Pakistan: Saga of Financial Challenges

Once hailed as a financial wizard, Ishaq Dar's return to Pakistan was accompanied by grandiosity, with a Red Carpet reception. However, the same individuals who celebrated Dar's financial prowess are now touting Muhammad Aurangzeb as a savior capable of instantly resolving Pakistan's myriad issues. While Aurangzeb may possess exceptional banking skills, his comprehension of Pakistan's complex economic landscape raises doubts.

Adding to the skepticism is his hefty monthly salary of US$100,000, amounting to a staggering US$1.2 million annually. Despite decades under the IMF microscope, Pakistan struggles to generate sufficient dollars to finance its imports, with around US$150 billion from overseas Pakistanis disappearing into a financial abyss over the last five years.

The finance minister's primary task now is to persuade the lender of last resort to release more dollars, settling outstanding loans and facilitating imports, particularly for the elite. The proposed solutions involve increasing electricity and gas tariffs, raising interest rates, and imposing additional duties and taxes, collectively squeezing every Pakistani financially.

Financial wizards argue that these measures will bridge the budget deficit, but they overlook the resultant surge in government borrowing and the negative impact on local manufacturers' competitiveness. This situation brings to mind the saying, "An expert is a person who makes things complicated." Pakistanis are inundated with advice on improving taxes, but there's a glaring absence of plans to tax those enjoying exemptions since independence, and austerity measures are conspicuously lacking.

As Pakistan rushes into talks with the IMF, concerns persist about addressing GDP growth, boosting exports, and curbing extravagance. The impending debt servicing crisis looms large, and while the IMF may greenlight a larger and extended standby program, the real question lies in whether policymakers have viable strategies to maintain debt servicing at a sustainable level.

IMF report on Pakistan: Indictment of Sharif government

The IMF staff level report on its new, short-term bailout loan of US$3 billion for Pakistan is a damning indictment of the Shehbaz Sharif government’s economic and financial policies that deepened the trust gap between Islamabad and the lender, and pushed the country towards the precipice in the last nine months, is the opening paragraph of DAWN editorial.

Policy missteps and breach of the previous Extended Fund Facility program had compelled the lender to halt the disbursement of funds, closing the door on other multilateral and bilateral financing.

The IMF document, released on Tuesday, also spells out the program’s goals, many of which, such as increased energy prices, will directly burden the people. It blames the Finance Ministry and State Bank for their frequent tinkering with the market-based exchange rate mechanism, leading to the growth of a large foreign exchange black market. It is also critical of the central bank for resisting a timely increase in interest rates.

That is not all. The report points out that the government balked at maintaining fiscal discipline, cutting non-essential spending, broadening the tax net, controlling the drivers of the power sector’s circular debt, and improving SOE governance.

In view of its experience with Pakistani authorities, the IMF has warned that continuation of the new program will depend on the implementation of fiscal discipline, a return to a market-determined exchange rate and proper functioning of the foreign exchange market, a tight monetary policy aimed at disinflation, and progress on structural reforms, particularly with regard to the energy sector, SOEs and climate resilience.

The report also cautions against the exceptionally high downside risks to the Stand-by Arrangement goals emanating from a tense political environment and potential deviation from agreed policies. Such risks could undermine the program’s implementation, and jeopardize macro-financial and external stability and debt sustainability, leading Pakistan to seek foreign debt restructuring.

Additionally, it says that external financing risks remain high, and delays in disbursement of external financing from IFIs and bilateral creditors would endanger the fragile external balance given limited buffers. Spillovers from Russia’s invasion of Ukraine through high food and fuel prices, and tighter global financial conditions continue to put pressure on the budget.

Highlighting Pakistan’s large gross financing needs of US$28.3 billion, including the US$6.4 billion current account deficit, during this fiscal year, it stresses that multilateral and bilateral support will remain critical for Pakistan beyond the upcoming elections and the SBA.

