By Waqar Masood Khan
The just released eleven-month balance of payments (BOP) data graphically captures the precarious state of our economy. The current account deficit was recorded at nearly $16 billion or 5.5pc of GDP. At this speed, the deficit, at the close of the fiscal year in June, would be at $18 billion or 6pc of GDP. This is the highest deficit in more than a decade. What has given rise to this unprecedented development?
Let us analyse various components of the BOP which have contributed to this situation. At the forefront is the massive surge in imports, which rose by 16.4pc from an already elevated level of $43.6 billion to an unprecedented level of $50.7 billion. The exports are also rising but are no match to the rise in imports, being less than half of imports. Exports increased by 13.2pc from $20.1 billion to $22.8 billion. Consequently, the trade deficit increased by 19pc from $23.4 billion to $27.9 billion. Helped primarily by workers’ remittances, which rose by a small margin of 3pc, from $17.51 billion to $18.03 billion, the overall current account deficit was contained to $15.961 billion.
It is important at this stage to underline a basic aspect of BOP situation. For a developing country that needs high rates of growth to generate required jobs for new entrants into the labour market, having a current deficit is a positive development as it acts like foreign savings supplementing national savings, supporting a higher level of investment. But the real difficulty is to have the required financing for this purpose. The financing comes in the form of foreign direct investment, loans brought by investors and the loans raised by the government for general BOP support. The other part of the BOP gives us the status of these inflows, called capital and financing accounts. We present a brief account of these inflows.
The capital account movements show a net balance of $336 million, slightly down from $346 million last year. On the financial account, the significant items included foreign direct investment (FDI), public investment (Euro Bonds and Sukuk) and other borrowings. FDI was recorded at $2478 million, which was lower than $2509 million last year. Public investment was recorded at $2289 million against an inflow of $620 million last year. The most significant item is the net borrowing of $4787 million compared to $6208 million last year. These four items add up to $9.89 billion. Therefore, against a deficit of $16 billion, financing of $9.89 billion was available leaving a gap of roughly $6.1 (after taking into account minor items and errors and omissions).
Where is the above gap financed from? The answer is from drawing down of the official reserves. At end June 2017, the SBP (official) reserves were recorded 16.14 billion. At end of May 2018, the reserves are down to $9.65 billion. However, this loss of reserves does not fully capture the deterioration in country’s external account in the last two fiscal years. The peak reserves were achieved at around End September 2016 at $20 billion (with gross reserves of $24.5 billion). The public external debt at the time was $58.7 billion. In June 2013, the level of debt was $48.1 billion. Thus, until then, in three years and a quarter, the government had added $10.6 billion to debt. However, during the same period, the reserves had increased from $6 billion (gross $11.0 billion) to $20 billion (gross $24.5 billion), a net increase of $14 billion, significantly more than increased debt of $10.6 billion. This situation reversed in the last two years as the country added another at least $12.0 billion in debt, whereas on June 1, reserves were reported at $10.0 billion. So, here is the equation: We lost $10.0 billion in reserves ($20.0-$10.0) and have accumulated additional debt burden of $12.0 billion, all for financing the current account deficit. Taken since June 2013, the government has added $22.6 billion in external debt during the last five years while net increase in reserves amounted to a meager $4.0 billion.
But there is a deeper question that needs to be answered. Where is this extraordinary demand for imports emanating from? The simple answer is: from the excessive demand coming from the budget. This year the fiscal deficit was targeted at 4.1pc (Rs1480 billion). However, through a number of revisions during the year, the eleven-month deficit was reported at 6.1pc (Rs.2098 billion). We estimate that the year would end with a deficit of close to 7pc (Rs.2408 billion), full one trillion rupees over-run. This is recklessness. Unfortunately, it seems, the outgoing government in its closing days simply lost any sense of public propriety. Such massive over-spending, translating into demand for imports (petroleum product demand was up 30pc with such new fuels in use like LNG increasing by 84pc from $1.1 billion to $2.1 billion) has brought about an unsustainable external account balance.
In view of what is presented above, it is not surprising to see the adverse rating action taken by the Moody’s Rating Agency, which has downgraded country’s outlook from ‘stable’ to ‘negative’. This is the first step toward a formal downgrade, which is currently B3 and may lead to a real downgrade to C category. Reportedly, Pakistan’s bonds are selling at significant discounts, which until recently were selling at handsome premiums. New borrowings would be extremely difficult and would attract fairly unfavourable pricing.
These events are happening at a time when there is no responsible economic manager looking after the economy. The decision of the interim government not to take any serious economic measures during their tenure means that the country would not have a minder for another two months. However, it looks very difficult if the position of reserves would be such that the economy could smoothly function until then. The reserves have fallen below the psychological level of $10 billion. But the net reserves, after excluding swap positions, short-term deposits and loan maturities falling due in the next twelve months, have been negative by several billion dollars.
We reckon that the country cannot wait for the formation of a new government to start the repairing job. This is an emergent situation calling for extraordinary measures. The interim prime minister should seriously consider inviting political leaders and place before them the facts about the economy. He should recommend to them that an immediate dialogue with the IMF is inevitable and some kind of temporary stand-by arrangements have to be put in place to ward-off the possibility of default. We have rapidly depreciated the currency and it has only exacerbated expectations for further depreciation since it was not part of a larger reforms agenda on the fiscal, monetary and structural sides. A Fund program would fill this gap and also give confidence to the market that responsible economic management would be practiced. The new government could decide if it wants to carry the program forward say beyond 9-12 months.
By Waqar Masood Khan