By Shahbaz Rana
Published in Express Tribune on October 13, 2023
ISLAMABAD: The International Monetary Fund (IMF) said on Thursday that Pakistan’s external financing needs remain large but its foreign exchange reserves coverage is precarious at only 70% of the country’s short-term foreign debt.
In its Middle East and Central Asia Economic Outlook, the global lender highlighted the risks Islamabad was facing due to a thin foreign exchange cover for debt repayments. The report warned about the growing risk to Pakistani banks from a substantially large exposure to the government debt.
“External financing needs will remain large, and reserve coverage is forecast to remain precarious in several countries, averaging about 70% of short-term external debt in Egypt, Pakistan, and Tunisia,” stated the report released on Thursday.
Commenting on the government’s high gross financing needs, the IMF said that elevated public sector gross financing needs are still a significant challenge, which will reach “21% of GDP by 2024 for Pakistan” (or over Rs22 trillion).
It said that Pakistan’s external buffers improved due to bilateral and multilateral financial support but its “international reserve coverage is well below standard adequacy metrics”.
The central bank holds hardly $7.5 billion in foreign exchange reserves, which is equal to one and a half month of import cover and not sufficient to back external debt payments in this fiscal year.
The government had estimated the receipt of over $20 billion in foreign loans in the current fiscal year but now its internal estimates show a big hole, which will be reviewed by the IMF in the upcoming talks.
In what appears to be a paradoxical situation, the IMF said that Pakistan may still require further tightening of the monetary policy due to “elevated inflation”, an eventuality that will further increase banks’ lending to the government due to the increasing debt servicing cost.
“Inflation is forecast to peak in Pakistan in 2023 but it is foreseen to remain elevated in 2024”. As of July, year-over-year food inflation remained above 35% because of lagged impact of exchange rate devaluations on import prices, it added.
The central bank has set the interest rate at 22% and Additional Secretary Finance Amjad Mehmood said that a 1% increase in the rate adds Rs600 billion to the interest cost.
The Ministry of Finance has not yet clarified whether the Rs600 billion figure is correct, as earlier it had been estimated at Rs250 billion.
High rate impact
The IMF said that a prolonged period of higher interest rates could trigger adverse feedback loops between the sovereign and the banking sector. In Pakistan where banks hold high domestic sovereign debt, high government exposure to interest rate risk and worsening sovereign credit conditions could spill over to banks, it added.
The IMF is the second global institute after the World Bank that in the past one week has warned about risks to Pakistan’s banking system from high exposure to the government debt.
The World Bank stated that the banks’ nearly 75% balance sheets are now invested in the government debt.
The IMF suggested that due to higher exposure of banks to the government debt, Pakistan should consider ways to lessen the sovereign-bank nexus gradually, with a precondition that macroeconomic policies are also set appropriately.
“This could include imposing capital surcharges on banks’ sovereign bond holdings above certain thresholds, which can moderate the nexus in a way that increases resilience if phased-in appropriately,” said the report.
But it seems that Pakistan’s government is now hostage to the banks that got away with currency manipulation last year and the previous government could not impose fines or taxes on them. These banks also got lowered the additional taxation on lending to the federal government.
While sovereign spreads have generally narrowed since last March’s financial turmoil, as of August, they remain at distressed levels at more than 10% for Egypt, Pakistan, and Tunisia, said the IMF.
Commenting on economic growth prospects, the IMF said that growth in Pakistan is estimated to have contracted during fiscal year 2023 because of severe damage from widespread flooding in the second half of 2022, broad-based inflationary pressures, and import curbs.
