Last month marked two years since the Pakistan Tehreek-e-Insaf (PTI) government was elected on the back of a transformative agenda that promised reforms to eliminate deeply entrenched structural inefficiencies in the economy.
A wave of optimism ushered in the change with expectations that it would eliminate corruption in the public sector, boost private sector investments, and generate economic activity to provide employment for the burgeoning youth bulge in the country.
The mountain PTI had to climb
However, the government inherited an expanding trade deficit and annual current account deficit in excess of $18 billion, much of it being driven by internal consumption. The previous PML-N government had borrowed over $34 billion internationally and encumbered the nation with external liabilities in excess of $95 billion, without consideration of how the foreign debt will be repaid.
The unsustainability of the external position was highlighted by Moody’s Investors Service downgrading Pakistan’s rating outlook to negative from stable in June 2018 on concerns that “foreign exchange reserves had fallen to low levels and low reserve adequacy threatened continued access to external financing at moderate costs, in turn potentially raising government liquidity risks”.
In the same month the international watchdog against money laundering and financing of terrorism, the Financial Action Task Force (FATF), placed Pakistan on a list of “jurisdictions with strategic deficiencies”, also known as the grey list. This threatened to adversely impact the links of Pakistan’s banking channels with the international financial system, thereby affecting imports, exports, remittances and access to international lending.
PTI assumed power with $9 billion of external debt repayments due in the first year, dwindling foreign exchange reserves, and limited access to international debt markets for continued financing of the domestic consumption-driven growth strategy pursued by the previous government. A balance of payments crisis was looming and hopes of reinvigorating the economy were greeted by the reality of a potential economic implosion. Stabilizing the economy had to be prioritized ahead of all other electoral promises.
While the previous PML-N government had insisted that the country would not have to go to the International Monetary Fund (IMF) for financial assistance, the stark reality presented to the PTI government made it clear that this option could not be rejected. All avenues had to be explored including the need to bolster forex reserves and secure some negotiation space with the IMF.
Prime Minister Imran Khan and his team, therefore, embarked on a whirlwind round of trips to friendly countries, which included Saudi Arabia, the UAE, Malaysia, and China to humbly entreat these friendly nations for help, in order to navigate the nation out of the dangerous swirls of imminent crisis.
The effort paid off as monetary infusion into the country’s treasury helped stave off the possibility of imminent default. The assistance from these countries also reflected their confidence in the new government’s economic team to take the difficult decisions that would demonstrate its determination to do what is necessary to put the economy in order.
Tough measures preempted loan requirements
Some measures taken by the government preempted the requirements under the IMF’s Extended Fund Facility (EFF) program that it committed to, nine months after coming into power. It is argued by some that terms of the facility were less onerous than would have been the case had the government entered the program earlier than it did.
Irrespective of timing, the underlying rationale for EFF was, as stated by IMF, “the challenging economic environment largely reflected the legacy of uneven and procyclical economic policies in recent years aiming to boost growth, but at the expense of rising vulnerabilities and lingering structural and institutional weaknesses.” In simple words, the economic crunch the country had to undergo was unavoidable given the policies of the earlier government.
Correcting the misaligned combination of loose monetary policy and supporting an overvalued currency, the government required the State Bank of Pakistan (SBP) to adopt a market-determined exchange rate mechanism that resulted in the rupee depreciating by 30 percent, which in turn fueled inflation.
This was exacerbated by gas and electricity tariff hikes that were necessary to stem circular debt growth. As these measures drove up inflation, which peaked at 14.6 percent in January 2020, the resultant tightening of monetary policy depressed economic activity.
While SBP was severely criticized for raising interest rates and suppressing growth, it had no option but to do so in order to maintain positive real interest rates against inflationary expectations. Failing to do so would have not only have further fueled inflation, but potentially could have encouraged dollarization of the economy, which in turn would have led to a vicious cycle of depreciation feeding into consumer price increases, and so on and so forth. Negative real rates in a high inflation environment would also have discouraged private banks from lending, thereby additionally harming economic activity.
The politically unpopular measures of tightening of monetary policy and fiscal austerity suppressed economic growth, but yielded results, as it helped narrow the current account deficit and stabilize the rupee. Imports fell by 6.8 percent in the fiscal year 2018-19 and a further 19 percent in 2019-20. Both inflation and interest rates were on a downward trajectory as of March this year. The economy showed signs of a turnaround as the government posted a primary surplus for the first nine months of 2019-20 after several years of deficits.
