On July 3, 2019, the Executive Board of the International Monetary Fund (IMF) approved a 39-month extended arrangement under the Extended Fund Facility (EFF) for Pakistan for an amount of US$6 billion to support the authorities’ economic reform programme. While announcing the approval of the facility, the IMF hoped that
“the programme would help Pakistan to reduce economic vulnerabilities and generate sustainable and balanced growth focusing on: a decisive fiscal consolidation to reduce public debt and build resilience while expanding social spending; a flexible, market-determined exchange rate to restore competitiveness and rebuild official reserves; to eliminate quasi-fiscal losses in the energy sector; and to strengthen institutions and enhance transparency”
Before assessing the prospects of the success of this 13th programme Pakistan has accepted since Pakistan became a member of the IMF in early 1950s, we must keep in mind the context in which this programme was approved
When Imran Khan assumed office in August 2018, Pakistan was facing one of its severest economic crisis. Some of the symptoms of these economic crises were as follows
- Thanks to consistently maintaining an overvalued exchange rate for several decades, country’s export base, which had always been small and narrow, had halved in relation to the overall size of the economy. Pakistan’s exports stood at 7.6 per cent of GDP — compared to 95pc for Vietnam, 20pc for India and 15pc for Bangladesh.
- Our penchant for living beyond means, has resulted in ever widening the gap between exports and imports; in 2017-18 it stood at $37.6 billion, the largest in the country’s history. Exports paid for only 38pc of imports in 2018, and far less as a percentage of imports and debt servicing combined.
- With exports paying for less than 35% of imports in 2018, and far less as a percentage of imports and debt servicing combined, the country had been relying on short term external borrowing from commercial lenders to bridge the domestic resource gap. By 2018, a large part of this borrowing had become due; external debt servicing (interest plus principal repayments) had shot up to an estimated $10bn to $11bn in 2019. This debt-servicing pressure is expected to remain elevated for the next few years.
- Consequently, Pakistan was in the throes of severe currency crisis, rapid depletion of foreign exchange reserves, adversely affecting rupee-dollar parity.With the rupee experiencing sharp decline, the State Bank decided to conserve its foreign exchange reserves to honour sovereign payment obligations in a timely manner. Both added fuel to the fire of inflation as well as impending recession.
- Internally, the picture was even worse. The ever widening fiscal gap-imbalance between expenditures and revenues, had ballooned to more than 7% of GDP,or Rs2.3 trillion. thanks to interest payments soaring to 87% of net federal revenue ie after transfer of resources to provinces,
Keeping in view the nature, magnitude and severity of the economic crisis, Imran Kham and his economic team should have realised that fundamental lomg term structural defects of Pakistan economy could not be rectified without carrying out fundamental structural reforms in multiple sectors of the political economy of Pakistan. Instead of looking into the causes of this dysfunctionality of the economy and coming up with long term solutions, his economic team just tried to hole the twin deficits of budget and the BOP by seeking loans and grants from friendly countries. The result was that even though Pakistan did get nearly $9 billion in loans from its friends, it only gave some breathing space to the Pakistan economy but didn’t address any of the deep structural problems that had forced Pakistan to approach the IMF more than a dozen times during the last 50 years.
Consequently, after exhausting all other options, Pakistan was finally forced to go back to the IMF. But the nine months delay neither improved Pakistan’s negotiating position, nor changed the tough conditions that the IMF was insisting upon. Because of the uncertainty caused by the government’s indecision, Pakistan was so desperate that the IMF agreement it finally signed with the IMF is virtually Pakistan signing on the dotted line.
The Extended Fund Facility (EFF) programme Pakistan has managed to extract from the IMF has less carrots and more sticks; $6 billion to be released in tranches over a period of 39 months. Pakistan will have to meet extremely tough conditions, some even impinging upon its sovereignty i.e., disclosure about CPEC loans,cutting transfers to provinces under NFC award. Some of the conditionalities imposed are as follows
- Budgetary Control: Although a usual recipe of the IMF i.e. slashing subsidies and exemptions, increasing revenues and cutting expenditures, the range and scale of the fiscal adjustments is daunting. Because of the inflexibility of the government expenditures, greater emphasis is on revenue generation. The government will have to collect anything between 30-35% more revenue. This means around Rs 1.5 trillion over the 2018-19 revenue collection of Rs 3.95 trillion.
