Bracing for economic known unknowns

Yearly headline inflation hit 38 per cent in May 2023. This means that on average, the purchasing power of the rupee was down 38 per cent in May compared to May last year.

If you have Rs138,000 now, you can buy only as many goods and services worth Rs100,000 a year ago. Or in other words, if you have Rs100,000 now, you can buy goods and services that were worth Rs62,000 a year earlier.

Inflation has made life too difficult. Hasn’t it?

A pertinent question is: has inflation peaked now? For some obvious reasons, it seems so. From June onwards, we may see inflation — or stagflation to be more appropriate — moderating. Two consecutive cuts in oil prices in May, the last one also accompanied by a cut in LPG prices, and the fact that aggregate demand across sectors has tanked should be a harbinger of inflation easing.

If the State Bank of Pakistan (SBP) goes for another interest rate hike or maintains its key policy rate at 21pc in its policy review meeting due in June, that should dampen inflationary expectations.

Pakistan’s economy is estimated to have expanded just 0.3pc during this fiscal year ending in June, after peaking at 6.1pc in the last fiscal year. But independent economists continue to question even 0.3pc growth this year, accusing Pakistan Bureau of Statistics of figures fudging. They claim that the economy has, in fact, witnessed a contraction during this year.

With the SBP’s forex reserves now at $4.09bn, barely enough to cover even a month of imports, the central bank cannot avoid the eventual rupee depreciation

But even if we assume that nominal economic growth was achieved during this year, the decline in the growth rate — from 6.1pc last year to 0.3pc this year — is huge enough to create massive joblessness.

Estimates vary about the number of people who lost their jobs in the current fiscal year, but they broadly range between four to five million. Now just imagine the impact of 38pc inflation on the lives of those 4m-5m jobless people and their dependents. Little wonder then that we see a resurgence in street crimes, beggary and extremism. Even a slight but consistent easing in inflation and a shallow but job-creating expansion in the economy next year will be reassuring.

But the challenges for the next fiscal year are too big, in some cases unprecedented, and quite complex.

Tax revenue collection during this fiscal year will remain below the target due to sluggishness. And excessive domestic borrowing by the government — and that too on higher interest rates due to interest rate hikes — will devour the bulk of this revenue.

As the stock of pricier domestic debt has ballooned this year, pushing the cost of debt servicing further up for the next year and as next year’s fiscal deficit is projected to be higher than that of this year, the economy will continue to feel the fiscal crunch.

Besides, the need for mobilising massive foreign debt will be much greater next year than this year due to an estimated external financing gap of more than $25 billion; overall debt servicing cost in the next year will far exceed that of this year, leaving very little for development and social spending.

General elections are expected to be held sometime in October, the fourth month of the new fiscal year FY24 and the government is planning to spend lots of money on subsidies and pro-poor welfare programmes.

Whoever wins the elections will inherit weak tax collection, the rising cost of debt servicing, a deteriorating external account and very few resources to continue social spending and subsidies.

Naturally, the incoming government will accumulate debts only to throw the economy deeper into the debt trap. Whereas domestic debt will come in handy from commercial banks, acquiring foreign financing will become more difficult if a new, larger IMF loan cannot be obtained timely.

Whether Pakistan gets the much-awaited last tranche of the ongoing $6.5bn IMF loan before the end of June is very important because that will indicate if Pakistan and the IMF have reached a certain level of mutual trust.

A recent statement by the IMF Pakistan mission emphasising the current regime to follow the country’s Constitution to resolve political issues and a stern rejoinder to it by Pakistan’s state minister for finance show the level of mistrust between the two sides.

The government claims that it has a plan B ready to meet all external obligations in case the IMF’s money does not come by the end of June. Though the details of the plan have not yet been shared with the public, media reports suggest it may include soft loans from old and “new” friendly countries“, the launching of yet another amnesty scheme for untaxed Pakistani foreign funds stashed abroad, the reimposition of import restrictions, an incentive scheme for overseas Pakistanis to send more remittances back home and tailor-made subsidy schemes for exporters of non-traditional goods as well as exports of services, particularly IT and IT-enabled services.

All this sounds promising but strained relations with the IMF need to be repaired immediately to ensure obtaining lifeline forex funds from any friendly state or international financial institutions. Other features of the proposed plan B of external financing seem to be just old wine in new bottles.

Meanwhile, the SBP’s recent decision to let banks purchase dollars from other banks to settle international card payments indicates the time for a sizable rupee depreciation. The SBP decision will boost demand for dollars, pushing the rupee’s value down in the interbank market and help reduce the existing gap of Rs25 per dollar between the two exchange rates.

With the SBP’s forex reserves now at $4.09bn, barely enough to cover even a month of imports, the central bank cannot avoid the eventual rupee depreciation even otherwise.

Published in Dawn, The Business and Finance Weekly, June 5th, 2023

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