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External finance risks constrain PTI govt: Fitch Ratings

HONG KONG: Pakistan’s incoming PTI-led coalition government, which took office this week, will be under immediate pressure to arrest the deterioration in external finances and address fiscal challenges, as well as to attract the external funding necessary to meet its financing gap, stated Fitch Ratings.
The new government has more political capital to take positive though difficult policy actions, but it has a thin majority in parliament and faces a strong opposition, which could complicate policymaking, the ratings agency said in an assessment of Pakistan’s current fiscal policies.
“PTI leader, Imran Khan, outlined a broad economic agenda for a “New Pakistan” during his campaign, with a focus on confronting corruption, reducing inequality and expanding social services. However, advancement of this policy agenda is likely to be limited in the short term, with external and fiscal problems taking priority. The current account deficit reached 5.6% of GDP in the fiscal year ended June 2018 (FY18), up from 4.7% in FY17, while liquid foreign-exchange reserves fell by almost USD4 billion from end-December 2017 to end-July 2018 to just over USD10 billion. The sharp rise in global risk aversion towards emerging markets, and a projected pickup in Pakistan’s external debt obligations in 2019 are adding to financing pressures. The fiscal deficit has also widened and is likely to well exceed our previous estimate of 6% of GDP in FY18, up from 5.8% a year earlier. We revised the Outlook on Pakistan’s ‘B’ rating to Negative from Stable in January 2018 to reflect these rising external and fiscal pressures.”
“The State Bank of Pakistan has already taken some steps, raising its policy rate by 175bp since January 2018 and introducing greater flexibility in the heavily managed rupee by allowing four separate depreciations since mid-December 2017, which resulted in a cumulative 17% decline against the US dollar. These measures have so far not been enough to prevent the widening of the large external financing gap, which has been bridged with support from China, including an agreement to provide USD2 billion in additional bilateral lending in July. The Saudi-backed Islamic Development Bank has also reportedly extended a USD4 billion loan.”

“The new government appears to recognise the urgency of the situation, with the likely incoming finance minister, Asad Umar, stating that “all options are on the table” and that the government will formulate a policy and financing path within six weeks. Fitch expects Pakistan to seek potential financing from several sources including China and multilateral development banks, and possibly the IMF.”

Pakistan has been a repeated user of IMF financing, entering 12 programmes since 1980. The IMF would probably require further fiscal and monetary tightening, greater exchange-rate flexibility, and wide-ranging structural reforms, which could also help attract other sources of financing. Moreover, the IMF has unique monitoring mechanisms to implement corrective policies, without which there will continue to be significant uncertainty over the medium-term sustainability of Pakistan’s finances.

Negotiations over an IMF agreement could be complicated by loans linked to the China-Pakistan Economic Corridor (CPEC), part of China’s Belt Road Initiative (BRI), particularly amid rising global geopolitical tensions. Recent statements from US Secretary of State Mike Pompeo suggest the US administration does not want IMF financing used to bail out Chinese lenders. US backing is not strictly required to secure an IMF programme, but the IMF board emphasises consensus decision-making. US pressure could lead to stricter programme conditionality, including the curtailment of CPEC projects and greater transparency in CPEC financing.

The USD62 billion CPEC project makes Pakistan one of the largest recipients of BRI financing. These loans have financed imports of capital goods, which have in turn inflated the current account deficit. The loans will eventually need to be repaid or refinanced.

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