Crisis, Bailout, Crisis Again: Pakistan’s Relentless Fiscal Cycle

Unless major structural reforms in managing public finances and challenges posed by debt repayments are undertaken, it will not result in GDP growth or control inflation in Pakistan.

A recurrent pattern of structural adjustment and approval by the International Monetary Fund, followed by another crisis and bailout, seems to have become the norm for Pakistan. It may just avoid sovereign default for now.

The $6.5 billion Extended Fund Facility agreement for Pakistan in 2019 was to expire on June 20, 2023. With just hours in hand, IMF mission chief Nathan Porter gave positive signals that Pakistan might regain access to the bailout programme, of which $4 billion have been released so far. Of the remaining $2.5 billion, Pakistan may gain access to a $1.1 billion tranche.

Pakistan faces about $23 billion of external debt payments for the fiscal year starting July, more than six times its foreign exchange reserves. A $1.6 billion payment is due this month, including a $1 billion Chinese deposit that is typically rolled over. Macroeconomic indicators have deteriorated, hurting business sentiment. The growth projection has been downgraded to 0.03% from 3-4% last year, large scale manufacturing growth dropped from 0.01% to -25% in March. A flawed policy of rupee-dollar parity lowered remittance inflows by $3.7 billion and forex reserves fell from $7,859.7 million in September 2022 to $3,536.9 million as of June 16. Pakistan’s monetary policy can’t control inflation, which stood at 38% in end-May, the highest in Asia, or protect a currency that has weakened about 30% in a year. Forex reserves have slid to only about one month of imports.

With no chance of a 10th IMF review, Prime Minister Shehbaz Sharif has been actively involved in discussions with the Fund’s MD, Kristalina Georgieva, trying not just to get $1.1bn pending funds, following the completion of the 9th review, but also to get the entire pending amount of $2.5bn released. Without it, the current IMF program of $6.5 billion will conclude at around $5.1 billion, without the remaining 10th & 11th reviews for $1.4 billion.

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The possibility of a bailout looked bleak earlier this month, when the IMF criticised Pakistan’s FY2023-2024 budget as insufficient to meet the goals of its bailout program. On June 9, the government presented the annual budget of Pakistani Rs 14 trillion ($50.4 billion). Finance Minister Ishaq Dar set a 3.5% GDP growth target, with a focus on the “real economy.” Esther Perez Ruiz, IMF’s resident representative in Pakistan, said that his tax policies miss “an opportunity to broaden the tax base in a more progressive way, and the long list of new tax expenditures reduces further the fairness of the tax system.”

Before the IMF board would consider releasing the pending tranche, Pakistan needed to satisfy the IMF on the budget, fiscal tightening measures dictated by the IMF, Pakistan Rs 215 billion additional tax measures, withdrawal of an amnesty on foreign exchange inflows and lifting of import restrictions. The Sharif government reduced budget outlays by Pakistan Rs 85 billion. On June 28, Porter announced that Islamabad was bringing policies “more in line with the economic reform programme supported by the IMF.”

The fulfilment of conditionalities will be a real test of the Sharif government’s commitment. But the targets set appear unrealistic. Expansionary policies needed to achieve 3.5% real GDP growth would be a challenge under the terms of the IMF. The manufacturing target of 3.6% is unlikely to be met, given the rising cost of inputs, including borrowing costs. IMF support arrangements do not promote self-reliance and may further weaken the economy. Without adequate reserves it may be difficult to meet import growth of 8.9% in dollar terms and 32.4% in rupee terms. The Pakistan rupee is likely to fall further to 322 to the dollar from 290.

As the nation makes a final attempt to revive its loan programme with the IMF, the State Bank of Pakistan raised its benchmark rate by 100 basis points to a record high of 22% to keep real interest rates positive. Credit rating agencies forecast that policymakers will not cut the repo rate until 2024, and that another bout of rupee weakness may prompt further policy tightening.

The tax net has not been expanded in effect, but indirect taxes are unduly relied upon. The widely reported budget cut is just 0.6% of total budgeted expenditure and, furthermore, is yet to be identified. Despite depleted foreign reserves, the government has hiked defence spending by 15.4%. Pakistan’s promises to set its house in order are cosmetic and there are serious concerns that the entire exercise with the IMF is a numbers game.

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Formalised in 2015, Chinese investments were envisioned to bring in $60 billion over 15 years. But it’s made Pakistan’s economy more vulnerable, as repayment of CPEC debts at interest rates as high as 7% will be difficult. Finance minister Ishaq Dar had hinted at a ‘Plan B’ to avoid default. Most likely, it involves the ‘reprofiling’ of bilateral debt to delay repayment. Plan B envisages increased government-to-government deals, which would include the sale of state enterprises, leasing of assets of government-owned entities to generate funds in foreign currency, and assistance from the Gulf nations and China.

Last year, Pakistan requested China to roll over its $6.3 billion debt, refinancing it at a higher rate upon maturity in June 2023. Earlier this year, China had rolled over a $2 billion loan, giving some relief to Pakistan, and this month it rolled over a $1.3 billion loan that was recently paid back by the Pakistani government. While these rollovers bring short-term relief, de facto maturities of rolled over Chinese rescue loans run longer, ultimately making Pakistan more dependent on Beijing. Meanwhile, Pakistan’s fiscal year ends with the rupee closing at 285.99 against the US dollar, a decline of Pakistan Rs 81 since June 2022 ― the highest-ever depreciation of 28%.

Due to high dependence on external financing, fulfilling the obligations set by the IMF is crucial for Pakistan. Unless major structural reforms in managing public finances and challenges posed by debt repayments are undertaken, it will not result in GDP growth or control inflation. The decision to discuss another fund bailout package will now be left to the next government, after the general elections in October 2023.

Vaishali Basu Sharma is an analyst of strategic and economic affairs.

This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.