Pakistan: IMF country report

International Monetary Fund (IMF) has released its Country Report on Pakistan after the Executive Board completed seventh and eight reviews of the Extended Fund Facility (EFF).

According to the IMF report, program implementation deteriorated after the completion of sixth review in February 2022. Amid a tense political landscape, programmed fiscal adjustment was undone and several key EFF commitments were reversed like imposition of Petroleum Levy (PDL) and grant of subsidies on petroleum products.

In June 2022, two Performance Criteria (PC) on net international reserves and the primary budget deficit requirements were not met, as well as three continuous PCs were missed.

Moreover, seven structural benchmarks were also not met. Analysts believe that fiscal deficit target of 4.6% of GDP was ambitious.

Recent floods in various parts of the country have caused major losses to human lives, infrastructure, and crops. According to Dr. Aisha Pasha, State Minister for Finance the initial estimates indicate that the losses caused by floods were close to Rs2 trillion (2% of GDP).

Considering this view, it is likely that Pakistan’s fiscal deficit will likely clock in between 6-7% of GDP for FY23.

It is also expected that IMF will consider the potential impact of floods and provide some relaxations especially if Pakistan continue to remain steadfast in implementation of reform agenda agreed with IMF.   

As per the IMF country report, Pakistan Government has recently taken major steps including the completion of prior actions that led to revival of the IMF program.

It is believed that the current political setup has taken unpopular steps recently in spite of increasing political noise. This helped Pakistan got two waivers on PCs and also brought IMF program back on track.

IMF also approved Pakistan’s request to increase the size of program by US$1 billion and extend the program till June 2023 instead of September 2022.

Waivers on PCs & extension in program tenure will provide the much needed support to the Pakistan economy.       

IMF has recommended Pakistan authorities to restore fiscal and debt sustainability, safeguarding monetary and financial stability and maintaining a market driven exchange rate.

IMF has projected GDP growth of 3.5% in FY23 with Current Account Deficit (CAD) of 2.5% of GDP (US$9 billion) and CPI inflation of 19.9%.

It is anticipated that GDP growth will be in the range 2.5% to 3.5% in FY23. Current Account Deficit is likely to remain less than 3% of GDP. 

Though, it is early to estimate the potential impact of floods on current account but risk to upward revision in current account estimate remain (close to around US$1 billion) depending upon the crop damage and the demand to meet required demand through imports.

It is also believed that pressures on current account due to crop damage could also be somewhat compensated through: 1) economic slowdown and lower demand for imports, 2) higher remittances due to flood support from expats, and 3) increased aid and financial assistance from international community.

As per IMF, gross external financing requirement for FY23 is estimated at US$31 billion and available financing is projected at US$33 billion for FY23 as against SBP’s target of US$37 billion for FY23.

Analysts believe any additional financing requirement due to higher current account could be compensated through increased foreign aid and financial flows to the country.

On the monetary front, keeping in view the recent inflationary trend (CPI Inflation of 27.3% in August 2022) and the outlook on food prices post floods, it is likely that average inflation will also cross IMF estimate of 20%.

CPI inflation is likely to remain below 24%, keeping in view the extent of damage from recent floods and potential economic slowdown.

Analysts do not expect any further hike in interest rates in 2022. In fact, it is expected to start falling from 4QFY23.

Pakistan: Staff level agreement reached with the IMF

Pakistan has finally reached staff level agreement with International Monetary Fund (IMF) on policies to complete the 7th and 8th reviews of Pakistan’s Extended Fund Facility (EFF). 

The agreement is subject to IMF board approval, likely in August, which will pave way for the release of US$1.17 billion bringing total disbursement to US$4.2 billion under EFF.

Additionally, in order to support program implementation and meet the higher financing needs in FY23, the IMF Board will consider an extension of the EFF till June 2023 instead of September 2022. The Board will also consider increasing the size of the EFF program to US$7 billion, up from initially proposed US$6 billion.

This support will provide some help as delays in IMF program and policy actions had led to increased economic uncertainty and a continuous decline in foreign exchange reserves.

To recall, 7th and 8th reviews of Pakistan EFF program was initially scheduled in March 2022 and June 2022 but Pakistan was not able to reach Staff level agreement with IMF due to delay in proposed policy actions like removal of petroleum subsidies, imposition of Petroleum Levy (PDL), energy tariff rationalization and increased tax measures.

It is believed that the implementation of key policy actions like increase in energy tariffs (gas and power rates) and other structural benchmarks like gradual increase in taxes on oil and implementation of anti-corruption law will remain key and will lead to IMF’s executive board approval and release of funds. 

IMF in its press release highlighted 5 key policy priorities to stabilize economy and bring policy actions in line with IMF-supported program which includes 1) Steadfast implementation of FY23 budget, 2) catch-up in power sector reforms, 3) proactive monetary policy to guide inflation to more moderate levels, 4) reducing poverty and strengthen social safety, and 5) strengthen governance.

The recently passed budget aims to reduce government’s large borrowing needs by targeting an underlying primary surplus of 0.4% of GDP by restricting expenditures and broad revenue mobilization measures.

Relating to power sector reforms, IMF noted that due to weak implementation of the previously agreed plan, the power sector circular debt flow is expected to grow significantly to about Rs850 billion in FY22.

Furthermore, adjustment in monetary policy and linkages of EFF and LTFF rates with policy rate remain the key given rising inflationary pressures. Government is also establishing a robust electronic asset declaration system and plan to undertake a comprehensive review of the anticorruption institutions (including the National Accountability Bureau).

