Pressure on rupee exposes Pakistan’s economic weakness

Looming currency crisis exposes consumer binge and debt service burden


YESTERDAY by Mohammad Zubair Khan
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It has only been a year since a $6.2bn International Monetary Fund programme in Pakistan was completed, and the markets are speculating about the timing of a substantial depreciation of the Pakistani rupee.

Gross foreign exchange reserves built up by borrowing heavily during the IMF programme are still over $14bn, worth three months of import cover, but speculation has been fired by the underlying weakness in foreign exchange earnings and rising foreign exchange liabilities.

Reserves are gradually declining now due partly to steadily declining exports, ballooning consumer goods imports and imports of investment goods for the China Pakistan Economic Corridor (CPEC). A burgeoning debt service, which is already 29 per cent of export earnings, is adding to the burden.

But the largest losses in reserves in recent months have resulted from central bank intervention to defend the untenable exchange rate of the rupee.

The continuing weakness in the balance of payments is a legacy of the weak IMF programme and flawed economic priorities of Nawaz Sharif’s government under finance minister Ishaq Dar. During that period, inflation was contained, helped by lower energy prices, and growth inched up but remained much below the 7 plus per cent achieved during Pakistan’s high-growth periods.

The feeble economic revival has been driven by consumption demand financed by an unprecedented surge in remittances, multilateral and bilateral donor support and expensive commercial borrowing. But the investment rate remained low despite increased government infrastructure spending as private investment in manufacturing shied away due to the uncompetitive economic environment, high cost of doing business and an excessive tax burden of a maximum 38 per cent corporate tax rate and GST rates ranging between 17 and 22 per cent.
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Like many democratic governments living and spending in the present while ignoring the medium term consequences of neglecting painful reforms and accumulating expensive debt, Mr Sharif’s government resisted calls for an exchange rate adjustment as the rupee appreciated nearly 20 per cent in real effective terms in the last four years and failed to undertake important reforms in the energy sector.

Instead it increased energy prices to cover losses of up to 30 per cent in power transmission due to inefficiencies and theft.

Conspicuously, government failure to reform the public sector enterprises, which have accumulated losses of nearly $8bn, continues to cost the budget. With the aim of raising revenue to fund high-profile spending programmes including expensive urban mass transit systems, transport and agriculture are burdened with sales tax and duties of more than 55 per cent.

In general, tax rates were raised each year for the few tax filers in the country while large segments of the population remained outside the net. In the frenzy to achieve unrealistic tax revenue targets as elections approach, the thin line between enforcement and victimisation has blurred as the Sharif government has doubled tax revenue but the number of tax filers have remained the same or declined.

Consequently, the competitiveness of the domestic economy has been adversely affected. It is not surprising that exports have declined for three consecutive years and imports surged to out-compete domestic industries, resulting in a record trade deficit of $22bn.

Industry closure is rife. The All Pakistan Textile Mills Association believes that nearly 35 per cent of textile sector units have closed down.

Agriculture production continues to fluctuate with the vagaries of weather and productivity is below a third of neighbouring countries.

Policy choices confronting the government are clear. One route is to follow the existing policy of borrowing more to finance consumption and remain on a spending binge to buy electoral victory whatever the consequences. An alternative would be to devalue the currency, improve competitiveness, reduce the cost of doing business, rationalise tax policy to invigorate its industry and reduce the country’s dependence on borrowing.

The time for making the policy choice is running out in the economic realm as next year’s debt service costs will increase to 7.5 per cent of GDP when the Paris Club rescheduled debt comes due. However, politically it is not the best of times, both because parliament approaches elections next year and because after the Supreme Court recently disqualified Mr Sharif on corruption charges, the new government is suffering political paralysis.

The new prime minister, Shahid Abbasi, who was handpicked by Mr Sharif, has not yet demonstrated his independence or his intentions to take on difficult decisions. Today both Mr Sharif and Mr Dar face corruption charges in courts but paradoxically Mr Dar continues as finance minster to ensure Mr Sharif’s control over political power and the continuity of his economic policies.

