19. It’s down to almost half at $4.2 billion in Dec19. The celling for Sep20 is $7.3 billion. No issues. The SBP’s job is well done.

The problem is in ministry of finance where the tax revenues are short. But it is harsh to blame Shabbar. The target was elusive from day one and he wasn’t welcomed by the FBR force. He wasn’t welcomed by the traders and retailers. He wasn’t welcomed by players manipulating agriculture value chain. The Finance Minister was apparently not happy with him.

The IMF would ask for the bottom line. The Fund usually leaves the option on authorities from where to collect revenues. In the first half, telcos’ pending licenses fees and higher than expected profits from SBP compensated the shortfall in tax revenues. There is a limit to these non-tax revenues.

The government was eying privatization of RLNG (to be treated as non-tax revenues based on accounting definition), but that has nothing to show for yet. The capacity is clearly missing and itseems unlikely that the transaction will happen this fiscal.

All what IMF could ask is to come up with new taxes or jack up rates on existing taxes to meet the shortfall. The indicative target of Rs5.5 trillion is already reduced to Rs5.2 billion. At current rate, FBR at best can fetch Rs4.5 trillion.

The other issue is in ministry of energy – petroleum and power divisions. All the plans to reduce circular debt through better administration and all was gimmick from day one. The core of the issues is not yet really touched. It is the growing capacity charge and discos inefficiencies. If the government cannot renegotiate on the lopsided contracts and cannot put discos’ management in order, then all IMF asks is to pass on the leakages to consumers and bring stock of circular debt on the fiscal books.

The issue is that any new taxes or passing on of energy inefficiencies to consumers, will bring more inflation home. It will further erode the industrial competitiveness. With inflation at 14.6 percent - there is no room to pass on more burden to consumers. There is no way industry can survive at higher energy prices. The prices are already too high. The government simply does not have the political capital do so.

That is why all kind of rumors are churning. The negotiations with the IMF are ongoing. Jihad Azour (Director of Middle East and Central Asia Department) is expected to arrive soon in Islamabad and the negotiations can move to its culminating round. The better performance on external accounts and meeting of all the binary targets is giving some room to authorities to delay on energy prices hike and any imposition of new taxes.

The rationale is simple. The external stability is achieved. Inflation is high due to some exogenous factors (and governance failure). Give us some time to tame down inflation. Once that is done, price (and taxes) passing on can take place. There is nothing wrong with the IMF. The fault lies in poor energy management, FBR reluctance to tax un-taxed, and governance failure to control perishable and nonperishable (wheat and sugar) inflation.