Imran Khan assumed office as the 22nd Prime Minister of Pakistan on 18th August 2018. The PTI reform agenda envisaged driving the Pakistan’s economy on a path to sustainable high growth. According to the PTI, the crux of the problem lay in flawed energy policies, spiraling fiscal deficit, grossly inadequate tax to GDP ratio, multiple bailouts by international agencies, under investment in education, health and skills sectors. The PTI also identified antiquated governance and all-pervasive corruption and lack of political leadership as the reasons for the long-term decline in the economy. The PTI said that a business as usual is not sustainable, as Pakistan will become the “poor man of the 21st century” with per capita debt of PKR 145000 per Pakistani.
PTI economic reform program envisaged creation of a fiscal space of 9 percent of GDP with a 5 percent increase in tax collections, 2 percent reduction in wasteful expenditure and 2 percent reduction in losses of PSE’s. Further the economic reforms vision projected a growth rate of 6 percent, inflation to be brought down to 7 percent, fiscal deficit to be brought down to 4.5 percent, tax revenues to be raised by 15 percent and a four-fold increase in welfare spending. Structural reforms were envisaged in energy sector, expenditure reform, revenue collection and human capital development. The Railway Ministry was to be abolished and replaced by a Railway Board, a fully autonomous board to manage the PSE’s similar to Malaysia’s Khazanah. An expenditure emergency was to be announced with all Governor houses, PM house being converted to places of public use and expenses of President to be cut to half. The number of Federal Ministries was to be reduced to 17 from 37, no development funds of Parliamentarians and elimination of all discretionary funds.
It was clear that the Imran Khan Government faced formidable macroeconomic challenges. Current account deficits were widening, there were fiscal slippages, and an accommodative monetary policy stance. Foreign exchange reserves had declined to 2.3 months of import cover and debt related vulnerabilities had increased. The foremost challenge to the economy was to rise the growth rates without corresponding resources to support it, leading to rising fiscal and external accounts deficits. To address the severe macroeconomic instability, Pakistan needed to adopt policy measures with the objective of maintaining fiscal discipline, contain losses of public sector enterprises and adopt structural reforms, in addition to a tighter monetary policy stance.
In his first address to the Nation, Prime Minister Imran Khan emphasized on cutting government expenditures as part of the cost-cutting initiative and several austerity measures were announced. The PTI Government banned the discretionary use of state funds, and first-class air travel by officials and leaders, including the President and Prime Minister. Shortly thereafter the PTI Government announced the sale of 100 luxury cars of the Prime Minister House under the austerity drive. The sale was held on the lawns of the PM House. The PTI Government hoped to get US $ 16 million from the sale but managed to make only US $ 600,000 from the sale of 70 cars. It was not easy to make the expenditure cuts that were necessary – cuts in defence spending, additional allocations to education were not feasible. Media criticized the PTI Government’s U-turns on converting the PM House into a research university named Islamabad National University and the failure to make any headway with the proposed education reforms or health care reforms. Quite clearly the challenges of macroeconomic stabilization had taken precedence over the issues of growth.
The Quest for Energy and CPEC
Pakistan embarked on a massive investment program in energy and infrastructure to mitigate the chronic shortages, diversify the country’s fuel mix and improve trade connectivity. The China – Pakistan economic corridor (CPEC) which is a large package of investment projects, totaling about US $ 55 billion (20 percent of GDP) over a decadal period. There are 19 CPEC Projects – US $ 17.7 billion in energy sector, US $ 5.9 billion in infrastructure which are in the advanced stages of planning and implementation. The CPEC infrastructure and transport projects are financed by long term concessional government borrowing from China, while the CPEC energy sector projects involved foreign direct investment and commercial borrowing from Chinese financial institutions. CPEC projects were expected to about US $ 13 billion to the Pakistan economy over a decadal period. At the same time, Pakistan faced long term payment outflows in the form of loan repayment, profit repatriation and imports of input fuel. The repayments are expected to rise every year reaching a peak of US $ 3.5 – $ 4.5 billion by financial year 2024/25. It is important for Pakistan to buildup foreign exchange reserves to cushion the impact of the enhanced payments outflows. This requires a significant amount of fiscal discipline, raising of tax revenues, restructuring of public sector enterprises to ensure cost recoveries and a gradual phasing of new external borrowing commitments.