‘Smart’ policies kept virus threat at bay
When COVID-19 broke out, it threatened to reverse incipient growth and the hard-won improvements on the fiscal account. While the government was successful in reducing overall fiscal deficit to 8.1 percent in FY 2019-2020 from 9.1 percent of GDP in the previous year, the pressure in the fourth quarter of 2019-2020 due to pandemic related expenditures is apparent in the quarter-wise breakup of the account. Fiscal deficit was 4.0 percent of GDP up to Q3 of FY 2019-2020, while last quarter of FY2020 alone registered the deficit at 4.1 percent of GDP.
The International Monetary Fund (IMF) and SBP predicted that Pakistan’s economy would contract by 1.5 percent, and the primary deficit rise to 2.7 percent of gross domestic product (GDP) in FY 2019-20. It was therefore encouraging for policymakers to see GDP in actuality shrink by only 0.4 percent, and primary deficit at 1.8 percent.
Read more: Economy of Pakistan and The Coronavirus
The deficit had been 3.6 percent of GDP in FY 2018-2019. Although the pandemic is still not over, and the government is careful not to claim victory, Pakistan appears to have fared better than what was initially predicted by multilateral organizations such as IMF, World Bank, ADB, and WHO both in terms of lives lost as well as the economic fallout.
The better-than-expected performance can be attributed to the decision to avoid a complete lockdown and institute a policy of smart lockdowns that allowed large segments of the economy to continue functioning. The Prime Minister’s Rs1,240 billion Economic Relief and Stimulus Package provided support to the most vulnerable members of society, small and medium industries (SMEs) and rural farmers.
Direct cash transfers of Rs160.4 billion to 13.1 million households through the Ehsaas Program helped prevent social unrest and maintain purchasing power. Prime Minister Imran Khan can also take credit for initiating the global discussion on debt relief for developing countries. The move led to debt rescheduling from G7 countries.
Signs of V-shaped recovery
There are early signs of a V-shaped economic recovery. The revival of the construction sector and export demand boosted cement sales in July by 37.8 percent year on year. Urea fertilizer has also picked up with sales in June higher by 81.2 percent compared to the same month in 2019.
Petroleum product sales and electricity output are back to pre-coronavirus levels. Auto sales in July increased by 38% year on year and car assemblers have announced they will be ramping up production levels to meet pent-up demand of consumers. After the damage caused by COVID-19 pandemic and shrinking by 10.2% in FY 2019-20 year on year, large scale manufacturing (LSM) appears to be turning the corner. Monthly figures show manufacturing activity grew by 16.8 percent month on month in June FY 2020.
Read more: PTI handed a Poisoned Chalice to drink from
On the external front, while exports fell by 14.6 percent to $1.9 billion in July compared to $2.2 billion last year, they have increased month on month by 19.7 percent from $1.6 billion in June. It is hoped that the easing of lockdown in the main destinations for Pakistani textile goods will further help revive the exports. Declining imports, which fell by 13.3 percent to $3.6 billion from $ 4.2 billion last year, helped shrink the trade deficit by 11.8 percent to $ 1.7 billion in July from $2.0 billion last year.
In the first month of the current fiscal year inward remittances rose by 36.5 percent to $2.77 billion from $2.03 billion in July 2019. This was the highest ever level of remittances in a single month and on a month on month basis showed an increase of 12.2 percent from $2.47 billion in June 2020.
Key policies helped support the upturn in the economy
While it is too early to conclude whether these increases are sustainable as some of the growth is due to seasonal effects, SBP has pointed out policy steps taken by the State Bank and the federal government under the Pakistan Remittance Initiative that are likely to have supported the recent upturn.
These include orderly exchange rate conditions, reducing the threshold for eligible transactions from $200 to $ 100 under the Reimbursement of Telegraphic Transfer (TT) Charges Scheme, an increased push towards adoption of digital channels, and targeted marketing campaigns to promote formal channels for sending remittances
Narrowing of trade deficit and robust remittances have helped turn around current account surplus of $424 million in July from a deficit of $100 million in June 2020 and $613 million in July last year. The improving balance of payments has helped boost Pakistan’s total liquid foreign exchange reserves to $19.6 billion by the end of July 2020, up by $ 4.5 billion over end-July 2019. The breakup of reserves accumulation in July 2020 shows that the SBP’s reserves stood at $ 12.5 billion ($7.8 billion last year) and $7.0 billion ($7.3 billion last year) in commercial bank’s reserves.
