The report card is all in the green. The government has met all the quantitative targets in the sixth review of IMF’s extended finance facility. It has also met most of the qualitative targets. The recently released country report highlights the achievement of macroeconomic stability which has led to improved medium-term economic outlook. The positives highlighted by IMF will not only improve Pakistan’s credit rating in the global financial market but will also enlarge the multilateral flows.
Finance Minister Ishaq Dar and his team must be very proud of their achievements. But they should not be carried away by the positives stemming from exogenous factors and try not to lose focus of the structural reforms.
The fall in oil prices has improved the current account which has resulted in higher net foreign assets. Had global oil prices not fallen as steeply, the NFA would have contracted, and the NDA would have ballooned given the growth in reserve money.
The fiscal deficit has to be financed one way or the other. The influx of foreign reserves through the international bond issuance and lower current account deficit has generated ample rupee liquidity to finance the fiscal deficit from commercial banking sources to reduce the reliance on SBP financing. What if the oil prices reverse?
The chances of getting back of oil prices to around $100 per barrel are thin, hence the macros may keep on showing better picture and IMF’s targets may continue to be met. After meeting all the quantitative targets in December, March-end targets might also have been met, though with some last minute efforts on the NDA.
Things may be rolling smoothly but the government’s growth target of 5.1 percent for FY15 seems to be unrealistic under IMF’s lens which estimates it to be at 4.3 percent as against 4.1 percent in FY14. BR Research thinks that fund’s projections are realistic. Inflation is coming down and the IMF expects it to be 5.5 percent for the full year which is higher than BR Research estimates of 4-4.5 percent. Lower oil prices and prudent monetary and fiscal policies are reaping fruit in terms of pushing both headline and core inflation lower.
The fund has shown satisfaction on prudent monetary policy approach which implies there is further room in easing by 50-100 bps in next policy review. The focus is more on managing interest rates corridor effectively, and the fund sees SBP’s progress as satisfactory by way of anchoring the overnight rates on OMOs rates.
The current account is showing a substantial improvement, driven by a lower import bill, despite weak export performance. This is a worrisome fact as exports are losing competitiveness which could have severe repercussions in coming years. To this end, the adjustment in currency and enhancing incentives can avert the crisis. However, stagnating exports may not allow the NFA targets to be met comfortably in coming quarters. Nonetheless, the IMF expects 3.5 months import cover by June end. This implies SBP’s foreign exchange reserves at $15.4 billion by June end as compared to $11.2 billion by March 25.
The fiscal deficit is expected to come down to 4.8 percent in FY15 as compared to 5.5 percent in the last year, which is a good development. But the revenues growth remained low and that questions the ability to bring down the deficit to below 4 percent in the medium term. Tax revenues grew by 14.8 percent in 1HFY15 and low growth is attributed to low oil prices and issues pertaining to the collection in GIDC (1/10th of budgeted amount).
However, the authorities have assured to bridge the revenue gap by eliminating tax concessions and exemptions and broadening the tax base. The steps taken so far include high GST on petroleum products, regulatory duty on steel products, mobile phone, and furnace oil, increasing withholding tax on non-filers, regulatory duty on luxury items and metal scraps, and to reduce electricity subsidy by 0.1% of GDP. The total impact through these measures is envisaged at 0.5% of GDP.
Energy subsidy has been reduced from 2.3% GDP in FY12 to 1.3% FY14 and expected to be at 0.7% this year, thanks to low oil prices. Plus, the focus is on thinning the cost and recovery gap of electricity by imposing surcharges to reverse the circular debt. With fall in oil prices, the decision is not as politically tough as was in the past since the surcharges can be adjusted against fuel price adjustment. For instance, the estimated change on FPA was Rs-0.61 and Rs-0.63 per unit as against the actual change of Rs-2.97 and Rs-3.20 respectively and the rest is adjusted against various surcharges.
In a nutshell, the fall in oil prices has given the opportunity for Finance ministry to meet the IMF’s targets and paved the way for a smooth economic recovery. However, there are serious challenges to regain economic growth and generate employment upon which the fund has not yet raised its eyebrows. Lower commodity prices are making domestic production expensive relative to imports and that is not only hindering export growth but also raising fears that the domestic factor of production will be replaced by cheap imports.
This article was originally published on April 09, 2015.
