A SECOND LOOK AT PAKISTAN'S BALANCE OF PAYMENTS

TANVIR HUSSAIN, Senior Research Analyst
Askari Investment Management Ltd.
tanvir.hussain@askariinvestments.com

Aug 11 - 17, 2008

CURRENT SCENARIO

Predictions of doom and gloom abound about Pakistan's economy in media and financial community.1 Ballooning budget deficit and current account deficit reinforce these perceptions. Latest figures show that Pakistan's budget deficit for FY08 has increased to 7.3% of GDP2, even more than the 7.0% target that the Government aimed for while presenting the Annual Budget 2008-09. Current account deficit has also touched US$14.016 billion3. The twin deficits forced the Standard and Poor's and the Moody's Investors Service to downgrade Pakistan's credit ratings in May 2008. This note looks at the ability of the Government of Pakistan to finance the precarious current account deficit and preserve foreign exchange reserves.

POSITIVE FUTURE DEVELOPMENTS

Some good news has emerged recently, showing that Pakistan would be able to tide over spending on foreign goods and services beyond its means:

* While visiting the Karachi Stock Exchange on July 22, Pakistan's Finance Minister said, "We are in talks with Saudi Arabia about the oil facility and there will be an announcement soon from Saudi Arabia". According to the Financial Times, the Saudi Oil Facility (SOF) is expected to be worth US$5.9 billion at a price of US$147 a barrel for about 40 million barrels. Although Saudi Arabia has indicated only to defer payments for one year of oil purchases, there seems to be a consensus in the financial community that the payments will finally be written off.

* On July 14, 08 the World Bank pledged $294.7 million to Pakistan for an electricity distribution improvement project and water sector capacity building and advisor services project.

* Pakistan will get a US$1.4 billion loan from the World Bank during the current year. Out of this US$1.0 billion will be given at market rates while the remaining US$0.4 billion will be a soft loan5.

* The Asian Development Bank will loan US$810 million for power projects. Disbursement of the loan will start in September or October this year. However, it is of note that not more than US$400-500 may be disbursed during the current year.

* US senators Joseph Bidden and Richard Lugar have moved a bill based on the idea of "democracy dividend" for Pakistan. The bill seeks to approve a non-military aid of US$7.5 billion for Pakistan over the next five years (US$1.5 billion/year). The bill is widely supported by Democrats including Barack Obama and Republicans including George Bush. The bill is very likely to be approved soon. It conditions release of the aid on certification by the US Secretary of State that Pakistan's security forces are not materially interfering in the political and judicial processes of Pakistan.

IMPLICATIONS AND OUTLOOK FOR BALANCE OF PAYMENTS

Based on the projections of the Trade Policy FY09, Pakistan will need financing of about US$13.4 billion current account deficit. A breakdown of the sources of financing is given in the Capital A/C in the text box on the last page. Sustainability and growth in workers' remittances and sustained inflow of foreign direct investment may provide key support to meet imports obligations. Adding and accounting for the emerging sources of financing as discussed above, further financing commitments will be required for the shortfall of about US$1.9 billion during the year. With foreign exchange reserves of about US$ 11 billion, Pakistan seems to be in a comfortable position in the short-run to finance its external deficit, as against the predictions of an impending crisis by some economists. Promising developments about two digit crude oil prices in the near future6 may also significantly reduce the external payments burden of Pakistan. Debt servicing obligations in the future, however, project a less than optimistic long-term outlook, especially if further debt rollover is not allowed by external creditors.

ASSUMPTIONS AND SOURCES OF DATA

* Minor growth in exports, imports, and services balance during the next year

* Import and export figures based on the numbers and implications given in the Trade Policy 2008-09

* Crude oil price for FY09 at US$147

* Trend growth in workers' remittances and other private transfers

* FDI (private capital) at the same level as in FY08

* Inability of the Government of Pakistan to raise money through floatation of Eurobonds or privatization

* Sources include Pakistan Economic Survey 2007-08 and the State Bank of Pakistan website

INDICATIVE BALANCE OF PAYMENTS FY09

(US $ Million)

CURRENT ACCOUNT

ITEMS

2008-09F

1. Trade Balance

(17,900)

Exports (f.o.b)

22,100

Imports (f.o.b)

40,000

2. Services (Net)

(7,500)

3. Private Unrequited Transfers (net)

12,000

Workers Remittances

8,000

4. Current Account Balance (1+2+3)

(13,400)

CAPITAL ACCOUNT (FINANCING)

5. Long-term Capital (net)

11,500

Private Capital (net)

4,000

Official Capital (net)@

7,500

Saudi Oil Facility

5,900

Borrowing from WB

1,400

Borrowing from ADB

500

Democracy Dividend

1,500

Disaster Relief and other Aid

700

Debt Service

(2,500)

6. Basic Balance (5 - 4)

(1,900)

7. Change in Forex Reserves

(1,900)

1 "Government should cut expenditure to avoid collapse", Meekal Aziz Ahmed, The Post, July 23, 2008

2 The Nation, July 09, 2008

3 The Nation, July 23, 2008

4 The Daily Times, July 15, 2008

5 The Daily Times, July 10, 2008

6 The Bloomberg, July 23, 2008