Once again the IMF has caused a stir in economic policy circles. The Fund has made a statement that presents Pakistan’s economy in terms quite at odds with the official stance. The IMF is known to be more realistic and less diplomatic when its programs are not actually being implemented, and the latest statement is an example of this.
The occasion was the first post-program monitoring mission (PPM) that the Fund normally undertakes a year after its program ends. In Pakistan’s case, the $4.4 billion Extended Fund Facility negotiated in September 2013 ended after four years and was up for review.
The PPM report has raised the following red flags. While acknowledging that growth could again top 5% in the current fiscal year, it points out that slippages in some major macroeconomic indicators could put this outlook at risk. The key slippages identified are: a) the fiscal deficit will slip to more than 5.5% of GDP; b) imports have surged, resulting in a higher current account deficit (up to 4.8% of GDP); and c) a significant decline in international reserves is expected.
All of this adds up to the IMF’s main concern in a PPM, that the borrowing country’s ability to service its loan to the Fund may be somewhat compromised. But the headline-grabbing statement was the one on net international reserves, which, the Fund alleged, stood at -$0.7 billion in mid February 2018.
If this were not an election year, it is pretty clear that the sitting government would, as of now, be negotiating another package with the IMF
Here is how the IMF calculated this. Gross reserves in mid-February amounted to $12.7 billion. The IMF’s own liabilities are of the order of $6.4 billion. The Chinese currency SWAPS amount to $1.3 billion while other SWAPs, or what the IMF calls the State Bank’s “net short derivative position” comes to $5.4 billion compared to $2.7 billion in September 2016.
So what does this mean in simple English?
The IMF requires central banks of its member states to report not just on the international reserve holdings but also on foreign currency liquidity, where the latter includes off-balance sheet activities, including dealings in financial markets by the government as well as authorized agents. Liquidity estimates typically look at the short term position—often just one year—and assess if the country has the necessary resources to meet its foreign exchange payment needs over this short time horizon. In the case of Pakistan, the IMF has doubts.
Central banks in modern economies don’t just sit on foreign exchange reserves, they manage them, invest them, leverage them in financial markets to make more money, or use financial markets to manage risk of exchange rate variability. One way to do the latter is to trade in derivative products, which in the case of the State Bank, includes swaps and options, essentially betting on whether the value of a particular currency will appreciate or depreciate in the future. The net forward position in currency markets thus refers to all amounts to be received less all amounts to be paid under forward foreign exchange contracts in the currency concerned (in this case the US dollar). It was after the financial crisis of 2007 that the IMF insisted that this data be reported upon, since it sheds light on the risk exposure of monetary authorities. Sudden movements in exchange rates could thus have implications for foreign reserves that may not be captured if only the reserve holdings position is studied. It would appear from the IMF’s data that demands on Pakistan’s foreign exchange in the financial derivatives market could potentially be close to $6 billion.
With characteristic aplomb, the political leadership in Pakistan has dismissed the IMF’s statement, and said that not only will GDP growth be higher than predicted by the IMF, but that the current account deficit will not be allowed to rise beyond 3% of the GDP max. There is thus no reason to expect the worst, as per the Finance Advisor. There is no mention in official statements of the State Bank’s short term liabilities, the assumption being, perhaps, that they will be held in check by growth in exports and the fact that exchange markets are unlikely to move in directions which will cause the State Bank’s attempts at hedging to backfire.
The authorities are right in saying that the IMF is reporting on worst-case scenarios, but they are not being sufficiently cautious when they dismiss the IMF’s speculation outright.
In short, a year after exiting the IMF’s program, Pakistan is in a potentially difficult position again when it comes to maintaining a safe level of foreign exchange reserves and meeting its obligations. If this were not an election year, it is pretty clear that the sitting government would, as of now, be negotiating another package with the IMF. As things stand, this may be delayed as the optics just won’t look good; no government in a developing country wants to go into an election saying the economy is in crisis and they have just negotiated a bailout package. But a bailout may very well be needed in the short term, perhaps before the elections. Some newspaper reports suggest that a “friendly” country is being approached to “loan” a couple of billion, just as they did a few years earlier when a mysterious “gift” was announced. Given the services that the military has rendered for this friendly benefactor, it seems like a small price for them to pay. And it may just save us a considerable degree of embarrassment in the international community.
In the longer run though, it comes down to the need to have a good, long review of why exports have been stagnant for half a decade and why we can’t seem to go beyond textiles. Such a review requires a long-term vision and the ability to face some unpleasant facts. Let’s hope that there is at least a recognition in the next government that planning for the future means a time horizon of more than three years.