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NO FREE LUNCH! – Pakistan’s deep rooted economic crisis

Usman Zahid discusses the economic condition Pakistan was in when it was handed to PTI's government. How is PTI handling the economic mess and what are its plans for bringing economic stability in Pakistan.

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Usman Zahid, is the Director Research at AKD. He has remained associated with Equity Research for over a decade and has previously led Equity Research departments in Pakistan’s top brokerage houses. He holds an MBA degree from the Institute of Business Administration (IBA), Karachi, and an MSc. Accounting & Finance from the London School of Economics & Political Science (LSE). GVS asked the economic expert to give his opinions on the following questions. 

What is your analysis on economic performance?

Faced with a cycle of external crises – with a myriad of challenges on both the external and domestic fronts – the PTI-led government has performed well over the past year. The crisis has its roots in the previous government’s policies underpinning a consumption-based growth model.

The drastic improvement in the external account (CAD narrowed down by 32%YoY in FY19), timely funding support from the friendly countries (i.e. KSA, UAE & China), a relatively successful amnesty scheme and finally, the formal entry into an IMF program (~US$6bn) are major achievements of PTI’s economic management.

This is within the backdrop of a recalibrated foreign policy aimed at creating regional inclusion. On the flip side, delayed decision making on key issues (i.e. fiscal and energy sector) possibly due to political inertia with an 11th-hour documentation drive has extended the crisis. This along with ongoing accountability drive has kept the overall macro environment uncertain and has risked undermining PTI’s noteworthy achievements.

Read more: No Free Lunch: Pakistan’s rocky relation with IMF

Can you shed light on the IMF loan deal, tax revenue collection measures, and the effectiveness of the budget tax measures? Will the govt succeed in generating sufficient revenues, and are they doing enough to facilitate businesses?

As mentioned about, an important milestone achieved by the incumbent government is its entry into the IMF fold for an amount of ~US$6bn (210% of quota). The program aims for ambitious fiscal targets, i.e. additional tax revenue of 4-5% of GDP along with concurrent 4.5% of GDP improvement in the primary deficit over the program horizon.

It seeks an annual PKR1.6trn additional tax revenue effort over the next three years. The prime focus of the fiscal reforms proposed under the IMF program has been on revenue mobilization that too by widening tax base while maintaining a low tax rate, which makes targets even harder to attain.

The government through FY20 budget has already kick-started the adjustment process as a prior action, targeting an aggressive adjustment of 1.2% of GDP. While the government resolve and efforts (so far) in overhauling taxation regime are encouraging, the authorities will have a tough time achieving the fiscal targets, considering the secular slowdown in domestic economic activity.

One should remain skeptical until full implementation of the tax reform agenda and highlight that policy implementation shortfall could lead to mid-term fiscal adjustments to meet the quarterly performance targets.

On ease of doing business, the Board of Investment (BOI) with full backing from PM office has made encouraging initial strides, however, the progress on this end has stalled following the resignation of BOI chairman, Haroon Sharif.

Read more: No Free Lunch: Pakistan’s rocky relation with IMF

Is the Rupee finally out of the crisis? Or will we witness further devaluation?

The adoption of a new ‘market-determined exchange regime’ has led to a steep adjustment in Rupee, with Rupee losing 15.5% of its value against Greenback in 2019. The same has pushed REER index – a metric to assess the equilibrium value of the currency – significantly below its equilibrium level, potentially signifying the era of major devaluation being behind us.

The central bank in its recent monetary policy announcement has sent the same signal. That being said, the Rupee stability in the near term remains contingent upon timely materialization of funding flows.

Rupee could swing either way in a narrow range depending on the direction and magnitude of flows. In the long run, improvement in external account position along with adequate new financing support remains critical in determining the Rupee stability.

Please shed light on the economic progress or decline to be expected in the upcoming months

Looking ahead, the progress on fiscal reforms and developments on the external front (i.e. further reduction in CAD) are two key areas that will determine economic outlook. Persistent improvement at a higher pace is required to achieve macro stability.

So far, the government’s steadfast efforts on the fiscal side (i.e. not caving in to pressure groups/lobbies) lend credence to an ambitious reform agenda. On the external side, continued improvement in the current account along with timely materialization of funding flows are necessary to ensure medium-term economic stability.