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Mushtaq Khan – Profit by Pakistan Today

Profit by Pakistan Today

Author: Mushtaq Khan

  • The mini budget is the price of failure

    The mini budget is the price of failure

    Despite the headwinds experienced when the Finance (Supplementary) and SBP Bills were tabled in the National Assembly last month, PTI had the votes and the strategy, and the two Bills (key prior actions to restart the EFF) were approved yesterday.  We can now look forward to the $ 1 bln tranche and the IMF Staff Paper. 

    People will blame the IMF for the mini-budget and the pain it brings, while our policymakers will shrug their collective shoulders in sympathy and look elsewhere.  The real story is that the mini-budget would not have been necessary had our policymakers not doled out freebies to the elite in early FY22, and now that they are left with a sizeable fiscal hole (which the IMF will insist be filled), they had no choice but to push the burden on the average citizen – take from the poor and give to the rich.  But the lopsided burden doesn’t end there: while the poor and middle class will suffer from higher prices (and the increase in fuel prices that is expected in a couple of days), the economic certainty will be a source of much comfort for the affluent.  Ahhh… back to the IMF program. 

    The price of this economic certainty is political uncertainty.  Each person played his/her part in the 7-hour National Assembly session yesterday.  Prime Minister Imran Khan and PTI’s top leadership were there till midnight, as were the heavy hitters from all opposition parties.  Perhaps they all felt that this was too important an event to skip, and appearances, after all, is as important as delivering results. 

    As the public pain begins to mount, the opposition is likely to find common cause to move towards a vote of no confidence.  While the Establishment had a clear view on the two Bills – the economy needed to be rescued and the IMF was the only option – it may not be so clear about the future of the PTI government.  But at least we have the EFF. 

    Someone asked me about the Finance Minister’s view that the mini budget is really only about documentation, and not about new taxes.  First, I thought it was an artful dodge, but I now see the logic.  The Dawn (14th January) claims that Rs 112 bln will come from reinstating GST on imported machinery and another Rs 160 bln from imported pharmaceuticals inputs, and only Rs 71 bln worth of taxes will burden the people.  Shaukat Tarin argued that tax rebates would be available on imported machinery and pharma inputs, but if the rebates are availed, it would reduce GST revenues.  So, what’s the point? 

    The point is that GST would be collected at the import stage and that would boost FBR’s revenues.  In turn, importers would pass this on to consumers of pharmaceutical and other products.  For the most part, individual consumers are not likely to apply for rebates as few file their taxes, and for those that do, who is going to document all their medicinal purchases for the year.  Furthermore, only the white-est of importers would apply for rebates as this would surely invite further inquiries from FBR.  So, it’s a trade-off: secure revenues because no one asks for rebates; or provide rebates, increase documentation but generate less revenue during the course of the year.  I’m sure the IMF would approve of this tradeoff. 

    Final point about the SBP Bill and the “loss of sovereignty”.  Instead of countering this erroneous view, SBP is talking up its own performance and talking down to the market, while opposition leaders are beating their chests about the IMF taking control of the central bank.  The optics could not be worse: December’s current account deficit (CAD) is likely to be released by Jan 21st and is expected to be elevated (our estimate is $1.4-1.6 bln).  However, SBP has been strictly managing the rupee since Dec 10th, and as a lead-in to the IMF board meeting in end-January, SBP may have to let the unsustainable external deficit be “reflected” in the rupee parity. 

    This means the rupee could start weakening around the time the CAD data is released.  While many analysts will happily equate the January currency adjustments with December’s CAD, media and the opposition will connect the dots using a political lens – this has been dictated to the central bank by the IMF.  As we have all been conditioned to see the value of the rupee as symbolizing the health of the economy, when the rupee starts to weaken, this will be viewed as the nefarious designs of the IMF executed via a subservient SBP.  While most Pakistanis will blame the IMF for their pain, some of them will point their guns at the SBP. 

    But let’s not forget how we got here.  The government is taxing the people to make up for the tax exemptions it gave to the rich, and the rupee is weakening because we import much more than we export.  So, let’s stop blaming the IMF and blame ourselves instead. 

