How do we avoid the IMF?

In a previous article, ‘Can we avoid the IMF? (September 18, 2017), we had alerted about the impending crisis that may push the country back into an IMF programme. New data on Balance of Payments (BOP) for Jul-Aug further supports this view and underlines the need for immediate action. We present some suggestions to avert the crisis.

Reducing fiscal deficit has to be the pivotal measure. For this, revenue collection (tax and non-tax) will have primacy compared to expenditure controls. While presenting the budget for FY2018, government claimed the deficit for FY2017 would be 4.1 percent, whereas the actual is 5.8 percent. Therefore, a prior adjustment in budgetary estimates, would be required to make them realistic. An added adjustment would be needed for revenue estimates since actual outcome was significantly below the revised budget for FY2018. It is likely that the fiscal deficit target for FY2018 is already out by 2.2 percent, which means against the target of 4.1 percent, the actual could be 6.3 percent.

An adjustment of nearly 2.2 percent is an uphill task. On the revenue side, the Jul-Aug figures were on track and if this trend continues, the challenge would be to meet the non-tax revenue target. Last year, a fairly large number of one-off items (like sale of the security printing press to the SBP) were helpful. It is doubtful if similar help will be available this year. Also, gas cess collections (budgeted at Rs110 billion) will be a formidable challenge as last year collection was only Rs42 billion against the target of Rs142 billion.

This leaves cutting expenditures as the only viable option to meet the deficit target. Things are tight on the current side as interest payments, defence and civil administration exhaust a lion’s share of current expenditures. Yet, austerity measures can still lead to significant results within these heads. A potential area of some savings, even of a temporary nature, is subsidies, transfers and contingent grants. Unfortunately, it is the development expenditure that has to take the big hit. With the exception of CPEC-related and other committed expenditures, every other development expenditure has to be put on hold until resource availability improves.

Another susceptible provision in the budget is for provincial surplus of Rs347 billion (nearly 1.15 percent of GDP). Last year, against a targeted surplus of Rs300 billion, provinces incurred a deficit of Rs162 billion. Contingencies have to be built against the repeat performance of provinces.

On the BOP side, things are getting tougher, as we continue to lose reserves in the face of rising current account deficit. During Jul-Aug, the deficit was around $2.5 billion, an increase of 100 percent over last year. At this rate, the deficit during the year could be around $15 billion, higher by nearly 25 percent over last year. As we said previously, we are not worried about the rising deficit since it indicates a growing economy. The July data on large-scale manufacturing shows a growth of 13 percent across a broad range of industries including iron & steel (46 percent), automobiles (43 percent), cement (38 percent) and engineering products (22 percent). This is the best growth in 11 years.

The question is that of financing. If we plan to run down reserves any further, it would be tantamount to tearing down a building we have painstakingly constructed. Imports cannot be controlled through fiat. Doing so would violate our international commitments (convertibility of our currency on current account transactions) and throw back the economy to the days of import licensing. The only credible mechanism for balancing is the exchange rate adjustment. Four reforms would help alleviate BOP imbalance.

One, except defence and debt servicing, all public-sector foreign exchange (Forex) needs should be met through the inter-bank market. Two, the SBP should not use reserves to defend the exchange rate, except to clear momentary disorder in the market; rather, it should purchase extra-liquidity even at slightly higher prices to build buffers against future instability. Three, Forex for capital goods (power projects etc) should not be provided; they should be financed through foreign credits. And, finally, an immediate ban should be imposed on the use of individual foreign currency accounts (FCAs) to be fed locally (dollarisation) and subsequent remittance abroad. FCAs fed by inward remittance from abroad can only be encashed in local currency or remitted abroad freely.

The fourth year of the government also witnessed near abandonment of the reforms process, particularly in the areas of energy and privatisation. This poses a serious threat to fiscal sustainability and for an enabling environment for investment.

The centrepiece of energy reforms was the debt settlement plan for public-sector entities (GENCOs/DISCOs) and suspension of any further accumulation of arrears in the system. As part of WB/ADB energy reforms programme, debts would have been settled through divestment of these entities to the private sector. In reality, not only do the arears continue to rise (Rs400 billion plus) but divestment plans have been shelved as well. The danger posed by the power sector to public finances is resurfacing. As media reports suggest, there is enough power available but finances for production are absent since arears are rising and liquidity shortages are becoming as acute as in 2013. Furthermore, significant tariff increases are being demanded by utilities, which is not acceptable to Nepra. This is a deeper challenge lurking in the background, which, if not fixed soon, could pose a serious challenge to macroeconomic stability.

These suggestions would restore government’s credibility in economic management. It is a herculean task, especially for a prime minister in transition, yet without it much of what the government had gained earlier would be lost.

 

The writer is a former finance secretary. Email: waqarmkn@gmail.com