It is a foregone conclusion that the next government will need another, longer-term IMF program to resolve structural challenges and meet high external debt obligations over the next few years. For that to happen, the country has to achieve the SBA goals, come what may.

 

Pakistan Posts Current Account Surplus in March 2023

Pakistan has posted US$654 million current account surplus in March 2023, against a current account deficit (CAD) of US$36 million in February 2023. It is the first monthly surplus since November 2020 and the numbers are higher than market expectations.

This is the first monthly surplus since November 2020, thanks to tighter monetary and fiscal measures along with administrative steps taken by the government. CAD for 9MFY23 has been reported at US$3.372 billion against a CAD of US$13.014 billion in 9MFY22.

Balance of Trade in Goods and Services improved considerably and reported at US$1.595 billion in March 2023 against a Balance in Trade of Goods and Services of US$3.437 billion in March 2022. Even Balance of Trade in Goods improved by 9%MoM.

Workers’ remittances were reported at US$2.533 billion in March 2023 against US$2.835 billion in March 2022. Remittances have improved by 27%MoM. The trend in remittances is improving after 10-15% gap between official and unofficial rate of local currency has eliminated.

A Topline Securities report about falling workers’ remittances dated January 16, 2023 had indicated that rising gap between official and unofficial rate of USD forced workers to remit money through non-banking channels. This was also seen in Sri Lanka and Bangladesh and remittances recovered once the countries moved to a more market based exchange rate.

Exports for March 2023 were reported at US$2.427 billion against exports of US$3.071 billion in March 2022, posting a decline of 21%YoY, mainly on the back of falling global demand and a fall in commodity prices. The SBP has taken measures to encourage exporters to bring back export proceeds in a timely manner.

Imports were reported at US$3.990 billion in March 2023 against US$6.114 billion in March 2022, posting a decline of 35%YoY.

Imports were down due to a weaker exchange rate along with administrative measures to curb imports.

To recall, State bank of Pakistan (SBP) in its Monetary Policy Statement on the April 04, 2023 stated that CAD had narrowed considerably and more than previously anticipated mainly on the back of import containment.

The SBP also stated that while the CAD had narrowed, the Balance of Payments (BOP) position remained under stress and noted that foreign currency reserves remained at low levels.

A reduction in imports led to a major improvement in CAD. Administrative measures such as a ban on Machinery Import which was later removed and replaced with banks prioritizing the imports of essential items.

Similar administrative controls on imports in Sri Lanka and Bangladesh played a key role. In fact after IMF deal in Sri Lanka it has been agreed that this L/C restriction will be lifted gradually, not immediately.

Topline Securities expects import controls to be removed gradually and expect no abrupt change in policy.

The brokerage house expects the Current Account Balance to remain muted for the remainder of the year. It estimates FY23 current account deficit of US$3.5 billion.

The brokerage house highlights that Pakistan’s main issue is external debt repayment. It believes that Pakistan has to talk to its lenders to push out maturities of its debt.

It believes that discussions on debt restructuring/ re-profiling will be done after elections by the new government along with a new IMF support program.

 

Pakistan Needs Effective Debt Restructuring

Pakistan’s leading brokerage house, Topline Securities, in its report titled “Pakistan’s Debt Restructuring - External Debt Repayment Crisis” dated December 03, 2022, had highlighted Pakistan’s external debt repayment obligations of US$24 billion annually and the need to address these in a sustainable way. The brokerage house opined these external debt repayments are too high and should ideally be rescheduled and reduced to sustainable levels.

The brokerage house further highlighted that current foreign exchange crisis was mainly driven by external debt obligations and not trade unlike Pakistan’s previous foreign exchange crisis of 2008. Therefore, despite ongoing import controls, Pakistan’s foreign exchange reserves continue to dwindle to 9-year low at US$4.6 billion only as debt repayments continue to come due and are serviced.

Falling foreign exchange reserves, delay in IMF review and slow policy actions are adding to Pakistan’s distress. Resultantly, despite of more than US$10 billion pledges, Pak Rupee (PKR) black market premium is continuously rising and has increased from 10% a few weeks back to 15% now when compared to the official interbank rate.