  • The adult in the room

    The adult in the room

    With interest rates creeping up and a persistent weakening of the rupee, the authorities are struggling to manage market sentiments. Unfortunately, this is not the end, and the drip-drip of bad news will continue in December. On December 14th, the SBP is likely to announce another hike in interest rates (we project a further 150 bps increase). On December 20th or 21st, the SBP will release its November BoP data where the current account deficit (CAD) for the month could be as high as $2.2 to 2.6 billion, and at some point, December’s inflation data will also be released, which could be above 12.5 % YoY (year-on year).  

    In response, Shaukat Tarin has blamed banks for driving interest rates up, claimed that demand for dollars from Afghanistan is weakening the rupee, and said that the rupee should be at Rs168/$.  He also warned that the authorities had formulated a policy response that will hurt those people who are speculating against the rupee.  These are fighting words, but they are unlikely to change market sentiments or arrest the trajectory of both the money and foreign exchange markets.  The fundamentals are siding with the markets.  [restrict level=1]

    Blaming commercial banks, speculators, and hoarders for manipulating the market is an indication that the economic team is unable to manage sentiments; it also creates a government narrative that the growing uncertainty is because of selfish individual behavior.  As things go south, this narrative could become more stringent.  

    One serious concern is that if the authorities call in the banks and read them the riot act, banks will simply stop bidding in the primary auctions. If so, this will reduce commercial bank funding to the government, which is already barred from borrowing from SBP.  With non-bank borrowing (via NSS) experiencing an outflow of Rs78.9 billion in the period from July to October 2021, this is a battle of wills that the government simply cannot win.  

    While the government is keen to ensure that interest rates do not rise too sharply (just think of the fiscal and borrowing pressures this would create), accusing the market of profiteering and working against the interest of the country could actually have the opposite effect. By putting banks on the defensive, the monetary tightening cycle could be prolonged, and the quantum of the rate hike may be larger.  To avoid this outcome, the authorities need to gain the trust of the market and convince banks that chasing inflation is not SBP’s policy objective.  If possible, the SBP should also try to communicate that the December monetary policy decision would be the penultimate hike before the EFF restarts in January 2022.  

    Another source of anxiety is the government’s decision not to participate in President Biden’s democracy summit.  With China and Russia conspicuously uninvited, this is an effort by the Biden administration to build a global coalition that is opposed to “authoritarian” governance.  Media reports claim that Pakistan consulted with China, and found that its Eastern neighbour was not pleased about being excluded by its arch competitor. The stakes in the US-China standoff are that much higher with the growing number of OECD countries boycotting the Winter Olympics to be held in China.  Then, of course, there is the US-Russia standoff over Ukraine.  

    Growing geopolitical tension should not impede Pakistan’s efforts to restart the EFF.  The conditions have been agreed upon, and it will reflect very poorly on the IMF if it changes the rules of the game in the midst of play.  As has been argued before, restarting the EFF with the accompanying IMF Staff Paper should go a long way in creating more certainty about what to expect.  Even though the program parameters are likely to formalize the policy priority to stabilize the economy (over economic growth), in our view, this austere outlook is better than the prevailing uncertainty.  

    But this is still five weeks away and the markets remain jittery.  If the authorities continue to intimidate market players, and take policy steps to hurt them financially, this could shatter the relationship between the economic team and the market.  Again, this is a battle the government cannot win.  Unfortunately, because of the underlying economic fundamentals (whether imposed from outside or engineered from within), Pakistan’s economy will continue on its roller-coaster ride, with the authorities and the market indulging in a pointless blame game.  

    And with each passing day, the rupee will continue to lose value (the midpoint rupee-dollar parity for December 9th is 177.8334).  As this continues to play out, both sides will get angrier, media reports will stoke this anger, and the markets will become more difficult to manage.  The authorities should realize that this is not the right way forward, and the longer this impasse continues, the worse off the country is.  So, the question is who should be the adult in the room: the government or the markets?  

    Mushtaq Khan has worked at Citibank, served as Chief Economic Advisor to the State Bank of Pakistan and now runs a private macroeconomics advisory by the name of Doctored Papers.

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