No Free Lunch: Pakistan’s rocky relation with IMF

Hussain Haider, an economic expert, analyzes where previous governments’ handling of the economy went wrong and how Pakistan has lived beyond its means for several decades.


We often hear that in the recent past, foreign loans were being used to artificially maintain the Pakistani Rupee at an overvalued rate. During this period, Pakistan’s trade deficit increased uncontrollably, with the blame pointed at imports of heavy machinery, and CPEC-related infrastructure. Granted, while machinery imports did increase, there was also a sharp rise in the imports of non-oil and non-machinery imports, luxury, automobiles and non-essential items.

As a result, our trade deficit was increasing alarmingly while our external borrowing capacity was getting completely choked up. The perfect storm ensued as these forces combined, accompanied by a government change after the 2018 general elections. Today, our shopping centers and grocery stores are flooded with imported goods, an obsession that is detrimental to the economy.

It goes without saying that the need of the hour is to cut imports in the short run by whatever means possible rather than excessively pursuing long term plans for increasing exports. Our past actions have brought upon us the sharpest and longest bearish spell of the Rupee in the last thirty years.

On average, bearish spells would last for around 12 months with the average rupee devaluation ranging between 15% and 19% in one go. The current devaluation cycle has been going on for 19 months now, and the rupee has lost around 35% of its value in its wake.

FATF’s final decision, expected later this year could be another significant influencer on Pakistan’s already formidable economic challenges

Despite the fact that oil prices have been comparatively lower than during the 2008 crisis, our economic situation has deteriorated alarmingly. The mounting fiscal deficit is a crucial indicator that the heightened budgetary financing requirements could eventually take a toll on the exchange rate. Although the current account deficit (CAD) has reduced from $18 billion in FY18 to $12.7 billion in Jul-May 2019, such a comparison would be fallacious since the previous year’s number was too high and in fact unsustainable.

State of Pakistani Rupee

In other words, a reduction was always on the cards. If this was, in fact, a major achievement, there would have been no need for the government to state that the current account deficit should be cut in half during the fiscal year 2019-20. It is important to highlight that to land at a CAD of $13 billion for FY19 – as mentioned in the budget speech – the deficit for the final month of the fiscal would have to be curtailed at approx.

$300 million (70% lower from May-19 and 63% lower than the average CAD for the previous five months i.e. Jan-May 19). For FY20, a CAD of $6.5 billion is achievable in a scenario where remittances rise by the usual 10% and imports shrink by about $7 billion from FY19 levels, ceteris paribus.

Those claiming that the IMF will push Pakistan into a financial ditch should realize that our fiscal condition already has us on the edge. It would be wrong to deduce that the IMF controls the conditions and manipulates requirements. In fact, there are no Pakistan-specific conditions. The IMF has put forward a diagnosis that encourages Pakistan to raise taxes and generate revenues.

Note that all the tough measures for which the government is being vilified would undoubtedly have to be taken in any case, with or without the IMF. One such measure is the market-based exchange rate. Our depleting FX reserves have simply left us with no other choice and the exchange rate volatility that ensues will soon become the new normal.

The past week saw news of debt repayments, and this outflow of dollars has created a lot of pressure on the rupee, triggering its rise to 165. The current month is an important one in this regard; approval from the IMF will allow $500-600 million to flow into the system as a first tranche. The situation can improve if the Asian Development Bank or the World Bank agrees to help.

If we receive, say $1-2 billion from them, coupled with any additional bilateral support, we might see the rupee appreciating to under 150 level against the dollar. Such news flows may create a feel-good factor, pushing people into a false sense of security that the Rupee has strengthened, possibly leading to a positive reaction from the stock market as well.

Read more: PM Imran holds constructive meetings with IMF & World Bank Presidents

Another topic of discussion is the Real Effective Exchange Rate (now around 102), which has some believing that further devaluation may be a myth. However, it must be kept in mind that this only reflects trade competitiveness; it does not take into account flows in the financial account. Given the debt repayments looming ahead, with the passage of time dark clouds could reappear and the dollar may eventually rise up to 165-170. The most important and widely anticipated news is that of debt rescheduling, allowing Pakistan some flexibility in terms of deadlines and relief.

Efforts to Bring Rupee Back

This will assist the Rupee to stabilize, but in the absence of such news, Pakistan will be in dire need of excessive external borrowing, compelling us to issue more bonds and reach out to external sources. In the absence of a debt rescheduling offer or any delay in foreign exchange inflows, the exchange rate is likely to go haywire, and it wouldn’t be surprising if the Dollar jumps up to 200 (in a worst-case scenario).

Additionally, we need to track developments on FATF, especially given their recent comments on Pakistan’s progress. The final decision, expected later this year could be another significant influencer on Pakistan’s already formidable economic challenges. It will be challenging for investors and individuals alike as disposable incomes erode and all salaried individuals are heavily taxed. Foreign trips including Hajj and Umrah will become increasingly expensive. It will undoubtedly be an extremely tough time.

Syed Hussain Haider has over 15 years of extensive experience in equity portfolio management, buy-side & sell-side research for institutional clients in South Asia, Middle East, UK & North America. He has worked with leading financial institutions in Pakistan and presently working as Head of Research at JS Global Capital Ltd. He is a CFA Charterholder, a CIPM Certificant and holds an M.B.A. from IBA, Karachi.

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