- We at Fitch Solutions expect Pakistan’s balance of payments to strengthen over the coming months, as the USD6bn bailout package from the International Monetary Fund (IMF) will help Pakistan to rebalance its economy.
- Foreign direct investment as part of the China-Pakistan Economic Corridor projects and loan packages from other international partners will also provide some support to Pakistan’s reserves.
- We believe that the sustainability of the external balance over the longer term hinges on Pakistan’s ability to deliver a material improvement in its fiscal balance.
In light of the USD6bn bailout package by the IMF under the Extended Fund Facility (EFF), and reforms in fiscal policies and the exchange rate regime, we believe Pakistan’s external position will slowly improve over the coming months. Moreover, investment and financial assistance from Pakistan’s neighbouring countries, such as China and Saudi Arabia, will help to finance Pakistan’s current account deficit and rebuild reserves in the near term. As such, we at Fitch Solutions forecast Pakistan’s import cover to rise to around three months in FY2019/20 from less than two months recorded in May, and its current account deficit to narrow to 5.0% in FY2019/20, from 6.7% in FY2017/18 according to the latest figures by the State Bank of Pakistan (SBP). That said, the sustainability of the improvement depends on whether Pakistan is able to push through its painful fiscal reforms, which would help to narrow the current account deficit.
Pakistan’s Balance Of Payments To Improve With IMF Bailout
Pakistan – Current Account Balance, Reserves, Import Cover & Budget Balance
Source: SBP, Ministry of Finance, Fitch Solutions
IMF Bailout Provides Short-Term Support
We expect Pakistan’s balance of payments to improve over the coming months, in line with previous IMF bailout programmes, for three reasons. First, the IMF EFF programme will encourage Pakistan to adopt more sustainable fiscal and exchange rate policies, which should in turn help reduce the current account deficit and strengthen foreign investment flows. As part of the agreement with the IMF, the Pakistani government has promised to adopt austerity measures, such as through revenue mobilization by broadening its tax base, to contain the fiscal deficit. The SBP has also switched from a fixed exchange rate regime to a market-determined exchange rate, in which the currency is left to market forces but the SBP is allowed to intervene when it deems necessary. These two policy changes should help to reduce the current account deficit and the need to support the currency, which has been one of the main contributors to falling reserves over recent years.
Reserves Have Likely Bottomed
Pakistan – SBP’s Reserves & Import Cover
Source: SBP, Fitch Solutions
Investment Flows Into Pakistan Could Pick Up Again
Second, the IMF bailout package will likely provide some support to the country’s capital and financial account, both directly and indirectly. Shortly after the approval of the USD6bn bailout package, the IMF disbursed around USD1bn worth of loans in July, while the remaining amount will phased over 39 months following quarterly and semi-annually reviews. The ongoing disbursements should help to lift investor confidence toward Pakistan and render it easier for Pakistan to borrow from the international market.
Market-Determined Exchange Rate Places Less Strain On Reserves
Pakistan – Exchange Rate, PKR/USD
Source: Bloomberg, Fitch Solution
Third, Pakistan has secured multiple investment projects and loan packages from its neighbouring countries, which will help to increase financial inflows. We expect investments related to the China-Pakistan Economic Corridor (CPEC), a major part of China’s Belt and Road Initiative, to continue to support Pakistan’s financial account (see ‘IMF Deal To Weigh On Pakistan’s Growth In The Short Run’, June 26). Moreover, the United Arab Emirates, Qatar, and Saudi Arabia have agreed to provide USD3bn worth of support each. During a visit to Pakistan in February, Saudi Crown Prince Mohammed Bin Salman also pledged to invest USD20bn into Pakistan’s economy, part of which would go to the construction of an oil refinery at Gwadar Port.
High Government Borrowing From Central Bank Ahead Of IMF Bailout
Government Credit From SBP, % chg y-o-y
Source: SBP, Fitch Solutions
Fiscal Prudence Crucial For Sustainability
That said, Pakistan would need to achieve a material improvement in its fiscal outlook to ensure long-term sustainability of its current account and reserves. Owing to the country’s large fiscal deficit (estimated by the Ministry of Finance to come in at 7.2% for FY2018/19), Pakistan has been trapped in the vicious cycle of borrowing to finance its debt and government spending. This has contributed to the high interest rate of 13.25%, depreciatory pressures on the currency, and a widening current account deficit. Failure to sustainably narrow its fiscal deficit could also lead to inflation as the government leans on the SBP for additional borrowing, as had happened in 2008, 2013, and 2019 ahead of the IMF bailout packages. Should inflationary pressures persist, there could be the risk that Pakistan tries to return to a fixed-exchange rate regime in an effort to contain inflation, which would renew downward pressure on reserves.