IMF stressed that “Steadfast implementation of the outlined policies, underpinning the SLA for the combined seventh and eighth reviews, will help create the conditions for sustainable and more inclusive growth”.

It is believed that Pakistan economic situation will remain challenging due to uncertain global economic and financial market conditions along with local political situation.

Pakistan need to arrange funding up to US$35 billion during FY23 which is big task considering rising interest rates and risk averse attitude around the world.

There are expectations that few friendly countries like China, Saudi Arabia will continue financial support to Pakistan after IMF deal.

Furthermore, Pakistan is also expected to receive financing from other Bi-lateral and Multi-lateral donor agencies that could provide some support to reserves of the country.    

Moreover, after ousting of the previous Khan government through a no confidence motion, the PML-N led coalition government will be going into elections next year whereby it will be difficult to take all much needed reforms.

Though, the recently announced measured by the new government in Pakistan will help stabilize the economy and reduce fiscal and current account deficit, the overall investor confidence will remain below average.

Pakistan Eurobond yields are now at 20%-32%, local lending rate is at 20 year high of 15.87% while Pakistan stocks are down 6% (US$ down 21%) in 2022 to date.

This new IMF deal may help in some recovery of Pakistan dollar bond prices but considering the overall global interest rate environment and Pakistan rising debt a strong recovery may not come.

Similarly, Pakistan stocks may react slightly positively to this news but given Pakistan’s high lending and policy rates & other challenges like high inflation could continue to impact stock market sentiments.

Recently in its monetary policy statement SBP also highlighted key risks like high global commodity prices, rising inflation and increasing external account concerns that remain critical for Pakistan economic outlook.   

Analysts expect FY23 GDP growth of maximum 4% against government target of 5% and estimate CPI inflation around of 19% in FY23.

Global energy prices also remain the key for Pakistan. In FY22, oil and LNG imports are estimated at US$22 billion which was 27% of total import bill. A sustainable fall in oil, coal and LNG prices can provide some support to Pakistan external account.

 

IMF Completes Combined Review of EFF for Pakistan

Reportedly, Executive Board of International Monetary Fund (IMF) has completed combined second through fifth reviews of the Extended Arrangement under the Extended Fund Facility (EFF) for Pakistan, allowing for an immediate release of US$500 million for budget support, taking total budgetary support under the arrangement to about US$2 billion.

Program performance has remained satisfactory notwithstanding the unprecedented challenges of the COVID-19 shock, and the authorities’ policies have been critical in supporting the economy and saving lives and livelihoods.

Pakistani authorities have remained committed to ambitious policy actions and structural reforms to strengthen economic resilience, advance sustainable growth, and achieve economic reform program medium-term objectives.

Pakistan’s 39-month EFF arrangement was approved by the Executive Board on 3rd July 3, 2019 for about US$6 billion at the time of approval of the arrangement, or 210% of quota. The program aims to support Pakistan’s policies to help the economy and save lives and livelihoods amid the still unfolding COVID-19 pandemic, ensure macroeconomic and debt sustainability, and advance structural reforms to lay the foundations for strong, job-rich, and long-lasting growth that benefits all Pakistanis.

Following the Executive Board discussion on Pakistan, Ms. Antoinette Sayeh, Deputy Managing Director and Acting Chair, issued the following statement:

The Pakistani authorities have continued to make satisfactory progress under the Fund-supported program, which has been an important policy anchor during an unprecedented period. While the COVID-19 pandemic continues to pose challenges, the authorities’ policies have been critical in supporting the economy and saving lives and livelihoods. The authorities have also continued to advance their reform agenda in key areas, including on consolidating central bank autonomy, reforming corporate taxation, bolstering management of state-owned enterprises, and improving cost recovery and regulation in the power sector.

Reflecting the challenges from the unfolding pandemic and the authorities’ commitment to the medium-term objectives under the EFF, the policy mix has been recalibrated to strike an appropriate balance between supporting the economy, ensuring debt sustainability, and advancing structural reforms while maintaining social cohesion. Strong ownership and steadfast reform implementation remain crucial in light of unusually high uncertainty and risks.

Fiscal performance in the first half of FY21 was prudent, providing targeted support and maintaining stability. Going forward, further sustained efforts, including broadening the revenue base carefully managing spending and securing provincial contributions will help achieve a lasting improvement in public finances and place debt on a downward path. Reaching the FY22 fiscal targets rests on the reform of both general sales and personal income taxation. Protecting social spending and boosting social safety nets remain vital to mitigate social costs and garner broad support for reform.

The current monetary stance is appropriate and supports the nascent recovery. Entrenching stable and low inflation requires a data-driven approach for future policy rate actions, further supported by strengthening of the State Bank of Pakistan’s autonomy and governance. The market-determined exchange rate remains essential to absorb external shocks and rebuild reserve buffers.

Recent measures have helped contain the accumulation of new arrears in the energy sector. Vigorously following through with the updated IFI-supported circular debt management plan and enactment of the National Electric Power Regulatory Authority Act amendments would help restore financial viability through management improvements, cost reductions, regular tariff adjustments, and better targeting of subsidies.

Despite recent improvements, further efforts to remove structural impediments will strengthen economic productivity, confidence, and private sector investment. These include measures to: 1) bolster the governance, transparency, and efficiency of the vast SOE sector; 2) boost the business environment and job creation; and 3) foster governance and strengthen the effectiveness of anti-corruption institutions. Also, completing the much-advanced action plan on AML/CFT is essential.