Pakistan Reader# 391, 22 October 2022
Ankit Singh
On 19 October, Finance Minister Ishaq Dar assured the market that Pakistan will not default and will fulfil sovereign responsibilities. Earlier, on 6 October, the rating agency Moody’s downgraded Pakistan’s rating by one notch from B3 to Caa1. The downgrading hinted at the increased relative credit risk in financial obligation due to increased government liquidity and external vulnerability risks and higher debt sustainability risks exacerbated by floods after June 2022.
The agency was rebuked by the finance minister; he clarified that rating had more to do with government bonds.
Between the Moody’s and Ishaq Dar, where is Pakistan’s economy? This brief looks at four issues.
1. State Bank of Pakistan and Macro-economic outlook
In its Monetary Policy Statement on 10 October, the State Bank of Pakistan (SBP) estimated GDP growth of around 2 per cent in FY23 against the previous forecast of 3-4 per cent before the floods. The main reason for subdued growth was persistent inflation due to food and energy prices and domestic economic and policy conditions. SBP maintained the policy rate at 15 per cent, while the average inflation stood at 18-20 per cent, which means SBP is lending money at negative real rates in PKR. This was done to control the current account deficit (CAD) and further curtail demand pressures. This aligns with IMF benchmarks and targets on CAD, targeted at USD 10-12 billion (3 per cent of the GDP) compared to USD 17.8 billion last year (6 per cent of the GDP), the budget deficit (5 per cent of the GDP compared to 6 per cent of the GDP for the last year), revenue targets, fuel price adjustment and avoidance of procyclical domestic policies. The import restriction of mobile and car as finished and semi-finished parts has also helped Pakistan reduce its imports by 19 per cent. Recently, the finance minister removed the petroleum development levy target of PKR 50 due to high prices of fuel amid flood-induced damage to control energy and power prices. The SBP has been prudent in restraining demand for credits while keeping the core inflation in the net growth zone.
2. External debt, bonds and liabilities
According to Moody’s the CAD has been projected in the range of 3-4 per cent of the GDP due to economic costs of around USD 30 billion. The increased social spending and decreased revenues might affect net debt affordability according to Moody’s.
In contrast, the finance minister has stated that Pakistan will only ask rescheduling of bilateral debts which amounts to around USD 27 billion. According to SBP’s annual report for FY21, the Pakistan government's next external debt amounts to USD 62 billion which means, Pakistan would need around USD 34-35 billion and as per the SBP governor, the country is overfinanced. As for the Pakistan Investment Bonds, the yields for long-term bonds have dropped which could create more room for the government to finance, while international bonds have been shelved for the short term. Hence as per the media reports and monetary policy committee statement, the country would not default on its pending liabilities.
3. The resurgence of Islamic Banking
According to the SBP June 2022 quarterly, the Islamic Banking Industry in Pakistan currently have capital assets worth USD 33 billion by June 2022. On the deposits side, Islamic Banks (IB) recorded a net amount of USD 24 billion by June 2022 and that gives IB a market share in the financing of the banking industry at around 27.2 per cent. Three major sectors that took the largest share by IBI financing include: textiles (15.7 per cent), agribusiness (13.5 per cent) and production and transmission of energy (11.5 per cent). IB is asset-based financing and not asset-backed, the depositors get a share of the profit rather than an interest and the above three sectors are tangible in that way. IB through tangible evaluation enables greater financial inclusion, facilitates funding of public infrastructure projects and small and medium enterprises and carries less systematic risks. Pakistan, where the real issues are zeroed in, are the circular debt of the power sector and export financing schemes can locate an alternative in IB as per Shariah compliance. Albeit, the quarterly also mentioned the need for improved regulatory oversight, and diversified financing to include industrial financing other than consumer financing.
4. The Dar vs Ismail perspective
IMF in its debt forecast on Pakistan has projected that public debt will likely reduce to 60.7 per cent of the GDP by 2027 if the extended fund facility program is followed in principle. Currently, the public debt stands at 89.2 per cent of the GDP. A thirty per cent drop seems very challenging. On 3 October, the former finance minister criticised the growth model in Pakistan, he said, it only facilitates the top one per cent elite of the country while making the lives of lower- and middle-income groups miserable. Miftah Ismail in the past has adhered to IMF’s terms and conditionalities, he termed the decision to freeze on petroleum development levy (PDL) as reckless while the current finance minister had different priorities, to curb speculative forex trading, combat inflation and bring down the interest rate. Miftah Ismail looked at the scheme of things in the long term, improving overall efficiency while Ishaq Dar is currently focused on the sustainability of the growth model. Along these scales, it would be interesting to see how trends in public debt as per cent of GDP follow. According to Ayesha Siddiqa, in an interview with The Print, “All Dar has to do now is stick to the IMF terms and other decisions that Ismail had made, closely watch over imports and refrain from giving out subsidies until the time is right.” The argument maybe is not about efficiency or sustainability of economic growth, rather it is about priorities and Pakistan seems to be gliding well current volatile domestic and global currency markets. Miftah Ismail took the hard decisions so Ishaq Dar could facilitate backtracking to maintain public sentiment.
References
Rizwan Bhatti, “SBP forecasts high inflation, weak growth,” Business Recorder, 11 October 2022
Dr Gohar Ejaz, “Energy prices: industry begins to buckle?,” Business Recorder, 19 October 2022
“Rating Action: Moody's downgrades Pakistan's rating to Caa1; outlook remains negative,” MOODY’S, 6 October 2022
“Govt getting $4bn as bonds take battering after floods: SBP,” Business Recorder, 11 October 2022
“An interview with Miftah Ismail, former Federal Minister for Finance and Revenue,” Business Recorder, 17 October 2022
Khaleeq Kiani, “Ishaq Dar reassures market of timely repayments,” Dawn, 20 October 2022
“Islamic Banking Bulletin,” SBP Publications Quarterly
“SBP Annual Report-Statistical Supplement FY 21,” SBP Publications Annual
Pia Krishnakutty, “Ishaq Dar back as Pakistan FM but it’s outgoing Miftah Ismail who did the ‘dirty’ work,” The Print, 28 September 2022
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