- Currency Rationalisation: with insistence on a “market determined exchange rate”, IMF is demanding a free float of currency with a minimal intervention by the State Bank of Pakistan (SBP). IMF is also insisting on positive Net International Reserves being maintained by the SBP. This means that SBP will have to build up reserves by buying dollars, which will push up the dollar price. It is expected that the Rupee would depreciate by around 20 to 25 % over the next few months
- Interest Rates Adjustments: In addition policy rate announced by SBP is expected to be jacked up by another 150-200 basis points. Given that over the last few months, the interest rate has gone from around 6% to over 11%, another 2% rise will take it to over 13%. The lending rate will go up commensurately to around 15-16%,
- Power Sector Reforms: A comprehensive plan for cost-recovery in the energy sectors to help eliminate or reduce the circular debt that drains scarce government resources will lead to 20/25% increase in the energy and gas tariffs
- Privatisation of State Owned Enterprise: Successive governments have been promising to either revive these units or sell them but without any tangible results. However, this time IMF to make the public sector behemoths like Pakistan Steel Mills, Pakistan International Airlines and Pakistan Railways self-sustaining or dispose them off.
- Deficit Control: IMF is stressing for the reduction of primary fiscal deficit( budget deficit calculated after excluding debt servicing) from its present 2% to 0.6%. This adjustment will have to come from any of the five namely defence budget, development expenditure, social welfare programmes, government expenditure or the transfers made to provinces under the NFC award. The IMF has indicated that ‘essential development spending’ has to be preserved, social welfare and direct income subsidy schemes to be scaled up, and targeted subsidies have to be improved.
- Damocles Sword: Finally, the IMF has listed Pakistan’s “continuing anti-money laundering and combating the financing of terrorism efforts” as one of the priority areas of the structural reforms agenda. This ‘priority area’ is directly linked with the Financial Action Task Force (FATF) commitments of Pakistan. Chances are that Pakistan won’t be black listed but will remain on the FATF grey-list for some more time. This will be a sword that will be kept dangling on Pakistan’s head to force compellence
Challenges and Prospects?
Whether the 13th IMF programme will be a resounding success or a dismal failure or a mixture of the two, depends on the gravity of the crises, appropriateness of the programme design and the degree of its faithful implementation in letter and spirit. Some of the challenges are as follows
- Party is Over: Sometimes, Pakistan looks like a Roman Empire- living beyond means!. Majority of our development plans and the high standard of living of our middle class was either due to foreign loans or remittances. David Easterly has rightly stated that Pakistan is one of the those countries that had the highest growth rate in intensive Adjustment Lending loans, but consistently ran huge budget deficits that left it with a major public debt crisis by the end of the period.
- Under the present world order, any assistance by the multilateral institution or even a commercial loan by the western commercial lenders are not geopolitics-neutral; no way. We took full advantage of our geostrategic location and our nuclear capability when the wind was blowing in our favour. Keeping in view the changed regional and global geostategic scenario, Pakistan has lost lot of its importance for the USA, the main lever of the international financial structure. As such, there has been virtually no concession given to Pakistan. The party is over.
- Micro-management of the Economy: This 13th IMF bailout is an excellent example of micro-management of an economy through remote control and internal checks. It has laid down the minutest details like budget deficit limit, extent of currency depreciation, adjustment of power tariffs, domestic gas prices, water and and other user charges. And to top it all, the agreement is front loaded, contingent on “timely implementation of prior actions and confirmation of international partners’ financial commitments”. Unlike the past when many concessions were given before and during the programmes, and Pakistan’s violation of the conditions were waived off, this time Pakistan is being forced to fulfil its commitments before the IMF gives a single dollar.
