The security environment is uncertain. In the best-case scenario, Pakistan-India relations will normalise. But no one knows how long the process may take.

In a bad-case scenario, both countries might witness slight to intense movements on the war escalation ladder.

Projecting the worst-case scenario is an insane exercise.

In this situation, Pakistan’s external account management has become all the more difficult.

The biggest worries right now are boosting foreign exchange and fuel reserves. For fuel reserves’ augmentation, the government has issued directives to the relevant department. But issuing directives won’t work for enhancing foreign exchange reserves. As of March 1, the central bank’s reserves stood at $8.11 billion, not enough to cover the imports of even two months. Total reserves, including those of commercial banks, were $14.95bn, equal to the imports of less than three and a half months.

What keeps the foreign exchange reserves of the State Bank of Pakistan (SBP) low is a high, though receding, current account deficit. In the first seven months of this fiscal year, the current account deficit was $8.42bn, down from $10.12bn in the year-ago period.

India is lobbying intensely to see Pakistan’s name on the FATF watch list. Our own diplomatic efforts to block such a move still have a long way to go

If this deficit does not fall dramatically, keeping the overall balance of payments will require a drawdown on the central bank’s reserves, continued injection of foreign funds from abroad or thick inflows of foreign investment. The current account deficit is likely to see a further fall due to the ongoing contraction in imports, modestly rising exports and fast-growing remittances.

But what will happen to exports and remittances if the security situation does not improve? One of the prerequisites of an improved security situation is our ability to crack down on banned outfits. Another one involves taking more steps to comply with the requirements of anti-money laundering and combating the financing of terrorism regime.

On both counts, particularly the first one, we finally saw some decisive action: proscribed organisations are being paralysed, seminaries are being taken over and people with alleged ties with banned outfits are being arrested.

But will all this avert an FATF action against Pakistan? India is lobbying intensely to see Pakistan’s name on the FATF watch list and our own diplomatic efforts to block such a move still have a long way to go.

For external debt payments to flow smoothly in March and the next quarter without taking a hit on SBP reserves, further injection of foreign funds into our state coffers is a must. China, Saudi Arabia and the United Arab Emirates have already pumped in $7bn so far. Media reports suggest we may get another $1bn from the United Arab Emirates. Will that be enough?

Oil imports from Saudi Arabia and the United Arab Emirates on deferred payments may lead to a faster shrinking of the trade and current account deficits in the next quarter. That may help the central bank keep its foreign exchange reserves intact and continue to make external debt servicing smoothly till the end of this fiscal year.

But even then we will still need thick inflows of foreign investment in order to keep the overall balance of payments in shape.

Even if we don’t see an immediate escalation, will the current situation on the eastern border not lead to the diversion of additional finances towards defence, thus putting extra pressure on an already high fiscal deficit and a deteriorating external account?

Making sincere peace gestures may help win some diplomatic support and that, in turn, may also encourage foreign investors to continue business as usual with Pakistan. But portfolio investment is hot money. With the slightest escalation, that may start evaporating. Foreign direct investment (FDI), particularly that of the strategic nature as promised by the United Arab Emirates and Saudi Arabia, may take time to materialise.

Even CPEC-related FDI flows may or may not continue flowing in accordance with the original schedule. That will now depend on how China perceives the security situation in the region, not just in the context of Pakistan-India relations but also in the backdrop of the likely resolution of the Afghan conflict. All this will have a direct bearing on our external account management.

Regardless of whether emergency dollar-pumping into the SBP account by friendly nations continue — and that depends more on geopolitics than the urgency of our need — regular flows of foreign funding are drying up. According to a Dawn report, budgeted foreign funding in July-December 2018 slumped to $2.3bn from $5.9bn in July-December 2017. Even if the $4bn special funding received from the United Arab Emirates and Saudi Arabia during this period is added, the total foreign funding, including loans and grants, comes to $6.3bn, far short of the budgeted $9.7bn for July-December 2018.

All hopes now rest on an IMF bailout package. According to the latest update of Fitch Solutions, “Pakistan and the IMF will reach an agreement over a bailout soon, with the potential bailout size of about $12bn.” Whether the IMF lending programme turns out to be exactly $12bn or substantially less than that will matter a lot in maintaining our balance of payments. But even if it is $12bn, until we get a letter of comfort from the IMF and the disbursement of funds start, nothing will change on the external account.

A letter of comfort issued after the approval of the bailout package helps in attracting foreign investment. With the release of the first instalment of the package, the authorities are able to make more realistic projections about the future course of the external account. But both things work under the normal security situation.

Let’s hope peace prevails. But let’s also be prepared for tougher times ahead just in case the peace process takes longer than expected.

Published in Dawn, The Business and Finance Weekly, March 11th, 2019