The inevitability of another IMF Program
Pakistan had been on an IMF program from 2013-2016. The policy agenda despite a prolonged IMF program had remained incomplete, requiring continued efforts for macroeconomic stability and growth supporting structural reforms. The 2018 post program monitoring discussions between Pakistan and IMF highlighted the risks of Pakistan’s medium-term capacity to repay the IMF was heightened on current policies with Fund repayments rising in the years 2019-2024. Pakistan’s repayments to the IMF were to commence at SDR 243 million in 2018 and peak at SDR 820 million in 2021, with a gradually declining schedule until 2026. The repayments amounted to 22 percent of the foreign exchange reserves in 2022. Further the report said, external imbalances have widened, international exchange reserves had declined and market confidence had eroded. The restructuring of Pakistan International Airlines, Pakistan Steel Mills and Pakistan Railways had not progressed and financial losses continued to accrue and the energy sector companies continued to incur new payment arrears. There were also external repayment obligations on account of CPEC investments. Quite clearly Pakistan’s capacity to make repayments was already fraught with high risks. It was in this scenario that Pakistan needed to approach the International Monetary Fund for the 22nd time.
On June 19, 2019, Reza Baqir, Governor of the State Bank of Pakistan wrote to the Managing Director IMF, seeking IMF assistance under the Extended Fund Facility (EFF), on grounds that international reserves have reached critically low levels, balance of payments gap is still large, in an environment of limited market access. The situation is grim and extremely worrisome. Macroeconomic vulnerabilities have increased on the back of weak policies, with pro-cyclical fiscal policies leading to a surge in fiscal deficit and an accommodative monetary policy resulting in a significant current account deficit. Fiscal deficit widened to 7.3 percent for the 2nd year and current account deficit which stood at 6.3 percent in 2018-19 which narrowed on the back of 19 percent rupee depreciation.
Reza Baqir said that although significant measures were undertaken to meet the macroeconomic challenges, the structural challenges remained unaddressed and institutions have not been strengthened to ensure economic discipline. Further a less favorable external environment had added to the difficult picture. The gradual policy measures – depreciation of the rupee, some monetary tightening, increase in gas prices were simply not enough to stabilize the economy. Comprehensive reforms became a felt need for fiscal tightening and addressing the maturing debt obligations in coming years. Economic activity in Pakistan had slowed considerably and with agriculture, manufacturing and construction sectors witnessing considerable contraction owing to reduction in government spending. Economic growth declined to 3.3 percent in 2019 from 5.5 percent in 2018 while inflation accelerated to 9.1 percent from 4.2 percent in 2018.
Fiscal deficit continued to build, the deterioration was due to revenue shortfalls, particularly in personal income tax collections. Tax to GDP ratio came down to 13 percent, which is the lowest in South Asia. At the same time expenditures continued to rise due to higher interest payments, subsidies and defense related spending. Fiscal deficit was largely financed, by increased borrowing from the State Bank of Pakistan. Power sector arrears accumulated in the past 2 years, and reached close to 4 percent of GDP as a result of delays in adjusting tariffs, reversal of policies and non-payment of implicit subsidies by the government. Losses were also witnessed in major Public Sector Enterprises of Pakistan International Airlines, Pakistan Steel Mills and Pakistan Railways, all of which amounted to 2 percent of GDP. The banking sector remained stable but there was a lot of reluctance to lend to government. Banks maintained the global norms of capital adequacy and non-performing loans in agriculture and SME’s remained high at 15 percent. Unemployment was 6 percent and 30 percent of population remained below poverty line.
The external sector was substantially weakened. Exports were flat, Pakistan rupee depreciated by 21 percent in FY 2018/19 and foreign direct investment inflows were weak.
Pakistan’s twin deficits – fiscal and current account have moved into unsustainable territory. Macroeconomic stability is a huge challenge. The overall situation of low savings, low revenue generation and high trade gap paints a grim economic picture which needs an immediate bailout.
The IMF Program 2019-2022
On July 3, 2019, the IMF Executive Board approved a 39-month extended arrangement under the Extended Fund Facility to Pakistan for an amount of USD 6 billion. This represents Pakistan’s 22nd program with the IMF since Pakistan’s membership to the IMF in 1950. The pace at which Pakistan’s IMF program has been approved, with low conditionality, indicates strong backing from large shareholders of IMF – the USA, Japan, and EU member countries. The IMF has projected considerable positive estimation for decisive turn around in Pakistan’s economy in the program period, which may not happen in the current sluggish global economic environment.
Pakistan’s economic reform program supported by the EFF, has 2 main pillars (a) macroeconomic stabilization and (b) strengthen and build institutions. The key elements of are the following:
Pakistan’s EFF program will run from July 3, 2019 – September 2, 2022 for a period of 39 months at 210 percent of quota, is a frontloaded program with SDR 716 million (35 percent of quota), the first tranche of which was released on July 3, 2019. The next 4 tranches of SDR 328 million (16 percent of quota) are due for release between December 6, 2019 and September 4, 2020. The last 4 tranches of SDR 560 million (28 percent of quota) are due for release from March 5, 2021 to September 2, 2022. In all 4 quarterly and 4 semi-annual reviews have been scheduled under the program.