The brokerage house highlights that the true culprit of the current debt conundrum is short term rollovers that have increased by 9 times to over US$12 billion since 2015. It is of the view that external debt restructuring is an eventuality, and the mode of restructuring, that is orderly or disorderly, will test Pakistan’s economic vulnerabilities.

The brokerage house believes that Pakistan should ideally try to convert its short term external loans with long term with the help of friendly countries like China, Saudi Arabia, United Arab Emirates etc, if that is not doable than Pakistan should try G-20 common framework of debt restructuring. These are less painful and will help recovery soon without affecting credit ratings. 

If the Government of Pakistan does not opt for orderly and amicable restructuring and continues to rely on short term funding from friendly nations or relief in the form of low cost loan vis-a-vis for floods to manage the country’s external accounts, the country could move towards a disorderly and coercive restructuring that will be very painful and may trigger a further credit rating downgrade.

After brokerage house’s earlier report, many other experts, trade bodies and polls suggest that Debt Restructuring is the most viable solution that can help reduce debt burden and will lead to relatively faster economic recovery.

The Monetary Policy Announcement of January 23, 2023 underscores the need for debt restructuring as US$8 billion of debt still needs to be dealt with in next 5 months till June 2023 while the country’s reserves are half of that. Even if the bulk of this amount is rolled over as the SBP is alluding to, the meter will again reset on July 1 when the rollovers will restart for FY24.

A few countries including Angola, Greece, Argentina, Ghana, Sri Lanka and Zambia among others have gone through debt restructurings. Based on their experience, the brokerage house found that orderly and timely debt rescheduling is relatively less painful and provide better chances of quicker economic recovery.

 

Pakistan facing the toughest time of its history

According to a report by Pakistan’s leading brokerage house, Topline Securities, falling foreign exchange reserves and rising external funding gap is worrisome. Though, current account deficit is coming down, the biggest worry is external debt servicing.

Pakistan economy is passing through one of the toughest times in its 75-year history. Large external financing gap, challenging global financial markets, devastating floods and local political instability has increased the risk of timely external debt payments.

According to IMF data, Pakistan’s external debt repayment obligations are estimated US$73 billion over the next three years (FY23-25) as against prevailing foreign exchange reserves hovering US$8 billion at present.

The huge repayment are due to large external borrowings that have doubled in 7-years from US$65 billion in FY15 (24% of GDP) to US$130 billion (40% of GDP) in FY22.

Resultantly, Pakistan’s total debt and liabilities (domestic & external) have increased from Rs19.9 trillion (72% of GDP in FY15) to Rs60 trillion as of June, 2022 (90% of GDP).

Considering this external debt repayment crisis, the brokerage house think Pakistan will do a Debt Rescheduling (Base Case) with its bi-lateral lenders especially China as it forms 30% of government external debt and the repayment to China will be huge in next few years.

Pakistan must capitalize on its friendly relationship with China and must seek IMF led Debt Restructuring of at least US$30 billion for next 3 to 5years. Finance Minister has already hinted at rescheduling of bi-lateral loans without any haircuts.

The Sooner the government starts this process the better it will be. In case, current coalition Government delays it for political reasons than new Govt. coming to power after 2023 Elections will have to do this. The new government will have to enter into a new and a bigger IMF program to execute this much needed rescheduling.

Commercial lenders, Eurobonds investors, local lenders and others may or may not be affected from this rescheduling depending upon the negotiations.

Pakistan credit rating that was recently downgraded (Moody’s downgraded to Caa1 from B3) may also be adversely affected. 

The brokerage house claims to have seen precedence from other countries like Argentina, Angola, and Zambia etc. that also undertook restructuring of loans. Even in past, Pakistan restructured its Eurobond and rescheduled certain portion of Paris Club payments post nuclear tests in 1998.

