The more things change in Pakistan, the more they stay the same. Most of the crucial economic reforms needed in Pakistan have been figuring on recommendation lists for some time, most notably since 2008. Three of these issues need urgent attention, as the fiscal year progresses towards closure.
High on the list of priorities should be foreign exchange reserves, which have dipped to alarming levels. Reserves held with the State Bank have been hovering around $3 billion, or less than a month of imports, since November. The IMF maintains that the State Bank should build up reserves by buying foreign currency from exchange markets, while “maintaining exchange rate flexibility.” That translates into letting the rupee slide if it must, but boosting the reserves. In the long term, the IMF expected the government to consider borrowing in international markets, negotiating further inflows with other donors (based on the security of the ongoing IMF program) and starting a program of privatization.
But there was some miscalculation along the way. The actual balance-of-payments deficit at the end of the first quarter of the current fiscal year was $1 billion more than that projected in the IMF agreement (which was signed in early September). In addition, the net flows in the capital account due to additional aid from donors and a boost in foreign direct investment never materialized. Even the IMF’s allies, like the World Bank and the ADB, who traditionally follow on with funding once the IMF has laid down the ground rules, have been slow to pledge balance-of-payments support. Remittances have been a savior for Pakistan over the last few years – $13 billion flowed in through regular banking channels in the last fiscal year, which was a huge support to the external account. These held up well in the first quarter of the current fiscal year, but with the recent “correction” in the official exchange rate, and the subsequent increase in the spread between kerb market rates and bank rates, there is a danger that flows will be diverted to the traditional hundi/hawala channels. It is as yet too early to say if this has happened, but it’s a threat.
[quote]Borrowing from the State Bank at Rs 2 billion a day is not sustainable[/quote]
The only time-tested, sustainable way to boost reserves is to effect export growth. But exports have stagnated at about $25 billion a year for the last three years, while imports have increased from $31 billion in FY2010, to $35 billion in FY2011, to $40 billion in FY2013, largely on the back of fuel price increases. The grant of GSP plus status to textile exports from Pakistan by the European Union is a much needed potential respite in this context. But in the short term, the government is going to have to double its efforts to negotiate inflows from multilateral aid agencies, and ensure that the official exchange/kerb rate differential does not increase to a point where remittances are affected.
That brings us to a second much-needed initiative. It is clear that this administration will do little to boost tax revenues, particularly those from direct taxes. There is little point in repeating the argument for checking tax evasion. However, the fiscal deficit has to be bridged one way or the other. If the Federal Board of Revenue is paralyzed, then the government must begin to watch expenditure. The recently announced 40% to 30% cuts in all ministries are only indicative of this. There is a need for a thorough review of non-salary current expenditure and some tough decisions. While the development budget definitely needs to be reviewed and allocations to wasteful or unnecessary schemes checked, indiscriminate cuts in development expenditure at a time when public investment is already on the wane is not the best idea.
Expenditure cuts can only go so far, and should not in fact go further. What is needed urgently is the restructuring and possible privatization of loss-making enterprises. This is a long running project with a Cabinet Committee on Privatization constituted some years ago. The government announced in October 2013 that 31 public enterprises would be up for privatization. A financial advisor has been appointed just last week to start a process of divestment of 26% of the shares of PIA. A further 32 entities will apparently be sold off in the next three years.
There are arguments for and against privatization, and it is true that a privatized entity will not necessarily be run efficiently or to a higher service standard. But ideology aside, the government does not have the option, in the current fiscal environment, to keep organizations like PIA, with losses of Rs 180 billion or so, on its books. This is particularly true if it is helpless in terms of carrying out initiatives to document the economy or bring more people under the tax net. It may not be the best option to raise money, but its one of the few that the government seems willing to go ahead with.
And lastly, inflation. Notwithstanding Finance Minister Ishaq Dar’s recent assertions that inflation is mostly due to hoarding, the government’s practitioners know that fiscal improvidence and monetary expansion are the key factors behind the current escalation of prices. Increasing the policy rate (or the base interest rate) is one way to control inflation, but this has implications for the uptake of credit by the private sector. The government has to bite the bullet and desist from borrowing from the central bank and commercial banks if it really wants to put the inflation genie back in the bottle. This means looking for other ways to plug the fiscal deficit, whether asking for budget support from donors or, in the medium term, plugging holes by selling off assets.
To sum up, the prescription for 2014 doesn’t look very different from the prescription for 2008:
l There is a balance of payments crisis and a need to build up foreign reserves – something which in the short run can best be done through flows into the capital account, either with donor aid or foreign direct investment and remittances.
l There is a need to plug the fiscal deficit. Ideally this should be done through a combination of enhanced tax revenue collection efforts and judicious expenditure cuts. In this case, the capacity to raise revenue to a significant degree is limited both because of the government’s reluctance to net the big fish, and FBR’s lack of capacity. The onus thus falls on divestment of shares in loss making enterprises. This isn’t a short term measure, but some action on this has now become imperative. The government has made some moves, and this momentum needs to be maintained.
l Inflation is a major issue but raising the base rate won’t go far unless borrowing from the banking system is curbed. There may be few options when it comes to plugging the deficit, and all (raising revenue, cutting expenditure, and asking for budget support) are difficult to do, but borrowing at the rate of almost Rs 2 billion a day from the State Bank is not a sustainable option.
In the short run, Pakistan needs external help to maintain macroeconomic stability. This means more flows from multilaterals and foreign enterprises into the capital account, and budgetary support. In the current hyper-nationalistic atmosphere, that may not be welcome news, but there are few alternatives out there.
