Pakistan’s difficult external account situation
PAKISTAN’S external account situation continues to deteriorate. A serious crisis is not immediate but is very likely to occur down the road, probably in about a year’s time.
Large flows of remittances which have registered significant increases in recent months are likely to continue. These are providing a cushion for a while. However, it is unlikely that they will continue to increase over time.
With one exception, it is mostly for political reasons that Pakistan now has very limited options available for financing the trade gap. The exception, as discussed below, is bad economic management which has raised the price the country will have to pay to access the international capital markets for raising funds by issuing government-backed bonds. This is always an option when the public sector as a
source of funds has dried up. That has happened in Pakistan’s case, the consequence of the problems with the IMF and the United States.
Having failed to implement the tax policies on the basis of which it had negotiated a large IMF support programme, Islamabad walked out of the arrangement. The Fund wanted Pakistan to increase the tax to GDP ratio by levying new taxes and broadening the tax base. Among the new taxes the IMF wanted to levy included a value added tax. However, Islamabad did not have the political will to press the provinces to accept the changes that needed to introduce the tax.
As had happened in 2007, the government is likely to spend freely to win votes in the forthcoming elections. During my most recent visit to Pakistan I was told by a senior member of the governing party that he and his colleagues were advising the prime minister to “spend, spend, spend” in order to prepare the ground for victory. When asked from where the resources for financing government constituency building expenditures will come, his answer was simple but scary: “We have said to the prime minister to print, print, print the needed money.”
The obvious impact of this will be a large fiscal deficit followed by a pickup in inflation, which has remained at double-digit levels. At that level, inflation gets to be built into peoples’ expectations. Once that happens it takes draconian measures to bring back price stability. These will be difficult in a country that is still engaged in the process of creating a democratic political order.
Following the elections of February 2008, the new government was left with no choice but to go to the IMF to seek support. The Fund was accommodating. Not only did it agree to provide large sums of money, the programme that it agreed to support was free of serious conditionality. The Funds generosity was partly motivated by politics. Several Western nations led by the United States were keen to stabilise the economy in order to help the fledgling democratically elected government to find its feet. But the democratic government found it difficult to implement even the soft programme. As already indicated, Islamabad decided to terminate the programme not having done much to improve the tax base.
Confident that Pakistan’s democratic experiment would have the support of the West-led the government in another direction. It mobilised the “friends of democratic Pakistan” into a group and approached it for help. The response was disappointing from Islamabad’s perspective.
The friends demanded actions by Pakistan to improve economic management but that did not happen. The countries that may have given support became weary. It was only the United States that remained engaged. It needed Pakistan’s support to make a success of its
Afghanistan operation. That worked only for a while.
A series of unpleasant events soured Islamabad’s relations with Washington. The Americans responded by blocking the flow of most aid to Pakistan. Islamabad’s attempt to generate some $500-600 million by heavily taxing the use of its roads by America’s truck and containers did not yield the expected results. All that Islamabad was able to procure from its presence at the recently concluded Nato summit in Chicago was a snub by the American president for his Pakistani counterpart. On May 22, a day after the conclusion of the Chicago summit,
the US senate moved to take $900 million pencilled in for Pakistan out of the budget for 2012-13.
Faced by these difficulties Pakistan could have turned to the private capital markets for tidying up the coming payment’s difficulties. Had times been better for Pakistan, as they are for a number of better managed emerging economies, it too would have benefited from an unexpected development in the perception of the international financial markets. The credit ratings of several emerging markets have begun to converge with those of developed states. Up until recently emerging economies were rated way below those in the developed world.
Many of them were considered to be below investment grade which meant that the bonds floated by them even when they were guaranteed by the state were considered to be “junk”.
However, the recent financial crisis and the continuing troubles in Europe have had a remarkable change in perception as to what is regarded by the international markets as safe as against those considered to be risky assets. International investors have piled into emerging markets sovereign bonds attracted by better credit ratings and better returns than those available in several rich nations.
Moody’s, the credit rating agency, has let it be known that it is reviewing or has a negative outlook on 29 countries several of which may be downgraded. The rating agencies’ axe may fall on 15 developed nations while a number of emerging markets may see an improvement in their grade. The United States was downgraded last year after the political wrangling over the question of the government’s debt ceiling. It is possible that the UK, Spain, France and Italy will see ratings decline.
However, a dozen emerging economies are likely to see improvements in the ratings. Included in this group are Brazil, China, Peru and
Turkey. According to Matt King, a senior strategist at Citigroup, “everyone is evaluating what ‘safe’ means now. Many investors are waking up to the fact that the risks are much higher in developed bond markets than they thought.”
Options are extremely limited for Pakistan at this time as the country moves towards another crisis. If the government has any plans for dealing with the developing situation it will do the country a favour by sharing it with the public.