Default in our stars: Pakistan’s flawed policies could bankrupt it soon
“In the simplest terms, the French government went bankrupt and did not maintain enough confidence among the people to pull through it. Instead, it was the signal to a great number of French people...that it was high time to reorganize society on the basis of reason and equality,” writes Christopher Oldstone-Moore, a historian at Wright University, while describing the collapse of the ancient régime. It would not be an inapt depiction of the mood among many middle-class Pakistanis as the country stands on the verge of bankruptcy.
The bleak prospect stares down at Pakistan’s financial managers with the State Bank of Pakistan (SBP) foreign exchange reserves falling to less than USD 7 billion, and projected to fall close to USD 6 billion by the calendar year-end, or barely one month’s import cover. As the country runs short of hard currency, importers are complaining about finding it difficult to open letters of credit (LC) despite the SBP’s denials of imposing any restrictions on imports.
On-ground reality indicates that as a result of delays in the opening of LCs, many businesses are facing severe difficulties. For example, the Pakistan Medical Association (PMA) has warned that a shortage of medicines due to the non-opening of letters of credit (LCs) for the import of active pharmaceutical ingredients (APIs) or raw materials will severely affect the country’s health delivery system. Similarly, All Pakistan Fruit and Vegetable Exporters, Importers, and Merchants Association (PFVA) have complained that commercial banks are not releasing documents because of the shortage of foreign exchange to allow clearance of vegetables. As more industries such as steel, automobiles, telecom, home appliances, etc., face supply constraints and increases in their costs, consumers are likely to bear the burden by having to pay higher prices, which in turn will further contribute to the inflationary pressure. The government is forcing default on current account transactions of the private sector and thereby suffocating the economy which hurts the vulnerable most of all.
The government appears not to have so far presented a realistic plan to meet shortfalls arising from expanded expenditures and less tax revenue generation due to the economic slowdown as well as to ensure adequate response to the floods. It has also failed so far to secure USD 4 billion in financing from friendly countries to support the program.
There is an urgent need to bring about macroeconomic stability to reverse the perilous position, for which the continuity of the International Monetary Fund (IMF) program is essential. However, during the ongoing 9th review discussions, the IMF has indicated that “not all end-September quantitative targets have been met”, which could be, inter alia, one of the reasons for the formal review mission timeline not yet being announced. Uncharacteristically revealing the failure to meet targets during ongoing review discussions could indicate dissatisfaction with Pakistan’s performance. Slippages in budgeted expenditure and revenues have resulted in a material primary fiscal deficit as opposed to the small surplus that had been agreed upon in August at the conclusion of the combined 7th and 8th review. The slow provision by the government of information necessary for proper diagnosis is likewise unhelpful.
Furthermore, the IMF may be disappointed with the SBP purportedly instructing banks to institute administrative measures to control imports through delays in the processing of LCs. Additionally, by forcing licensed forex dealers to only transact at SBP-recommended exchange rates, the central bank in effect is trying to manage the rupee parity price against the dollar. Suppressing the trend movement in the exchange rate goes against the market-determined mechanism agreed upon with the IMF under the Extended Fund Facility (EFF) program. Artificially managing the rupee will not only exacerbate the deteriorating reserves situation, which are well below program target levels to start with but also signals to the lender a lack of commitment to structural reform, which is a fundamental tenet of the EFF program.
The forex administrative measures have fueled the growth of an undocumented curb market for currency transactions as volumes at the SBP recommended rates have shrunk to negligible levels. This has contributed to the reduced inflow of foreign exchange. With almost a 10 percent difference between the curb market rate and the interbank rate, more of the workers’ remittances are being channeled through informal means such as hawala/hundi. The inflow of remittances in Pakistan fell nearly 16 percent in October 2022 on a year-on-year basis. The uncertainty in currency markets would also encourage exporters to delay the conversion to rupees of export dollar proceeds in anticipation of future depreciation.
The government appears not to have so far presented a realistic plan to meet shortfalls arising from expanded expenditures and less tax revenue generation due to the economic slowdown as well as to ensure adequate response to the floods. It has also failed so far to secure USD 4 billion in financing from friendly countries to support the program. The Finance Minister, Ishaq Dar, should now avoid bellicose bluster, but rather undertake corrective policies that focus on successfully concluding the 9th review with the Fund. Failure to do so is almost certainly going to result in sovereign default, and in the resulting irremediable turmoil, the poor will suffer the most.
- Javed Hassan is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets at @javedhassan.