High on the list of priorities should be foreign exchange reserves, which have dipped to alarming levels. Reserves held with the State Bank have been hovering around $3 billion, or less than a month of imports, since November. The IMF maintains that the State Bank should build up reserves by buying foreign currency from exchange markets, while “maintaining exchange rate flexibility.” That translates into letting the rupee slide if it must, but boosting the reserves. In the long term, the IMF expected the government to consider borrowing in international markets, negotiating further inflows with other donors (based on the security of the ongoing IMF program) and starting a program of privatization.
But there was some miscalculation along the way. The actual balance-of-payments deficit at the end of the first quarter of the current fiscal year was $1 billion more than that projected in the IMF agreement (which was signed in early September). In addition, the net flows in the capital account due to additional aid from donors and a boost in foreign direct investment never materialized. Even the IMF’s allies, like the World Bank and the ADB, who traditionally follow on with funding once the IMF has laid down the ground rules, have been slow to pledge balance-of-payments support. Remittances have been a savior for Pakistan over the last few years – $13 billion flowed in through regular banking channels in the last fiscal year, which was a huge support to the external account. These held up well in the first quarter of the current fiscal year, but with the recent “correction” in the official exchange rate, and the subsequent increase in the spread between kerb market rates and bank rates, there is a danger that flows will be diverted to the traditional hundi/hawala channels. It is as yet too early to say if this has happened, but it’s a threat.
[quote]Borrowing from the State Bank at Rs 2 billion a day is not sustainable[/quote]
The only time-tested, sustainable way to boost reserves is to effect export growth. But exports have stagnated at about $25 billion a year for the last three years, while imports have increased from $31 billion in FY2010, to $35 billion in FY2011, to $40 billion in FY2013, largely on the back of fuel price increases. The grant of GSP plus status to textile exports from Pakistan by the European Union is a much needed potential respite in this context. But in the short term, the government is going to have to double its efforts to negotiate inflows from multilateral aid agencies, and ensure that the official exchange/kerb rate differential does not increase to a point where remittances are affected.
That brings us to a second much-needed initiative. It is clear that this administration will do little to boost tax revenues, particularly those from direct taxes. There is little point in repeating the argument for checking tax evasion. However, the fiscal deficit has to be bridged one way or the other. If the Federal Board of Revenue is paralyzed, then the government must begin to watch expenditure. The recently announced 40% to 30% cuts in all ministries are only indicative of this. There is a need for a thorough review of non-salary current expenditure and some tough decisions. While the development budget definitely needs to be reviewed and allocations to wasteful or unnecessary schemes checked, indiscriminate cuts in development expenditure at a time when public investment is already on the wane is not the best idea.
Expenditure cuts can only go so far, and should not in fact go further. What is needed urgently is the restructuring and possible privatization of loss-making enterprises. This is a long running project with a Cabinet Committee on Privatization constituted some years ago. The government announced in October 2013 that 31 public enterprises would be up for privatization. A financial advisor has been appointed just last week to start a process of divestment of 26% of the shares of PIA. A further 32 entities will apparently be sold off in the next three years.
There are arguments for and against privatization, and it is true that a privatized entity will not necessarily be run efficiently or to a higher service standard. But ideology aside, the government does not have the option, in the current fiscal environment, to keep organizations like PIA, with losses of Rs 180 billion or so, on its books. This is particularly true if it is helpless in terms of carrying out initiatives to document the economy or bring more people under the tax net. It may not be the best option to raise money, but its one of the few that the government seems willing to go ahead with.
And lastly, inflation. Notwithstanding Finance Minister Ishaq Dar’s recent assertions that inflation is mostly due to hoarding, the government’s practitioners know that fiscal improvidence and monetary expansion are the key factors behind the current escalation of prices. Increasing the policy rate (or the base interest rate) is one way to control inflation, but this has implications for the uptake of credit by the private sector. The government has to bite the bullet and desist from borrowing from the central bank and commercial banks if it really wants to put the inflation genie back in the bottle. This means looking for other ways to plug the fiscal deficit, whether asking for budget support from donors or, in the medium term, plugging holes by selling off assets.
To sum up, the prescription for 2014 doesn’t look very different from the prescription for 2008:
l There is a balance of payments crisis and a need to build up foreign reserves – something which in the short run can best be done through flows into the capital account, either with donor aid or foreign direct investment and remittances.
l There is a need to plug the fiscal deficit. Ideally this should be done through a combination of enhanced tax revenue collection efforts and judicious expenditure cuts. In this case, the capacity to raise revenue to a significant degree is limited both because of the government’s reluctance to net the big fish, and FBR’s lack of capacity. The onus thus falls on divestment of shares in loss making enterprises. This isn’t a short term measure, but some action on this has now become imperative. The government has made some moves, and this momentum needs to be maintained.
l Inflation is a major issue but raising the base rate won’t go far unless borrowing from the banking system is curbed. There may be few options when it comes to plugging the deficit, and all (raising revenue, cutting expenditure, and asking for budget support) are difficult to do, but borrowing at the rate of almost Rs 2 billion a day from the State Bank is not a sustainable option.
In the short run, Pakistan needs external help to maintain macroeconomic stability. This means more flows from multilaterals and foreign enterprises into the capital account, and budgetary support. In the current hyper-nationalistic atmosphere, that may not be welcome news, but there are few alternatives out there.