Pakistan current external liabilities stand at USD 85.48 billion which is 43.4 percent of GDP. External debt to China stands at USD 15.15 billion, Japan at USD 5.67 billion and Saudi Arabia at USD 6.41 billion. External debt to China is far more than entire Paris Club debt. External debt risks remain high, the IMF has projected that external debt will decline after peaking in FY 2021.
Without strong and timely support from official/ bilateral lenders a return to sustainable debt path is not possible. General Government and government guaranteed debt stands at 80.5 percent of GDP and maturity structure of the public debt has worsened with 57 percent of the public debt having a maturity of less than a year. The debt management strategy is aimed at lengthening the maturity profile and widening the investor base. Gross Official foreign exchange reserves currently stand at USD 11.2 billion barely enough to cover 2 months of importsare expected to increase to USD 28.1 billion which would be 4 months of import cover in the program period.
Over the Program Period, IMF approval will unlock around USD 38 billion from Pakistan’s international partners.
The expected support from bilateral and multilateral creditors is expected as follows:
The gross inflows of multilateral and bilateral disbursement would be
July – September 2019
USD 3 billion
October – December 2019
USD 5 billion
January – March 2020
USD 6.5 billion
April – June 2020
USD 4.8 billion
Debt sustainability is an integral part of the program if these moneys are to materialize.
The IMF has said that there is a need to reduce fiscal and quasi-fiscal deficits and stronger revenue mobilization. Pakistan seeks to increase revenue collection through a broad-based tax policy and bring down fiscal deficit. General Government Debt at 80 percent of GDP has to be brought down to 67 percent of GDP to create space for investment. Accordingly, the 2019-20 Budget, has proposed higher revenue measures for 1.7 percent and power sector subsidies have been budgeted. However, there have not been major cuts in social sector spending with the Benazir Income Support Program (BISP) showing a slight increase in allocations. The BISP program reaches over 5 million families. A disbursement of Rs.1000 to all BISP beneficiaries by end August 2019 and launching of “one woman-one account” to bring 6 million women under financial inclusion by end October 2019 are significant initiatives.
Amongst the major tax policy reforms are measures aimed at removing exemptions and preferential treatment to reduce distortions in the tax systems and broaden the tax base. The first step is increased sales tax on petroleum products. Preferential sales tax rates to sugar, steel, edible oil, medium and large retailers exist. Removal of sales tax exemptions, simplifying filing procedures and increased compliance are proposed. Pakistan also seeks to strengthen the taxation on real estate and agricultural turnover. A shift from sales tax to VAT has been proposed in the coming years. A semi-independent tax authority is to be created and no further tax amnesty will be given. This is a continuous structural benchmark under the IMF program. Income tax threshold has been reduced for salaried and non-salaried individuals. A gift tax has been introduced. Federal excise duties on cigarettes, aerated drinks and cement have been introduced, customs duty exemptions on LPG have been eliminated.
To increase fiscal discipline, Pakistan adopted a Public Fiscal Management Act which necessitates Parliamentary approval of budget authorizations.
Monetary Policy Program
Macroeconomic stability remains a key area under the program. For this, the monetary policy needs to be tightened. There has been a cumulative upward revision since 2017 of 450 basis points in the policy rate and the rupee has moved 31 percent against the dollar. Interest rates have risen above 10 percent. While the Governors of State Bank of Pakistan have pressed for a tax to GDP ratio of 15 percent, primary and revenue surplus has remained a mirage with both tax and non-tax revenues well below the target. The State Bank of Pakistan has been pressing for deferred oil payments arrangements, increased government efforts to arrange for financing from China, Saudi Arabia and UAE to give Pakistan some cushion against the headwinds.
Monetary Policy has been tightened and inflation objective of 5-7 percent has been laid down. One of the important steps envisaged under the program is elimination of the State Bank of Pakistan financing the budget deficit. Fiscal dominance had eliminated every semblance of autonomy of the State Bank of Pakistan and the continuous performance criterion on refraining from new direct financing of budget by the SBP is significant for the autonomy of the institution. Amendments to the SBP Act are proposed to be undertaken to enhance operational independence, governance and the Governor’s tenure.
The IMF program does not interfere with the ongoing social sector programs – the national financial inclusion strategy, the long term financing facility, the export financing scheme, the low cost housing plan, the SME financing plan and promotion of digital payments. The IMF has said that protecting the most vulnerable from the impact of adjustment policies is an important priority. Citing poverty reduction and social inclusion as crucial for sustainable growth an indicative flo/or on social spending has been prescribed to support the most vulnerable. Pakistan’s policy of protecting lower income households from higher energy prices will continue, although there will be a specific upward revision in the gas tariffs.
