The liquidity crunch

The last few months have seen a disorderly movement in key markets. High fluctuations of the rupee against all major currencies, abnormal increase in Pakistan’s credit default swaps and an increase in yields of Pakistan’s international bonds to above 50 per cent on an annual basis. Less than a desirable picture.

Resumption of the IMF programme carried an inherent expectation of economic stabilization and return of confidence in markets. Board approval of the programme in end August did give a temporary boost in confidence to markets – which proved short-lived. The recent change in the economic team has again given an uptick in sentiment to Pakistan’s foreign exchange (FE) market.

Jittery markets are a reflection of a heightened dollar liquidity crunch, engulfing the economy. A host of factors have led to this crunch. The inordinate delay till August 29, 2022in having IMF as an anchor has primarily contributed in taking the economy through an agonizing odyssey.

It slowed the flow of programme and project loans from multilaterals and bilateral partners at a time when Pakistan’s external financing needs increased due to a burgeoning current account deficit (CAD) to $17.4 billion. The overall gross financing needs for FY22 escalated to $34.3 billion but the authorities could only put together $26.9 billion. This resulted in a sizeable shortfall of $7.4 billion, leading to a fall in the State Bank of Pakistan’s (SBP) FX reserves. The ordeal has continued in FY23- with SBP reserves dwindling by 18 per cent in the first three months.

Central banks hold FX reserves to ensure liquidity to meet a country’s international financial obligations and to reassure markets. Erosion of reserves during a short span of time has kept the markets on edge.

Foreign Direct Investment (FDI), a non-debt creating instrument, has plummeted by 26 per cent or $60 million in the first two months of FY23 compared to the same period last year. Political uncertainties hurt sentiment for investment, especially when the global scenario for foreign fund flows is less conducive. Rate hikes by the US Federal Reserve have reversed capital flows from emerging markets (EM). Outflows from EMs bond funds have reached $70 billion in 2022. The Ukraine crisis has further diverted major funding. All the above add to the spectre of heightened dollar liquidity crunch in Pakistan.

The liquidity crunch has serious repercussions for the real economy. Contraction in Pakistan’s large-scale manufacturing by 16.5 per cent in July 2022 partly reflects impact of administrative curbs on opening L/Cs to save precious FX. Global stagflation and domestic flood damages are likely to weigh on exports. Pakistan’s export growth may fall way short of the estimated increase of 13 per cent to $35.9 billion in FY23. Taking the first quarter run rate exports of goods may not cross $30 billio – this is truly worrisome.

On the other hand, additional food and cotton requirements can translate into imports surpassing estimated $68.7 billion in FY23. And so the estimated CAD of $9.3 billion for FY23 may exceed. Estimated foreign financing of $33.3 billion to cover debt payments and CAD, even if made available, may barely cover the increase in CAD.

A revision of macroeconomic projections has become imperative. Estimates of GDP growth, fiscal deficit and CAD for FY23 need reassessment on account of severe negative impact of floods on agriculture, livestock and infrastructure and adjustment of the rupee.

A revised macro-framework can form the basis for further negotiations with the IMF. The donor of last resort is well aware that macro stability still eludes the country. Enhanced support through the ongoing IMF programme and evoking the concessional window of rapid financing instruments can help ease the crunch and build FX reserves.

Overcoming the liquidity crisis is a prerequisite to macro-stabilization and market confidence. Fast tracking projects funded by multilateral financing and highlighting new infrastructure projects due to floods can expedite pipeline of international funds. Programme loans to the tune of $1-2 billion can be fast-tracked by completing agreed reforms. Counter cyclical financing facility by ADB of $1.5 billion even at a slightly higher mark-up is a welcome step.

Market signalling will matter. Authorities’ affirmation of rollover of existing facilities of $7 billion, with bilateral partners for FY23 is crucial. New financing commitments from China, Qatar, Saudi Arabia and the UAE of $4 billion remain foggy. Part of the money is promised as investment in Pakistan. Given a weak state of economy and political tumult, investments monies can only become a reality with concrete steps and bypassing a clogged system.

The import bill can be lowered. Conservation is the energy policy today and the energy policy is the economic policy for the foreseeable future. A conservation plan can reduce the import bill of petroleum products from a high of $23.3 billion in FY22. Additional FX savings are possible by ensuring RLNG and oil on deferred payment from Saudi Arabia and Qatar for FY23. At the same time, consumption compression is necessary to lower imports.

There are echoes of a rescheduling of external loans through a policy note by the UN. This can be considered on the lines of a Paris Club rescheduling and recent Debt Service Suspension Initiative. Specifically, $1.175 billion of Paris Club payments due in FY23 can be deferred to give some fiscal space to spend on flood relief efforts.

Bilateral rescheduling does not imply a default on Pakistan’s commercial and bond obligations. Authorities should plan on refinancing the $1 billion of Sukuk bond due on Dec 5, 2022. The kerb market for FX also needs steps for more liquidity through administrative actions on controlling smuggling and managing excessive foreign credit card payments. Other areas include swift actions against banks allegedly involved in overcharging on L/Cs, reducing the period of export receipts held abroad and allowing FE 25 account conversion. In the immediate, the country needs to ensure that a liquidity event turn doesn’t into a solvency issue.

Building buffers can help cover financing needs in case of delays in anticipated inflows. Authorities have to start thinking about a plan to ensure permanent sustainability of the country's chronic balance of payments issue. This requires a path to a much more modest CAD. Rethinking of the financing of machinery by companies through raising funds abroad are some ideas which research can shape into concrete doables for reducing CAD.

A permanent solution to our dollar liquidity challenge lies in rethinking the trajectory of the growth model to be based on productivity, global integration, promoting competition and strengthening the country's human capital base.

The writer is former adviser, Ministry of Finance. He tweets @KhaqanNajeeb and can be reached at: khaqanhnajeeb@gmail.com