The Hindu Business Line : Pakistan’s financial quagmire

The global financial crisis has worsened in the last two months. Financial sectors of the US, Europe and other countries have been facing acute liquidity crunch amidst the collapse of large global finance houses. It has affected the prospects of global economic growth.

Mr Olivier Blanchard, Chief Economist of the International Monetary Fund (IMF), has warned that the global financial crisis is set to worsen and that the situation will not improve until 2010.

Pakistan’s economy is also in the doldrums. The IMF approved a bailout package of $7.6 billion for Pakistan on November 24, under the Standby Arrangement, to strengthen the country’s rapidly depleting foreign currency reserves. The first instalment of $3.1 billion has already been released. The balance will be disbursed after quarterly reviews during the next 23 months.

The IMF has warned that Pakistan was not out of the woods yet and needs as much as $13.4 billion in 2008-09 and $12.2 billion in 2009-10 to stabilise its economy.

This is IMF’s first rescue in Asia since the beginning of the global financial crisis. Pakistan has also sought $3.8 billion loan from World Bank and Islamic Development Bank, and $4.5 billion from the Friends of Pakistan club and other donors to combat the financial turmoil in its economy.

Sinking forex reserves

Pakistan’s forex reserves with State Bank of Pakistan (SBP) fell from $7.1 billion (July 2008) to below $3.4 billion (November 21), which were just sufficient to meet the country’s import requirements for a month. This prompted depreciation in the domestic currency.

The Pakistani rupee hit a record low of 84.40 per dollar on October 17, compared to 62.72 per dollar on March 31, 2008. However, forex reserves and exchange rate went up to $5.9 billion and 79.35 per dollar, respectively, after the IMF loan approval.

At least five Pakistani banks are on the verge of collapse.

The Karachi Stock Exchange 100-share index has fallen 48.5 per cent in the current year and is at a three-year low. Both the balance of payments and fiscal deficit have come under renewed strain.

Further, the current account deficit widened to $6.8 billion during July-November 2008. And the foreign capital inflows have slowed down. Total external debt rose to $46.9 billion.

The country added $4.2 billion to its stock of external debt during 2007-08 without borrowing a single penny because of depreciation of the dollar versus major currencies such as the euro and the Japanese yen.

The gulf between the rich and poor in Pakistan has been widening. A large segment of the population hovers around the poverty line.

IMF’s conditions

Due to the liquidity crunch in the banking and financial sectors and deficit in balance of payments, it is difficult for the Pakistan Government to accept the IMF’s conditions for achieving net zero borrowing for budgetary purposes, and reduction in fiscal deficit to 3.3 per cent of the GDP by 2009-10 from 7.4 per cent of GDP in 2007-08; inflation to 6 per cent by 2009-10 from 21.5 per cent in 2007-08; and pruning development expenditure by around $1.9 billion. This will slow down economic activity and massive unemployment would further aggravate miseries till June 2010. Failure to adhere to these conditionalities will pose a threat to the disbursement of second and third tranches by the IMF.

Earlier also, SBP had accepted the IMF’s condition to increase discount rate from 13 to 15 per cent on November 12.

The country has been maintaining a tight monetary policy for the past four years. It launched a comprehensive macro-economic stabilisation package for the medium term, which aimed to restrain the growing macro-economic imbalances and to build the foreign exchange reserves to an adequate level. The purpose is to reduce external current account deficit and bring fiscal deficit to sustainable levels by rationalising expenditure and strengthening tax revenue generation.

Fear of rising inflation

The performance of Pakistan’s economy has deviated from expectations during July-November 2008. The main factors complicating macro-economic management were public sector spending beyond resource availability, 45.4 per cent increase in import bill (compared to 4.4 per cent in the corresponding period) despite oil prices plunging at the international level, 44.7 per cent increase in current account deficit, and rise in inflation (Sensitive Price Index - SPI) to 32.05 per cent.

However, weekly SPI for the period ended December 18 was 24.76 per cent. Further, fear of increase in inflation has strengthened due to rise in gas prices, electricity tariff, general sales tax, and exchange rate depreciation. The share of oil bill in total imports has increased to 37 per cent during July-November 2008.

The increase in import bill raised external current account deficit to $6.8 billion, which had to be financed by SBP’s foreign exchange reserves. This involved depletion of reserves.

On domestic account, subsidies on oil rose to Rs 17,500 crore and, on external account, oil import bill was equivalent to 7 per cent of GDP. The savings-GDP ratio fell to 13.9 per cent in the current year from 17.8 per cent in 2007-08. The overall economic growth is expected to be 3.4 per cent during 2008-09 compared to 5.8 per cent in 2007-08.

An opinion survey by the US-based International Republican Institute, released on December 19 shows that 58 per cent of Pakistanis believe rapidly rising inflation is their main concern, while 77 per cent cite an economic issue as their top priority.

There is a fear that the high inflation rate along with high interest rates for a longer period could aggravate Pakistan’s economic crisis. If interest rates are high and inflation keeps eating into the common man’s income, then there is a potential danger to the economy.

The inflationary situation that is prevailing in the economy is likely to continue and could in some ways get steeper because of the cost of food and fuel. On the domestic front, consumption is not likely to rise.

In fact, the origin of Pakistan’s economic pressure lies in the country’s growing weaknesses in macro-economic fundamentals. The economic stability in Pakistan is not possible until equitable income distribution is achieved. Further, there is a need to restore investor confidence in the Pakistan economy.

(The author teaches economics at Punjabi University, Talwandi Sabo, Punjab. blfeedback@thehindu.co.in)

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