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Artificial foreign exchange reserves position

Pakistan’s foreign exchange reserves increased to $21 billion during the week ended May 19 from $20.678 billion a week ago, according to the State Bank of Pakistan (SBP). While the reserves held by the central bank rose 317 million to $16.213 billion, the reserves of commercial banks increased to $4.795 billion as compared to $4.782 billion in the preceding week.

Realistically speaking, the SBP does not currently hold $16 billion reserves. The borrowing of $3.93 billion in April by Central Bank from commercial banks for up to three months is a step to artificially sustain official foreign exchange reserves at $16 billion level. The $3.925 billion loan is part of the $16 billion reserves held by the SBP that are currently under pressure. The Central Bank’s borrowing is against the terms and conditions agreed with the International Monetary Fund (IMF) under the $6.2 billion Extended Fund Facility three-and-a-half-year ago. However, the agreement had expired in September 2016 paving the way for the Central Bank to avail the loan. As of April 21, the country’s total foreign exchange reserves, including $5.1 billion of the commercial banks, stood at $21.1 billion. The Central Bank borrowed $3.925 billion from commercial banks bringing down the net total reserves to $17.185 billion. With the exclusion of the borrowings from the central bank’s reserves, the official foreign currency reserves would stand at $12.12 billion, which are largely built by borrowing from various sources.

Now question arises: Are the $12.12 billion reserves held by the Central Bank sufficient to finance the imports for four months? The answer is a big ‘NO’. The SBP’s forex reserves have started depleting due to a sudden spike in imports of heavy machinery under the China-Pakistan Economic Corridor (CPEC) and growing obligations of debt servicing.

WEAKENING EXTERNAL SECTOR

The external sector’s stability depends on strong position of foreign exchange reserves, which will boost through foreign exchange receipts. So far as remittances from overseas Pakistani workers are concerned, it fell to $15.596 billion during the 10-month period as against $16.044 billion a year ago. Secondly, the country received only $550 million from the United States under coalition support fund in July-April period of the ongoing fiscal year. Thirdly, net external inflows fell 40 percent further worsening the balance of payments position of the country.

The country’s current account deficit mainly due to growing imports widened to $7.247 billion during the first 10 months of the current fiscal year 2016-17, according to the State Bank of Pakistan report. The current account deficit was estimated at $2.378 billion in the July-April period of ongoing fiscal year. The current account gap reached equivalent to 2.7 percent of GDP in the first ten months as compared to one percent in the same period last year.

The government had set the full-year current account deficit target at 1.5 percent. The widening current account deficit shows a worsening balance of payments position, which is more than expected.

The country’s trade deficit surged 40 percent to $26.55 billion during the first 10 months of the current fiscal year. Imports rose to $43.473 billion during this period from $36.265 billion a year earlier, while exports stood at $16.918 billion as compared to $17.314 billion a year ago. The surge in China-Pakistan Economic Corridor (CPEC) imports of machinery and equipment are likely to keep trade account under pressure. The foreign debt repayments rose 35 percent in the first 10 months of the current fiscal year 2016-17.

WEAKENING EXTERNAL DEBT-BEARING CAPACITY

The country’s stock of external debt increased rapidly than its foreign exchange earnings, according to the Debt Policy Statement 2016-17. Total external debt and liabilities rose 14.6 percent to $74.6 billion by September last year, according to the statement. The external debt and liabilities were at $61.4 billion in June 2015. In the external debt, the public debt rose to $58.7 billion. The external debt-to-foreign exchange earnings ratio increased to 1.1 times, showing that Pakistan’s debt-bearing capacity weakened by the end of last fiscal year 2015-16. In the past three years, external debt-to-foreign exchange earnings ratio had remained stable. Similarly, the external debt-to-gross domestic product ratio weakened from 18.8 percent to 20.4 percent. The public debt-to-government revenue ratio stood at 442.5 percent against the generally acceptable threshold of 350 percent. The external debt-to-foreign exchange reserves ratio, however, slightly declined to 2.5 times, reflecting the positive impact of increase in the foreign currency reserves.

The debt-to-GDP ratio actually indicates a country’s ability to pay back its debt. A low debt-to-GDP ratio indicates an economy that produces and sells goods and services sufficient to pay back debts without incurring further debt.

The country’s poor debt-to-GDP ratio amply debunks that country’s economic managers have not been successful in initiating timely fiscal and monetary reforms to raise revenues. Last year, the IMF painted a bleak picture of the country’s economy when it estimated that the country’s external debt obligations would surge to $70.2 billion by end of the last fiscal year. The IMF had also predicted that Pakistan’s debt-to-GDP ratio was all set to touch the 65 percent mark.

“Credit challenges include a relatively high general government debt burden, weak physical and social infrastructure, a fragile external payments position, and high political risk,” Moody’s said in its recent report.

The country has virtually come in a debt trap, which is bad omen for the economy. The country witnessed a significant increase in its overall debt in the past three years. The overall debt, estimated at Rs9.5 trillion in 2013 rose to Rs12.7 trillion in 2016. Similarly, the external debt at $73 billion in 2016 increased substantially from $61 billion in 2013.

There is nothing wrong with debt in itself. Private businesses borrow happily, as long as the rate of return on the debt-financed investment is higher than the cost of borrowing. The surging debt is a burden for Pakistan because its Gross Domestic Product (GDP) growth is not faster than the rate at which debt is serviced. The cost of external debt is incurred in foreign currency, hence a surge in the debt burden depletes foreign reserves, triggers devaluation and increases the cost of debt. The external debt service-to-exports ratio at 20 per cent for 2016 was better than the 22.5 per cent in 2015, according to State Bank of Pakistan. The country’s exports are stagnant depicting a decline. The exports were estimated at 27.4 billion dollars in 2016, compared to 31.5 billion dollars in 2013. These estimates show the country’s weakness to service future external debt liabilities.

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