Country needs investment on BOT basis, not IMF loans

[Naveed Yaseen]

ALI KHIZAR ASLAM
KARACHI (July 21 2009): A serious lack of imagination among our economic managers is becoming more pronounced. That they eventually stretched their arm for a $4 billion of additional loan from the IMF again a case in point.

Aptly termed 'insurance' by Advisor to PM on Finance and Economic Affairs Shaukat Tarin, the additional facility is sort of a hedge or bridge financing - if commitments, worth over $5 billion, made by Friends of Pakistan (FoP) forum at their Tokyo meet earlier this year do not materialise in time.

If that is the case then there are no substantive damages on medium to long term debt servicing and sovereign ratings of the country. But the problem is that all is not too well. There is a widespread whispering among government circles, that the commitments will not actualise. Other interlocutors in press and those closely linked to the corridors of power have also reportedly lost hope.

And their apprehensions are not outrightly unfounded. After all many pledges after October-2005 earthquake did not materialise and that too in an economic environment which was more stable than the current one, which is marked by global financial crises and consequent trends towards protectionism world over.

So if the fears of non-materialisation of FoP commitments come alive or even if FoP disbursements are delayed beyond expectations, such that the calculations of our financial mandarins run out, then we will be heading towards a vicious cycle - a debt trap.

There could be two sides to the picture, both dark and pertinent to note. One; bleak internal security situation and non-compliance of some of the stipulated conditions for its $7.6 billion standby facility has clearly put off the IMF. Even if after much persuasion and promises, the IMF gives us its third tranche ($840 million) - whose fate yet hangs in balance - chances are that the lender will simply refuse the $4 billion funding request, as seen in the light of recent developments.

This might lead to a massive cut in development outlay substantially given that Rs 191.4 billion ($2.3 billion) from FoP pledges are budgeted to plug the revenue-expenditure gap. Add to this, the likely unbudgeted short fall of Rs 120 billion arising out of post-budget relief measures, and we will likely inflate our fiscal gap by over Rs 310 billion (2.1% of GDP).

Eventually, the government will need some form of additional funding as the fiscal problem cannot be resolved merely by curtailing development projects. But then considering recessionary factors world-wide, global capital markets are unlikely to entertain any new sovereign bond issue. Even if the markets were to entertain; there isn't any visible intention on the part of our government.

This will force our economic managers to rely on domestic sources - primarily central bank and commercial bank borrowings. Central bank borrowing has two major drawbacks; a) it is against the will of IMF, implying more doubts on the remaining IMF tranches, and b) it is inflationary in nature which will badly affect the government's poverty eradication programmes.

Likewise, going to the doors of commercial banks also has it own repercussions as it will crowd out the private sector furthermore. This will seriously hamper the revival of ailing manufacturing sector and consequently jeopardise the FY10 growth target. The other side of the picture is even worse.

If our economic team in Washington is able to pocket $4 billion in its debt pool, short-term twin deficits would narrow down to budgeted targets without hampering short-term growth and development expenditure - but in the long run we would have to make more fiscal room for debt servicing.

It is pertinent to note that IMF funding is usually geared towards the central bank to help it overcome balance of payment crises, but not for fiscal support. In contrast, however, the bridge-financing sought by the government is clearly aimed at plugging or reducing its fiscal gap. This implies for the government much harsher repayment conditions both in terms of timing and magnitude. Hence, more strain on fiscal balance going forward.

The inclusion of additional IMF facility would take Pakistan's external debt to $55 billion (net of debt retirement of $3.6 billion in FY10), which will account for 30 percent of total economic output while incorporating the optimistic growth target of 3.3 percent in FY10. This means that external debt, which was reduced sharply to about 28 percent in 2008, is back on upward trajectory - threatening to revisit the debt trap of the 1990s.

Furthermore, 2011 onwards, the repayment of IMF standby facility and this additional financing will raise questions on its financing. Between 2004 and 2008, we dealt with this problem through higher foreign direct investment. But with FDI flows already showing a profound decline (down 31% in FY09) with its major avenues, telecom and banking, not being attractive any more due to industry consolidation, even this option seems bleak.

Likewise, no big transaction is on the cards on the privatisation front given political sensitivities in the backdrop of Pakistan Steel Mill case and the currently damp conditions in global financial environment.

Add to this the strain of soaring defence expenditure and debt servicing which cumulatively doubled in the last four years to Rs 1,122.5 billion budgeted for FY10. This represents a huge 66 percent of our current expenditure and if these rise any further, we would be barely able to pay for them given constraints on our fiscal revenue ahead. How will then our government machinery run and what will happen to development expenses - is another dreadful story.

Hence if we don't want to fall further into debt in 2011, the government must seriously consider strengthening its foreign investment programme, sans services sector though. What the country needs is investment, preferably on a built operate transfer basis, in the real sector - which will also help reduce import reliability. Sectors such as energy and petroleum, transportation, agriculture and manufacturing sector will do the trick.

And since the government does not seem to shy away from asking for more - touting the sufferings of its role against terror - why not demand closer economic interaction on the same premise instead of making requests for just loans and grants. Greater interaction in terms of trade and bilateral investment seems more wisely - after all we are living in a knowledge economy.

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