Where do we go now?

The new government faces serious economic challenges. The list is quite long, and sadly quite familiar. The immediate challenge will be unwinding the power and fuel subsidies announced by Imran Khan a few weeks ago. This alone can send the price of petrol soaring well past Rs 200 per litre, with all the attendant consequences on inflation. Rising inflation will put pressure on the central bank to raise interest rates, which in turn will hit state finances with higher debt service costs as well as putting the brakes on economic growth. The story is the same with power tariffs, where further hikes will become necessary, hitting household budgets, raising the costs of doing business for industry and also putting the brakes on economic growth.

But beyond the immediate decisions, the biggest challenge for the new government will be to seek a resumption of the stalled IMF program and arrest the protracted decline in the foreign exchange reserves. Despite an injection of more than $6 billion since August of last year, the reserves have fallen continuously month after month. They were sufficient to finance well more than three months of imports last summer, but now they risk falling below even two months of import cover by June if the decline is not arrested rapidly. Moreover, almost two thirds of the $6 billion injected into the reserves since August is borrowed money, much of it short term, such as the $2 billion deposit from Saudi Arabia arranged in December of 2021. The room to borrow is severely curtailed given how sharply public debt, especially external debt, has risen over the past three years, and the stalled IMF program.

There will be only one way to arrest this trend: kill the growth rate and devalue the currency. Petrol is not the only thing that will be soaring past the Rs200 mark. Treasury heads of major banks anticipate the dollar soaring past that mark too, although it is not clear by when this threshold could be crossed. Already the exchange rate is seeing tremendous pressure as the current account deficit hit $12 billion in the July to February period alone. The State Bank has been anticipating a CAD of $13 billion for the full fiscal year, so clearly this target is now set to be breached significantly, regardless of what steps the new government takes in the remaining three months of the fiscal year.

The new government is going to find that large subsidies and equally large interventions from the State Bank have been propping up prices of fuels as well as the exchange rate. It is almost certain that these props will have to be withdrawn as part of the resumption of the fund program, but even in the absence of that, it is seriously doubtful the government will be able to continue with these for very long. The inflationary jolt that the removal of these props will administer to the economy should not be underestimated.

Beyond these challenges there loom the mounting losses of the public sector enterprises with their resultant claims on government finances. And then the circular debt that has crossed Rs2.5 trillion with no signs of abating any time soon. And now the gas sector is seeing a similar build up of receivables. Loadshedding has returned to vast swathes of the country as power generation plunges due to mismanagement of the LNG supply chain, and a period of protracted gas shortages loom. And to top it off, the country is also looking at the prospect of wheat shortages by the summer months.

Profit takes a closer look at some of these pressures in this special edition this week, and the emerging picture is not a pretty one. The new government will have very little time in which to find its feet and will have to take very difficult decisions quickly. It will also be sitting atop an unwieldy coalition and will have to face a formidable opposition in Imran Khan who is determined to not go out gracefully. The country now faces a very serious situation, with the only consolation being that we have faced heavier odds in the past. That does not make the job any easier though. Nobody should harbor any illusions that with the change of government better times will return.