http://www.thenews.com.pk/PrintEdition.aspx?ID=125177&Cat=9&dt=8/7/2012
The reimbursement by the United States of 1.1 billion dollars to Pakistan under the Coalition Support Fund seems to have evoked a sense of relief in the government. Taking an accountants approach to economic management, officials minimise the fact that this respite will be short lived especially as a number of repayments to the International Monetary Fund loom. More importantly this day-to-day approach will only exacerbate the perilous state of public finances and threaten to drive the economy in to an abyss.
The official calculus however is one determined by the timeframe of the upcoming election rather than the countrys economic interests. The governments worry has been how to get to the election without encountering a foreign exchange crisis. When the CSF was suspended and other external financial inflows began to decline, doubts grew about the countrys ability to finance the balance of payments gap and meet foreign liabilities in the months ahead.
At that time, government officials privately conceded that without an infusion of external financing, foreign exchange reserves would continue to deplete and the country could face a foreign exchange liquidity crunch later this year, well before the election. Now these officials see the CSF money as buying the government time to make it to elections, due in March 2013, without worrying about a foreign exchange crisis erupting before then.
The $1.1 billion shores up an otherwise weakening reserve position, but only momentarily. The inflow of funds postpones by a few months the inevitability if no remedial policy action is taken of a full-blown financial crisis being generated by growing external vulnerabilities.
A confluence of negative trends in the past few years has worsened the fragile state of public finances. The balance of payments position has become more precarious and reserves have been steadily falling around $500 million a month recently. In July reserves held by the State Bank were $10.4 billion. Another $4.4 billion held by commercial banks are leveraged and not available to finance the balance of payments deficit.
The budgetary situation is equally shaky with the deficit at its highest since 2008. But the government has been less concerned about this because it can print rupees as well as borrow from the commercial banks. The State Bank has virtually surrendered its authority to determine and enforce government borrowing from the banking system. More borrowing from the central and commercial banks to finance the huge budget deficit is not only adding to domestic inflationary pressures and vulnerability of the banking system, but also fuelling the deterioration in the balance of payments.
These mutually reinforcing factors risk pushing the economy over the cliff. Deterioration in the external position and drying up of financial inflows has already put downward pressure on the rupee, which plunged to a record low last month and is expected to post only a modest recovery following the injection of CSF money.
The greatest short-term danger to the countrys financial stability comes from the sharp rise in the current account deficit. This shot up to $4.5 billion in 2011-12 compared to a surplus of $214 million in the preceding year. This is principally due to worsening in the foreign trade deficit, which widened to $15.3 billion in the outgoing fiscal year from $10.5 billion in 2010-11. Imports have risen sharply. Last years escalating global oil prices contributed to a higher oil import bill up by almost a quarter from the previous year. The subsequent fall in oil prices is yet to be reflected in the external account.
Meanwhile, exports have declined. This is due not so much to weaker demand in Pakistans largest market, financially troubled Europe (which will nonetheless kick in over time), but because of falling global cotton prices. Falling exports also reflect disruptions being caused by the most serious power shortage in the countrys history. This domestic restraint on export growth is likely to persist with no end in sight to the electricity crisis.
The rise in the trade and current account deficits has coincided with the precipitous fall in foreign direct investment. In 2011-12, FDI fell by half, from $1.6 billion in the previous year to $813 million, the fifth consecutive year of FDI decline.
Remittances from overseas Pakistanis have been the big saving grace, reaching $13 billion in 2011-12. But with other external inflows tapering off, remittances and export earnings are not sufficient to meet the balance of payments financing requirements especially when the capital account has been deteriorating as net inflows dry up. As a result foreign exchange reserves have eroded in the past several months.
Against this backdrop, the view among government officials that $1.1 billion of Coalition Support Funds provides them a reprieve underestimates the impact on the reserve position of the accumulation of liabilities the country has to meet in the months ahead.
A significant part of these liabilities are repayments to the Fund for the $8 billion loan Pakistan contracted in 2008. Already repayments earlier this year have reduced the reserve cushion. More payments lie ahead. Between now and December, Pakistan needs to pay $1.1 billion to the Fund including two big payments, this month ($411 million) and in November ($605 million). Another $800 million will be due by the time the government is obliged to call elections, in March 2013.
The key question is this. With reserves dwindling to less than adequate levels and by early 2013 to where they will cover just over a month of imports, how will the incipient financing crisis be addressed? The short answer, already being contemplated by the government, is to go back to the IMF for assistance under a new programme. But here is the rub. Top government figures have long indicated they would prefer an interim government to negotiate a new programme and take the political heat of prior actions that will be necessitated by a new arrangement.
There are at least two problems with this pass-the-buck approach. One, it can no longer be assumed that the IMF will be willing to conclude an agreement with an interim administration. The Egyptian case has set a recent precedent in this regard. Before agreeing to a $3.3 billion loan, the Fund insisted on a broad political buy in, which the interim government wasnt able to deliver. And in Greece, where an agreement had to be concluded with an interim government to avoid an imminent crisis, the Fund asked for the leaders of the main parties to also sign up to this.
The second problem with the governments approach is that delaying corrective policy action and seeking timely IMF assistance will mean that internal and external imbalances will become even larger. In consequence, there will be a bigger economic mess to deal with next year. A more severe fiscal adjustment will be needed to address the unsustainably high budget and balance of payments deficits. This will entail much tougher and painful measures, which may have to be taken in a shorter timeframe.
The government strategy of living on borrowed time to make it to a full-term election while spending its way to the ballot box represents a danger to the countrys financial stability. It also offers no assurance of averting a financial emergency before March. Once reserves begin to dwindle, as they will by year-end, at a time of uncertainty in global markets and commodity price volatility, the pressure on Pakistans external position will grow manifold.
This will expose the economy to the risk of market confidence being shaken by the continuing fall in reserves. In such a fragile situation it would be hard to predict the psychological point at which confidence might begin to evaporate, intensifying capital flight and leading to rapid drawdown of reserves. This will push the country to the edge of insolvency.
The people of Pakistan would then end up paying an even heavier price for a self-serving and inept coalition that prioritises its interests over that of the country.
The writer is special adviser to the Jang Group/Geo and a former envoy to the US and the UK.
Comments: The writer has her analysis correct and I think she is being timid in saying that there will be a failure of confidence. I think that has already started happening. She quoted that $500million have been leaving the SBP per month. I am seeing $300~400million on a weekly basis. Here's the reserve chart
Notice the drop started back around summer. SBP has been going short on the dollar, trying to prop up the rupee. Try to stand in a bucket and then lift that bucket up while standing in it. If you can do that, help me understand how SBP's actions can possibly work. SBP later admitted to this activity when their losses exceed over $3 billion! They have wound down a major portion of their trade by taking a $2.45 billion loss. I cant find on their balance sheet where they have hid that loss.