The improving economic conditions are also reflected in the Federal Bureau of Revenue (FBR) exceeding its tax collection target by 23 percent in the first month of the current fiscal year. With improved growth prospects, foreign exchange reserves providing import cover of around 3 and half months, and consumer price index (CPI) August figures indicating that inflation is likely to average below 8 percent for the current fiscal year, the government can now focus on delivering on its agenda for policy and administrative reforms.
On the back of power sector inquiry report launched earlier this year, renegotiation of the highly one-sided power purchase agreements with independent power producers points toward comprehensive sector reforms and help mitigate the circular debt issue and will possibly provide relief to consumers in tariff reductions. The government has also shown commitment in implementing the Financial Action Task Force’s (FATF) action plan for addressing deficiencies in policies and legislation to control money laundering and terror financing.
Reports commissioned by the government on the sugar and wheat sectors also highlight how state subsidies to large swathes of the economy have entrenched rent seeking within the system, and depressed the overall competitive environment. In order to enhance productivity and growth, the role of the public sector has to be limited to only addressing market failures. Where interventions are required to support an activity or alleviate particular sections of society, it must be ensured that these are specifically targeted and for a limited period only.
SOEs severely impaired by operational inefficiencies in the economy
Pakistani state-owned organizations (SOEs) continue to be severely impaired by operational inefficiencies and a chronic lack of profitability. For instance, the state-owned Pakistan Steel Mills (PSM) has accumulated losses and liabilities of almost Rs230 billion. Despite PSM stopping production in 2015, Pakistani taxpayers spent Rs55 billion over the last five-and-half years on salaries of 9,350 workers — many of whom had reportedly secured other employment in the period. Recently the government finalized on a Rs19.66 billion redundancy packages for these employees.
Between June 2018 and March 2020, the total debt of SOEs increased from Rs 1.393 trillion to Rs1.980 trillion. This increasing liability limits fiscal space required to invest in high-priority social sector areas such as education and health. Given its commitment to reducing the fiscal deficit, the government needs to accelerate the process of extricating the state from loss-making corporates, especially where the private sector can do the job more efficiently and profitably.
The government needs to accelerate the steps being taken toward comprehensive trade reforms simultaneously and urgently to help Pakistani entrepreneurs and the economy generally be much more globally integrated than it presently is. Although the last budget proposes a tariff reduction from 11 percent to 3 percent or zero on many raw materials and semi-finished products for the industrial sector, Pakistan still maintains the third-highest average weighted tariff among the 68 countries having more than $20 billion annual exports. It needs to ensure that it gives its industry a fair chance to improve competitiveness by rationalizing the tariff structure that not only eliminates many of the existing duties but also makes those that exist transparent and predictable.
Going forward, the government must maintain fiscal prudence and avoid creating macroeconomic imbalances. Revenue collection will have to be broadened by improving FBR functioning through modernization and digitalization, improvement in databases and the streamlining of legal procedures will mitigate some of the difficulties in taxing the informal sector of the economy. It should not improve FBR’s organizational efficacy, but also to minimize reliance on regressive measures like withholding/indirect taxation and the contrivances of filers/non-filer distinctions, as well as transform the General Sales Tax into a broad-based Value Added Tax.
Entrenching a business-friendly but competitive environment should help remove rent-seeking cartels and revitalize the economy. A progressive tax regime can help fund much-needed support to society’s most vulnerable members. Finally, Pakistan has recorded fewer COVID-19 fatalities per million than many other countries and this has helped boost public sentiment considerably. It is vital that the so far successful policy to combat the coronavirus pandemic and opening up of the economy government is not forced into reversal due to a resurgence of the pandemic. It is incumbent on the government to keep nudging the people in the right direction so that easily enforceable protocols are strictly adhered to.
The Prime Minister must continue to provide a vision of reform and renewal. This cannot be merely in terms of rhetoric but has to be supported by concrete proposals and a timeline for action. It will require him to regularly, directly, and candidly communicate with the people of Pakistan in a manner that leaves behind the fears and ghosts of the past, and provides confidence that the government can bring about transformations such that the worst of times are behind, and better times lie ahead.
Javed Hassan is a graduate of Imperial College London and an MBA from London Business School. He is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan.
The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.