EAG for urgent need for responsible macroeconomic policies

The EAG had earlier pointed out that relying on untargeted subsidies to provide relief to masses poses significant risk to public finances. Since then, energy prices have continued to remain elevated. The Russia-Ukraine war and subsequent increase in global commodity prices have further triggered a sharp increase in Pakistan’s credit risk. The CDS (credit default swap) rate has also increased from around 4% to around 12% since 4th March 2022.

These developments have increased Pakistan’s vulnerability both on the internal and external front. The outgoing finance minister reports that the fiscal deficit for the first nine months of FY22 equals 3.9% of GDP. At the same time, the new government projects that the fiscal deficit for FY22 will be Rs5.6 trillion. This is close to 8.8% of GDP under the new base. Taken at face value, an increase in the fiscal deficit by about 5% of GDP in just one quarter will be extremely destabilising both from the point of view of public finances and external stability. 

The increase in vulnerabilities on the external front imply that the government should adopt a prudent fiscal policy. Pakistan’s total external debt servicing during FY22 and FY23 is expected to be around $35bn. While the nature of debt which is to be paid over the next two years is such that it can be rolled over, especially once in the IMF program, it nonetheless limits Pakistan’s ability to contract new debt. Raising new debt from the international markets at a time when the credit default risk is close to 12% will be expensive, if not impossible. 

The implication is that it will no longer be sustainable for Pakistan to finance large CAD during these years. A high CAD will also increase debt servicing costs in subsequent years, thus undermining financial stability over the medium-term as well. An expansionary fiscal policy which increases aggregate demand and, as a result, exacerbates CAD will put further pressure on reserves and will ultimately lead to a severe balance of payments crisis. In this context, the recent decision by the new government to not pass on the increase in fuel prices to consumers is a step in the wrong direction.

In adopting policies to ensure economic stability, an important first step would be to work towards reinstating the IMF program. This is critical both for ensuring that Pakistan can rollover a significant fraction of its existing debt and also for unlocking new funding sources. The decline in SBP foreign currency reserves in recent weeks should instil urgency. 

It is equally important that any engagement with the IMF is complemented with adoption of prudent fiscal policy. An expansionary fiscal policy will result in a sharp increase in CAD. However, as discussed above, the difficulty in financing large CAD by issuing new debt in current circumstances and the subsequent increase in debt servicing that comes with it will threaten financial stability over the medium-term. A prudent fiscal policy will require rationalising energy prices. In this context the EAG hopes the government will review its decision to reject the OGRA recommend petroleum product price increase.

The EAG insists that, in an attempt to stabilize the economy, the government should avoid policies which undermine long-term productivity of the economy. These include increasing restrictions on imports, offering untargeted subsidies to business groups in the hope to increase exports, and price controls. Instead, to achieve sustainable growth, Pakistan must improve its trade linkages with the rest of the world and implement productivity reforms as discussed in the EAG vision document.

The Economic Advisory Group is an independent group of individuals from economics, policy, and the private sector that deliberates regularly on economic developments and shares its views with the government and the public. It is supported by PRIME, an independent think tank.

For media inquiries, please contact Ali Salman at ali@primeinstitute.org or 0301-8451179.