As with every IMF program, there is an emphasis on structural policies. Eliminating power sector losses on a sustainable basis will require new pricing and improvements in governance and infrastructure. Privatization of 7 selected Public Sector Enterprises, audit of Pakistan International Airlines and Pakistan Steel Mills, Triage of SOE’s and Enhancing of SOE legal framework have been prescribed.
The IMF program also entails Pakistan to improve the effectiveness of the AML/ CFT regime to support its exit from the Financial Action Task Force list of jurisdictions owing to shortcomings in effectively addressing terrorist financing risks. The National Executive Committee of FATF is monitoring and coordinating the efforts to implement the FATF action plan and Pakistan’s evaluation report will be taken up by the Asia Pacific Group on Money Laundering in August 2019.
Managing Director IMF meeting with Prime Minister of Pakistan
On July 21, 2019 the Acting Managing Director of IMF David Lipton met Imran Khan, Prime Minister of Pakistan. In his discussions the Acting Managing Director discussed the recent economic developments and the implementation by Pakistan of the economic reform program supported by the IMF. He said that Pakistan needs to mobilize domestic tax revenue now and place debt on a firm downward trend.
On November 8, 2019, the IMF staff and the Pakistan authorities reached an agreement on the policy reforms needed to complete the first review under the program and disburse US $ 450 million, which will unlock significant bilateral and multilateral funding. The IMF noted that the performance criteria were met, while the work was in progress for meeting the structural benchmarks, progress has been achieved in improving the AML/ CFT framework with additional work to be done before March 2020. Five indicative targets for end September 2019 were missed, including tax revenues collected and the power sector arrears. Structural benchmarks were implemented albeit with delays and internal auditors have been selected to conduct audits of Pakistan International Airlines and Pakistan Steel Mills. The IMF noted that international partners remained supportive of Pakistan’s reform efforts. The recommendations of the IMF staff were duly ratified by the Executive Board of the IMF on December 19, 2019. The Executive Board has called for faster progress to improve the AML/ CFT framework and swift measures to exit all the FATF’s list of jurisdictions with AML/ CFT deficiencies.
Pakistan submitted a 500-page report to the Joint Group of Financial Action Task Force (FATF) on January 8, 2020 sharing the progress on the 22 points in a bid to come out of the grey list. The FATF will examine the reply submitted in its Beijing meeting from January 21-24, 2020. In the last plenary meeting FATF continued Pakistan on the grey list upto February 2020. Another relaxation up to end May 2020 is expected to be granted.
Is Pakistan’s EFF program is viable?
Debt risks are very high in the low conditionality program. The debt ratio in the absence of strong implementation would rise of 83 percent of GDP by 2024 and financing needs would remain at 26 percent of GDP. External debt risks are also very high, and from a current high of 37 percent of GDP are projected to decline after 2021 to a sustainable path. There are significant risks of current account and exchange rate and unless Pakistan’s economic program responds to the IMF prescription and the financing assurances materialize, a major economic crisis requiring a stronger adjustment program cannot be ruled out. It is rather surprising to note the Army Chief being nominated to the National Development Council even when the economy is in doldrums.
It should be noted that Pakistan continues to receive strong financial support from China, Saudi Arabia and UAE who have maintained their exposure to Pakistan by extending new financing in the amount of US $ 700 million from China and US $ 3 billion from Saudi Arabia fully covering the matured loans, the Asian Development Bank has approved US $ 1 billion new Special Policy Based Loan to further strengthen the balance of payments. For the next 12 months, Pakistan remains fully financed under the IMF program with bilateral and multilateral commitments being realized. Even after this, Pakistan will owe the IMF SDR 6146 million by September 2022 and debt repayment risks would continue to exist.
Pakistan 2020 under Imran Khan
In 2020, Prime Minister Imran Khan will be heading to the mid-term of his electoral tenure, there exist enormous challenges on the economic front and meeting public expectations remains an uphill task. The Government will have to enhance the use of AML tools to support anti-corruption efforts, ensure independence of the financial intelligence unit and establish a robust asset declaration system for public servants. There is also a need to strengthen the effectiveness of anticorruption institutions in investigating and prosecuting corruption cases. On the social sector, Pakistan has said that it intends to transfer the additional one-off disbursement of PRs 1000 to beneficiaries of the Benazir Income Support Scheme in August 2020, after finalizing the banking contracts for the stipend disbursement. Not many major social sector programs have been launched, although there have been structural modifications in the existing schemes for girls education like Waseela e-Taleem (WeT) and the affordable housing program in Ehsaas.