As he faces serious charges of corruption, Mr Sharif leaves behind the legacy of a heavily indebted and uncompetitive economy, beholden to western creditors. The latter will come to haunt Pakistan as it tries to realign its foreign policy away from the US.

Mohammad Zubair Khan, a former Pakistan minister of commerce, was formerly on the staff of the IMF

Pakistan targets import curbs to ward off currency crisis

Abbasi to impose fresh curbs on luxuries in effort to avoid devaluing rupee

Shahid Khaqan Abbasi says currency devaluation is not on the table © Reuters

11 HOURS AGO by Kiran Stacey and Farhan Bokhari in Islamabad
Pakistan plans to tighten curbs on luxury imports to ward off a foreign currency crisis without devaluing the rupee, Shahid Khaqan Abbasi, the prime minister, has said.

Mr Abbasi said he would rather place further controls on imports in an effort to preserve fast-dwindling foreign reserves than allow the rupee to fall against other currencies.

Some experts believe Pakistan will have to request another bailout from the International Monetary Fund within a year.

In March, the Pakistani government made it harder to import non-essential items such as vehicles, mobile phones, cigarettes and jewellery by insisting buyers put down 100 per cent of the cash upfront.

The measure drew criticism that it would encourage people to trade instead on the black market. The IMF said it had been told by Pakistani officials that the restrictions would be removed within a year but Mr Abbasi told the FT his government was planning to impose more.

“We can put regulatory duties on certain items, especially luxury finished goods, that’s possible,” he said. “We probably will do more of that, yes definitely, to discourage imports.

“Currency devaluation is not on the table, it’s not. A lot of people thought it was . . . [but] it is important to have stability for the rupee,” said Mr Abbasi.

Pakistan is running out of foreign currency as exports and payments from Pakistanis abroad fall while imports rise.

The central bank had $14.3bn of foreign reserves as of September 15, according to the most recent data — enough to cover exports for about three months. That is down from a high of $18.9bn last October.

Pakistan has been importing more than it exports for some time, but the problem has been exacerbated by having to buy Chinese supplies for projects as part of the $55bn China-Pakistan Economic Corridor.

While the scheme is aimed at improving Pakistan’s energy supply and transport networks, many economists believe that in the short term it will push Islamabad back towards the IMF.

“We will have to go back to the IMF any time now,” said Muhammad Zubair Khan, a former commerce minister who worked at the IMF for more than a decade. “The current situation is not sustainable.”

Sakib Sherani, a former economic adviser to the government, warned: “From a balance of payments crisis, we will have a full-blown macroeconomic crisis, where private sector sentiment is hit, growth stalls, inflation is high, and the central bank has to act.”

As well as restricting imports, the country has also borrowed money at short notice from various international lenders to pay off its debts. In 2016 and early 2017, Pakistan borrowed $1.2bn from state-backed Chinese banks.

Many economists believe the only long-term way out of the crunch is to allow the rupee to fall, encouraging exports and discouraging imports.

But doing so has become politically sensitive, with ministers insisting on a strong currency while central bankers warning of the likely consequences.

In July, the rupee suddenly fell 3 per cent, having traded in a narrow band since 2015. Central bank officials said they had backed away from shoring up the currency, but the move drew an angry response from the government, which stepped in to boost its value again before replacing the acting governor.

Two months after that political skirmish Mr Abbasi said: “The government stepped in to defend the currency . . . [after] the acting governor forced it to drop. That was probably a sign of a lack of experience in the post.”

The market closed down 6pts at 42743 after hitting an intra day hugh of plus 300pts. Trading remained lackluster with volumes of 126mln and value traded of Rs 6.9bln. Last weeks weekly absolute index movement was 35pts which is the lowest such change since Sep 2016. Lack of triggers and political uncertainty have left the index moving sideways.

Todays star performer was the fertilizer sector while NBP hit lower cap on a very negative court ruling which could leave the banks EPS significantly impaired.

It is encouraging that the market has so far resisted further declines from these levels and could see support from oil stocks as crude prices rally.