Under the new IMF program along with debt restructuring, Pakistan will have to follow stringent monetary, exchange rate and fiscal policies. The economic growth is anticipated to remain slow. On top of all, while PKR will remain under pressure, interest rate may spike to higher levels despite receding inflation.

According to the brokerage house, under the Best-Case scenario if commodity prices fall 25% and financial markets improves that will provide the much-needed relief and the country may not require debt restructuring.

If the debt is not restructured on time, Pakistan’s debt crisis could worsen further which could hamper Pakistan’s ability to pay on time.

 

Getting Federal Budget approved should be the top priority of Shehbaz Sharif

In all probability, the incumbent government, headed by Shehbaz Sharif, is scheduled to present Federal Budget 2022-23 in the lower house on June 10, 2022. There is an overwhelming perception that the economic team hasn’t been able to put its much talked about plans and finalized the nitty-gritty.

This impression is based on the fact that Pakistan and International Monetary Fund are still polls apart, mainly because the Pakistani economic team is not paying heed to the instructions of the Fund.

Over the last six weeks the Shehbaz team has not met even the first target of raising prices of petroleum products and electricity and gas tariffs. Most of the time is being wasted on maligning the previous government headed by Imran Khan, rather than taking into account the harsh domestic and international realities.

The team faces the most tedious task of projecting income and expenses targets and meeting the deficit. It is too obvious that the coalition government has fewer options available to boost income and it will not be able to follow any austerity drive because of the mindset of the ruling elite. There is a consensus that the elected representatives will not be ready to accept any substantial cut in their salaries and perks.

It is feared that the axe will fall on federal and provincial public sector development programs. The top priority areas are: 1) improving irrigation system, 2) strengthening electricity and gas transmission and distribution infrastructures. The mounting circular debt can’t be contained without containing rampant pilferages.

For boosting country’s exports, cost of doing business has to be reduced. The top two expenses to be rationalized are interest rate and energy tariffs. The GoP expects to receive US$2 billion from IMF over the next two years. Experts believe that this much amount can be raised by exporting just one item, one million tons urea. The country has the surplus capacity to produce one million ton exportable surplus urea by ensuring uninterrupted supply of natural to the fertilizer plants.

There is no denying to that fact that huge quantities of wheat, edible oil, POL products and even urea fertilizer are being smuggled to the neighboring countries. The key problems are 1) highly porous borders and 2) restriction on the export of these commodities. These problems can be overcome by plugging boarders and bringing necessary changes in the Trade Policy.

Last but the foremost, the economic team has to come out of the illusion that hike in interest rate can help in containing inflation in the country. Let this be known to all and sundry that Pakistan suffers from cost pushed inflation. The biggest loser of hike in interest rate is the GoP. Let me reiterate that GoP is the biggest borrower and with each hike in interest rate, its debt servicing ability is marred.

 

 

 

Is Bangladesh heading toward a Sri Lanka like crisis?

According to a report in South Asia Journal, like Colombo, Dhaka has also taken on massive foreign loans to embark on what critics call ‘white elephant’ projects. The economic turmoil in Sri Lanka should serve as a cautionary tale for Bangladesh, say experts.

Soaring prices of essential items are bringing enormous pain to economically weaker sections of Bangladeshi society. Sri Lanka has been mired in economic turmoil over the past few months, with the country battling severe shortages of essential items and running out of petrol, medicines and foreign reserves amid an acute balance of payments crisis.

The resulting public fury targeting the government triggered mass street protests and political upheaval, forcing the resignation of Prime Minister Mahinda Rajapaksa and his Cabinet, and the appointment of a new Prime Minister.

Many in Bangladesh fear that their country could face a similar situation, given the rising trade deficit and foreign debt burden.

Bangladesh imported goods worth US$61.52 billion during the first nine months of the 2021-22 fiscal year, a rise of 43.9% as compared to the same period last year.

However, exports rose at a slower pace of 32.9% while remittances from Bangladeshis living abroad — a key source of foreign exchange — dropped about 20% in the first four months of 2022 from the year before, to US$7 billion.