- Mission difficult if not Impossible. The government will have to collect anything between 30-35% more revenue. This means around Rs 1.5 trillion over the 2018-19 revenue collection of Rs 3.95 trillion. At a time when growth is expected to fall under 3% and inflation expected to rise to double digits, raising revenue by a third through increasing tax rates, eliminating tax exemptions and concessions (including to exporters) and subsidies, and cutting government expenditure is going to be a mission difficult if not impossible.
- More assistance still needed; US $ 6 billion being offered under the IMF package in tranches are not enough to bridge the likely financing gap of anything between $10-11 billion annually. Coupled with its obligations to pay back over $30 billion over the next 7 years, Pakistan will not only have to tighten its belt, extract more resources from within but still seek assistance from abroad. Besides seeking roll over, rescheduling and even a moratorium of the debts from friends and creditors, Pakistan will have to seek assistance from other multilateral financial institutions and borrow money from international financial markets. IMF package provides that ‘seal of approval’ for seeking commercial and export credit facilities from abroad.
- Dutch Disease: Currency depreciation helps exports promotion; however, the massive depreciation of Pakistan rupee will increase our exports only marginally because of supply constraints and quality issues of exportable surplus. Rather, it will not only increase the debt profile and stoke the inflation but will also reduce the imports thus adversely affecting the import duties stream
- Investment; The lending rate will go up commensurately to around 15-16%, which will make the cost of doing business very high, stifle investment for the foreseeable future and lead to a contraction of the economy with attendant rise in unemployment and poverty.
- Hrdships for the public: The rise in power and gas tariffs will no doubt help the government in controlling its circular debt but will definitely hit hard the general public particularly the middle classes. The government has already squeezed the budgets of the middle class, and a further rise will only add to the already high economic distress level.
- Centre-Provinces Relations: IMF is stressing for the reduction of primary fiscal deficit( budget deficit calculated after excluding debt servicing) from its present 2% to 0.6%. This adjustment needs curtailment of allocations made under any of the following five heads namelt a)defence budget, b) development expenditure,c) social welfare programmes, d) government expenditure or e)the transfers made to provinces under the NFC award. Keeping in view the difficulties in reducing the allocations in the first four for one reason or other, the bulk of the cuts will however be sought by cutting the funds to the provinces. If implemented, it will have serious implications for the federation.
Is it all a doomsday scenario?
Pakistan’s economy is suffering from what I call 4 Ds namely
- Double Deficit, the chronic gap between government revenues and and expenditures on the one side and the one between its export earnings and outflows on the other
- Debt payments-internal and external payments of the loans, principal and the interest thereon
- Defence and Development expenditure shortfall
- Documentation of the economy to increase the taxnet
And the remedy for tackling these 4 Ds are what I call 4 Ss namely
- Structural reforms
- State owned enterprises,
- State bank independence,
- Sustainable development
To me , the latest 13th IMF programme is a blessings in disguise; the package makes it possible for the government to take unpopular decisions for increasing the tax net and improving documentation of the economy, under the pretext of conditionality and shift the burden of the unpopular decisions to external actors like IMF.
One should not believe in doomsday scenarios about Pakistan economy collapsing any time soon. It is a very resilient economy, sure to bounce back after the successful completion of of structural reforms being being carried out under the IMF Programme. With 70 to 90% informal economy(ADB/WB figures), all our estimates about Pakistan economy are just conjectures.
While officially our economy has been growing at 4/5% per annum for the last two decades, in actual figures it has been touching an annual growth rate of 6/7 percent during this period. This can be verified from 1.high demand for consumer goods, 2. electricity consumption, and profit & loss statements of the foreign multinationals. One of the main reasons for good ranking of Pakistan in global happiness scale is the high standard of living of an average Pakistani as compared to his counterpart in other South Asian countries (along with lower disparity of inter-class incomes)
Of course the recipe for curing our economic ailments namely 4Ds through the 4Ss under the IMF is very painful but it is the only recipe which can cure our long term structural dysfunctionalty of the economy