First, the good news: the International Monetary Fund (IMF), one of Pakistan’s biggest lenders, has expressed confidence that Pakistan’s economic growth in the last fiscal year was more than double its earlier estimates.
Business-friendly measures announced in the recent federal budget, an accommodative monetary policy, concessionary loans for businesses, and disbursement of cash to the poor under the Ehsaas programme are steps that are believed will keep the growth momentum consistent throughout the current fiscal year too.
The improved business environment has directly benefited many sectors of the economy, such as large-scale manufacturing, export-oriented industries and construction etc. Weather permitting, agricultural growth is also expected to remain robust this year. Prime Minister Imran Khan himself is seen to be taking a keen interest in agricultural transformation and has announced a slew of fiscal concessions for the winter crops.
Foreign exchange reserves – $24.87 billion on July 31, 2021 – are also expected to remain robust this year. By the end of this month, these reserves will rise further by $2.8 billion through a special allocation made by the IMF. In tandem with these developments, $1 billion was raised last month through the sale of Eurobonds and $1.89 billion has been raised since September 2020 through term deposits in Roshan digital accounts.
Compared to their very high growth in 2020-21, workers’ remittances may decline slightly as corona-necessitated travel restrictions ease and Pakistani expats are able to bring money into Pakistan in person rather than through banks, as they have been doing over the last year or so. This decline may be counterbalanced by the restrictions that the Financial Action Task Force (FATF) has imposed on currency movements across borders to discourage money laundering.
These reserves will help Pakistan in making repayments to its external lenders. Pakistan is estimated to pay $14.7 billion this year in principal and interest amounts to its foreign lenders.
The overall impact of the factors mentioned above is that the economy is growing, leading to increased demand which is resulting in increased imports. This is where the story of Pakistan’s economic growth takes a twist. Increased imports of petroleum products, edible oil, wheat, sugar and cotton, among other things – at prices which have been highest in recent years – are causing import bills to go through the roof. Even though this is good news for the Federal Board of Revenue (FBR), which collected more than half of its revenue during July 2021 through import taxes, this could easily eat up all the gains that the economy has made in the last year or so.
Here’s why: Pakistan’s current economic growth is fueled by import-based domestic consumption which is heavily dependent upon a constant build-up of foreign exchange reserves (so that import bills are continued to be paid). In the absence of a corresponding increase in export earnings, however, the ever-rising import bills lead to a balance of payments (BOP) crisis. To explain this crisis in simple words, it means that you need more money to pay for your imports and to return loans than you have in your kitty.
In a high-import growth scenario, any substantial decrease in remittances or other inflows of money can easily lead to a situation in which dipping into the foreign exchange reserves becomes inevitable. This, in turn, puts pressure on the rupee’s exchange prices and declines in Pakistan’s credit-worthiness.
To shore up its foreign exchange reserves, Pakistan can go to multilaterals (ADB, IMF, and the World Bank).
The only way to reduce circular debt in the short run is to increase electricity prices. The World Bank’s move to link its $1 billion loan with increase in tariffs also points the same way.
PM Khan is determined not to increase the power tariffs as costlier energy will impact the people. However, if the government cannot pass on the price impact of expensive imports – such as oil and gas – to consumers due to political compulsions then it will have to absorb the price shock through subsidies. While, on the one hand, these subsidies will increase the government’s expenditure and thus increase the existing gap between its income and its expenses, on the other, they will increase circular debt accumulating in the energy sector which is already touching Rs2.5 trillion.
In the meantime, as imports surge – having been valued at $6.05 billion in June 2021, an all-time high, and $5.4 billion in July 2021 – importers need more dollars than they can find in the market. The State Bank of Pakistan could have improved the dollar supply by using its reserves, but it has to rightly spend those reserves on external debt and liability payments. It will only interfere if the foreign currency market goes totally haywire. Resultantly, the rupee’s value has slipped from 152 to a dollar to 164 to a dollar in the last two months.
The rupee’s ongoing depreciation is making imports costlier in local markets which is highly likely to push up inflation. It could, simultaneously, also result in the dollarization of the economy – a state in which people want to turn their assets into dollars to stave off the effects of depreciation in local currency.
If this depreciation of rupee is unable to slow down the demand for imports and current account deficit crosses a certain threshold, then the SBP will have no other option but to increase interest rates to curb consumption and incentivize savings. It will be easier said than done though.
As the demand for certain imports such as fuel, edible oil, and certain other food items is inelastic. Curbing it will curb economic growth and cause food inflation. This means that the depreciation of the rupee will not have its desired impact on imports and exports and will, instead, increase the domestic sales price of imports.
Similarly, the SBP cannot easily increase interest rates, which it has kept at 7 percent for more than one year now, without the risk of hurting an already precarious economic growth overshadowed by Covid-19.
This leaves Pakistan with the same option that it has often used in order to have enough foreign exchange in its kitty to pay for its high imports as well as to return its debts: reengaging with multilaterals by accepting their demand about increase in electricity tariff.
The Ministry of Energy has a decent circular debt management plan. It can use some ‘consumer neutral’ bookkeeping solutions (such as replacing general sales tax with increased base-tariff) to partly recover the cost of electricity generation. The rest of the cost can be recovered through progressive increase in tariffs, better bill collection, and reducing losses etc. Doing so, it has the cushion to insulate the consumers of less than 200 units of electricity per month (lower 40 percent of population) from any price shock through subsidies.
Pakistan is on a growth trajectory. However, to tackle a potential balance of payments crisis, it will have to choose a rational combination of three moves: a gradual depreciation in the rupee’s value, a gradual increase in interest rate and a phased increase in energy prices.
Having said that, to sustain growth beyond this period, the government will have to ensure an increase in export earnings and encourage investment – both foreign and local.
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