Muinul Islam, a Bangladeshi economist and former professor at Chittagong University, fears that the trade deficit could grow in the coming years as imports are increasing at a faster pace than exports.

“Our imports are set to reach US$85 billion by this year, while exports won’t be more than US$50 billion. And, the trade deficit of US$35 billion can’t be bridged by remittances alone,” Islam told adding: “We will have to live with around a US$10 billion shortfall this year.”

The expert also pointed out that Bangladesh’s foreign exchange reserves have fallen from US$48 billion to US$42 billion over the past eight months. He is worried that they may drop further in the coming months, likely down another $4 billion.

“If the trend of more imports against exports continues and we fail to minimize the gap with the remittances, our foreign reserves will go down to a dangerous level in the next three to four years,” he stressed, underlining that this would lead to a significant devaluation of the nation’s currency against the US dollar.

Bangladesh, like Sri Lanka, has also taken on foreign loans in recent years to fund what critics call “white elephant” projects, which are expensive but totally unprofitable.

These unnecessary projects could cause trouble when the time comes to repay the debts, Islam said.

“We have taken a loan of US$12 billion from Russia for a nuclear power plant which has a production capacity of just 2,400 megawatts. We can repay the debt in 20 years but the installments will be US$565 million per year from 2025,” he pointed out. “It’s the worst kind of a white elephant project.”

In total, the country will likely have to repay US$4 billion per year from 2024, as installments for foreign loans, Islam estimated.

“I fear Bangladesh won’t be able to repay those loans at that time because of the shortage of income from the mega projects,” he stressed.

Prime Minister Sheikh Hasina’s government has taken several steps to slash spending and save foreign currency reserves.

Nazneen Ahmed, Bangladesh economist at the United Nations Development Program (UNDP) office in Dhaka, said that the government has to make sure the projects are completed without additional cost and delay.

“We have to finish the mega projects carefully. There is no room for negligence and corruption. Those projects should neither be delayed nor the existing budget be increased,” she said, adding, “If we can finish them on time, only then will we be able to repay the loans we have taken for them.”

Adding to the problems of debt and deficit is the surge in prices of essential items.

The Russia-Ukraine war, which began at the end of February, has compounded the inflationary pressure.

Bangladesh has been particularly vulnerable as the country imports significant amounts of goods like cooking oil, wheat and other food items, as well as fuel.

Ahmed said that poor people are suffering the most because of the skyrocketing prices of these items.

“The government has to offer commodity goods subsidized to the poor people. Additional financial support should also be provided to them under a social security system,” she noted.

But the expert remains optimistic about the South Asian nation’s prospects, saying that the current economic indicators could improve as the global economy recovers from the COVID pandemic-induced downturn.

“We have been observing inflation worldwide during the COVID recovery phase. The Ukraine war has added more uncertainty to it. And the economic crisis in Sri Lanka has also created fear among us,” she told adding, “Still, if nothing big happens within the next few years, the global economy will recover again.”

Prime Minister Sheikh Hasina’s government has taken several steps to slash spending and save foreign currency reserves.

It has decided to suspend foreign trips of officials and postponed some less important projects that require imports from other countries.

Hasina has also urged citizens to do their bit, by practicing austerity and being careful about spending decisions.

“The Prime Minister earlier gave some directives to the government officials on practicing austerity. She called upon the private sector and the people to be economical,” Bangladesh’s Planning Minister M A Mannan said during a press conference in Dhaka.

Islam said that the government needs to be extremely careful with economic management, given the widespread suffering on account of soaring price rises, which could aggravate the already high political tensions in the Muslim-majority country.

“Bangladesh’s last election was not good. It was a fraudulent one. Another national election is due in the next two years. So the political situation will remain tense anyway. The economic uncertainty could fuel it even more.”

While the experts don’t see any imminent economic crisis, they believe that good governance and financial management are needed to ensure Bangladesh doesn’t end up facing a situation that Sri Lanka now finds itself in.