Economic advisory group analysis: Debt burden up, 2023 repayment becomes highly compromised

ISLAMABAD: The Economic Advisory Group (EAG), an independent platform of Prime Institute, says Pakistan’s debt burden has increased and the government’s capacity to repay debt due in FY2023 is becoming increasingly compromised. The growing dependence on official sources is striking.

In a statement issued on Sunday, the EAG, comprising economists and researchers, said as indicated in a recent podcast by the SBP governor at the outset of FY2023, the year’s requirements were estimated at $33 billion of which $23 billion was debt repayment and $10 billion the Current Account Deficit (CAD) forecast. Of the $23 billion debt repayments, $6 billion has been paid and $4 billion bilateral debt has been rolled over, leaving $13 billion still to take care of. Of this, $8.3 billion are government or government-related commercial loans that the government hopes to roll over, $3.5 billion are multilateral loans and $1.1 billion are commercial foreign bank loans.

The SBP forecast $34-38 billion in inflows at the start of FY2023. In the first 5 months of FY2023, only $4 billion has materialised, and that too is flood assistance ($3.64 billion in loans and $435 million in grants). The UN’s initial flash appeal of million was pledged) was raised to $816 million later.

Pakistan’s forex reserves are declining. On the back of receiving $500 million from ADB, reserves were $7.9 billion last week. After paying the $1.1 billion Sukuk instalment and some other loans, the country ended the week on 2nd Dec 2022 at $6.7 billion, good for 4.5 weeks of imports. The commercial bank reserves are $5.9 billion. The SBP hopes to be re-lent $1.2 billion that it has recently repaid foreign banks. It hopes to get a $3 billion fresh cash injection from Saudi Arabia.

The forex reserves forecasting reflects the nation’s economic fragility. If it is true that Pakistan is not allowed to touch $3 billion and $2 billion deposits from Saudi Arabia and China, then the amount that can actually be used may be $1.7 billion, as indicated by the recent podcast by the SBP governor.

Why has the IMF review stalled? Pakistan faces a credibility gap. After managing to revive the IMF programme with great difficulty, floods hit the country with sympathy for Pakistan initially high. A World Bank-led effort estimated flood losses at $30 billion, with 50% directly attributable to climate change. Initially, given the post-flood situation, multilaterals expressed their intention to be accommodative towards Pakistan’s financing needs.

However, while communicating vociferously regarding flood losses and requesting international assistance and flexibility in the IMF programme, the government was unable to manage flood-related financial assistance and support in a credible, transparent and well-planned way.

During the time of fund-raising for floods, some of the largest spending has been on items like textile subsidies. Prioritising subsidies in areas not directly affected by floods undermines the credibility of policy commitments made by the government to the international community.

What have our coping strategies been? According to the SBP, towards the end of FY2022 when a lot of pressure was felt on the external account, the government decided to put restrictions on some imports. In May 2022, restrictions were put on certain items through an SBP circular. In July 2022, some additional restrictions were placed. The SBP maintains that even after these two circulars, there are no restrictions on 85% of the imports, and only some restrictions on 15% of the imports. Subsequently, importers from 8-10 sectors were allowed to import 50-60% of their average monthly imports from Jan-June 2022. In the next step, cases of shipments that were initiated before the circulars and were accumulating demurrage at ports were cleared. After that, small LCs up to $50,000 were cleared. Later, this limit was raised to $100,000. As a result, all LCs of up to $100,000 opened before October 31, 2022 were cleared and imports took place, helping businesses. Next, import was allowed for projects in which only 25% of the machinery remained to be imported. In this way, 6-7% of the imports got released from restrictions, and now restrictions remain on only 8-10% of imports, as explained by the SBP governor in his recent podcast.

The government claims that initially imports were decreased through administrative measures, but now rising imports (October and November 2022 imports were $4.6 billion and $5.3 billion respectively) prove that import restrictions are easing. It insists that banks have not been restricted from opening oil or pharmaceutical LCs, as these are priority sectors. All oil, medicines, medicine raw material and medical equipment imports are continuing unrestricted. Of the imports in the first 5 months of FY2023, 35-36% are oil and gas imports.

Whether the initial decrease in imports happened due to restrictions or a contraction in aggregate demand is an open question. Also, the FX market is extremely fragmented. The official FX market for PKR/$ at 223 is non-existent, even the grey market at 233 does not operate; often dollars can only be procured in the black market at 244. How can we improve the situation? The first step for the government is to clearly define the present situation. The markets have already assessed it and are reacting accordingly. When the government states that the situation is satisfactory, there is a credibility deficit, and this makes the market respond even more negatively. A clear depiction of the state of affairs will help the government justify the strong measures that need to be taken to address it.

The government has to do a lot more to reduce both the primary and overall fiscal deficits; in both, it is exceeding targets that were agreed with the IMF at the end of September 2022.

The government has consequently been operating with significant financing gaps, which makes its debt sustainability vulnerable. These are substantive issues that it needs to address in order to restore credibility with multilateral institutions.

Giving an accurate depiction of the state of the economy and undertaking, effective reforms will begin to restore the trust of the multilaterals. They will be more inclined to offer timely assistance, which Pakistan badly needs. This will also help Pakistan with its bilateral negotiations, and calm markets.

Pakistan must be committed to a market-determined exchange rate and limit intervening in the FX market. Greater exchange rate flexibility will address external pressures and build reserves.

In the medium-term, strong macroeconomic policies and structural reforms will build confidence in the PKR. Ultimately, Pakistan can only use exports to emerge from its ballooning debt and CAD trap. It needs to undertake reforms to improve exports and convince lenders that these reforms are real and serious to get sufficient loans in the medium term until the economy has reconfigured. It needs to build its ability to export goods and services and find new markets. It needs to reunify the fragmented FX market, make sure it is freely market-determined, in order to bring back remittances into the banking network. It needs to control the fiscal deficit.

Not concluding the 9th IMF review increases the chances for requiring debt restructuring. In the event that restructuring of commercial debt takes place, the bonds will automatically come in for restructuring. Hence all efforts must be made by the government to remain engaged with the IMF in good faith, and expeditiously complete this review. In addition, the government must secure rollover of debt from friendly countries and look into the possibilities of multilateral debt rescheduling. The next commercial payments are now due in 2024. If bilateral and multilateral debt rescheduling can be achieved, this will give the economy precious breathing room. But the government must ensure that this cushion is not used for subsidies and imports but is utilised to catalyze reform.