Huzaima Bukhari, Dr Ikramul Haq and Abdul Rauf Shakoori

Pakistan’s macroeconomic imbalances have assumed dangerous proportions and the hope for economic recovery is yet to materialise. Absence of any concrete plan for revival has led to a situation where the government is taking steps to slow down economic activities and suppress demand to reduce pressure on foreign reserves and inflation at the domestic level. However, the economic team of the present government has ignored the fact that such aggressive measures to reduce economic activities can lead to unemployment and reduction in revenue collection. This approach will eventually enhance the vicious cycle where government ends up borrowing heavily to bridge revenue gap, whereas most of the revenue receipts are consumed in debt servicing.

Pakistan has a long history of boom-and-bust cycles where the economy fails to succour after short spells of growth. The macroeconomic indicators, after short spells of boom, start manifesting visible signs of rupture, because of fundamentally flawed policies where growth is mainly supported by import-based inputs. Local economic production/consumption has failed to develop endurance and the required level of resilience to stay afloat during challenging times. Consequently, as a cooling down measure, the government opts for scaling down overall economic activity level in the country. Obviously, these actions are undertaken to restrain domestic demand to prevent the compounding of inflationary density and reduce risks of external default.

Our exports on FOB (free on board) basis grew by 26.7% during July-May of the current fiscal year (FY) and reached US$ 29.3 billion (as compared to US$ 23.1 billion in the corresponding period of FY 2021). However, the current account witnessed a deficit of US$ 15.2 billion from July-May of 2022, as compared to deficit of US$ 1.2 billion of the same period of FY 2021. This happened mainly because of the resumption of post-Covid economic activities, where the import volume of energy and non-energy commodities was constantly growing and there was a rising trend in the global prices of fuel, energy, food, and metals.

The imports on FOB basis grew by 36.5% during July-May of 2022 and reached US$ 65.5 billion (as compared to US$ 47.9 billion of the same period in FY 2021). Accordingly, trade deficit from Jul-May of FY 2022 reached US$ 36.1 billion as against US$ 24.8 billion of the same period in FY 2021. Due to this rise in deficit, foreign exchange reserves and Pak Rupee remained under immense pressure.

For addressing challenges of fast erosion of foreign exchange reserves, the State Bank of Pakistan (SBP) has restricted import of multiple items and also added numerous items under the requirement of prior permission from the Foreign Exchange Operations Department (FEOD) and SBP Banking Services Corporation (SBP-BSC) for initiating import transactions. Due to these curtailment measures, non-energy imports have decreased in the first quarter of the current fiscal year. The positive impact of these restrictive measures has been more than offset by substantial increase in energy imports, which rose from a low of US 1.4 billion in February 2022 to an estimated record high of US$ 3.7 billion in June 2022.

In its latest meeting, SBP’s Monetary Policy Committee (MPC) raised the policy rate by 125 basis points. In a limited period, policy rate has been increased abnormally. In the last quarter of the calendar year 2021, the policy rate was 7.25% and within nine months, this reached a level of 15%. This unprecedented pace of increase has made the business environment extremely challenging.

The above aggressive steps have been taken to deescalate economic growth and provide support to the falling green pack in the wake of global inflation coupled with record imports. However, this flawed demand management policy may not be very effective as one of the key factors of inflation is supply constraints plus increasing commodity and energy prices in the international market.

Further, the interest rates on Export Finance Scheme (EFS) and Long-Term Financing Facility (LTFF) are now linked directly to the policy rate with a discount of 500 basis points. The markup rate for financing under EFS (Part-I & Part-II) increased from 7.5% per annum to 10% per annum. The markup rate for financing under LTFF is increased from 7% per annum to 10% per annum. Accordingly, with any change in the policy rate, markup rates for EFS and LTFF will be revised automatically so that difference between policy rate and EFS and LTFF rates is kept at 5%.

The step taken on account of economic correction, namely, the pass-through of international oil prices and cost of domestic energy products is critical in paving the way for the resumption of the IMF’s Extended Fund Facility (EFF) which can help address risks associated with bridging gaps in external reserves. Constant bleeding of foreign reserves got some respite with the recent inflow of US$ 2.3 billion in commercial loans from China. However, the successful completion of the ongoing IMF review will complement important additional funding from external sources that will ensure Pakistan’s external financing needs during FY23 are met.

The inflationary impact of these steps, however, has jolted cost structures of businesses and monthly budgets of the common man, opening floodgates of inflation that reached a 14-year high level of 21.3% year-on-year basis in June 2022, which was 9.7% in June 2021. As per MPC release, energy, food, and core inflation are rising significantly and more than 80% of items in the CPI basket are experiencing inflation of above 6%. It is concerning to state that the MPC believes that despite the dampening effect of fiscal and monetary tightening, inflation is likely to remain elevated around current levels, and during the FY23 inflation forecast is around 18-20%.

The government should also ensure that it complies with policy items agreed with the International Monetary Fund (IMF). Pakistan agreed to curtail circular debt. As per the IMF Staff report dated February 2022, “strong efforts to advance electricity sector reform are needed to restore the sector’s financial viability and address adverse spillovers on the budget, financial sector, and real economy”. The IFI-supported Circular Debt Management Plan (CDMP) will help to guide “the planned management improvements, cost reductions, alignment of tariffs with cost recovery levels, and better targeting of subsidies to the most vulnerable”. In the budget for FY 2022-23, the government exempted tax on the import and distribution of solar panels. The step was considered a way forward to meet energy requirements. However, in a recent circular, SBP imposed restrictions of prior approval for the import of solar products as well. This will slow down imports and will severely affect the initiative of providing cheap energy to people.

The abrupt and unwise tightening actions are beyond the capacity of business and the common man to bear the burden. The government is caught up in a dilemma where macroeconomic adjustments are to be undertaken while protecting the overall economic environment as well. The financial burden of this correction must be shared fairly and equitably. The most vulnerable segments of society should be protected through targeted and adequate subsidies, including financial assistance and stimulus packages. Similarly, the new businesses and many sectors of economy still enjoying exemptions must be brought into the tax net, rather than excessively taxing the already compliant taxpayers/sectors.

(Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions)