The IMF and After

By Amir Zia
Money Matters
The News
Sept. 19, 2011

The bitter pill of IMF-supported reforms could have been the right prescription to achieve high growth and lower the inflation rate, but it meant taking unpopular decisions. For the PPP and its allies, implementing a meaningful reform agenda when elections are drawing near, could be a recipe for disaster

The government has formally announced its decision to end the International Monetary Fund (IMF) programme that has remained in limbo since August 2010 because of Pakistan’s failure to carry out the promised reforms considered vital to revive the country’s ailing economy and pull it out of the vortex of low growth and high inflation.
The timing of the announcement is significant as it came ahead of Finance Minister Abdul Hafeez Shaikh and his team’s departure to Washington for annual talks with the IMF and World Bank due later this month. The announcement shows that the government has abandoned all its plans to introduce reforms, which it promised in November 2008 while signing the Stand-by Arrangement with the IMF.
The government may boast that the decision to pull out of the IMF programme without its completion reflects the strength of the economy, but appearances can be misleading in the long-run and its implications serious for the country.
However, in the short-term, the government will be able to keep the economy afloat on the back of high foreign exchange reserves of around 18 billion dollars, continued record remittances from Pakistanis working abroad and expected high export yields. The Finance Ministry officials are not wrong when they say that Pakistan’s fiscal position remains comfortable – at least in the current financial year and perhaps in 2012-13, which will lead to the next general elections.
The bitter pill of IMF-supported reforms could have been the right prescription to achieve high growth and lower the inflation rate, but it meant taking unpopular decisions. For the PPP and its allies, implementing a meaningful reform agenda when elections are drawing near, could be a recipe for disaster. Therefore, pushing reforms to the backburner makes sense for the PPP think-tank until the hurly-burly of elections is over and the battle lost or won. Yes, the time for reform for any political government is at the start of the innings and not at its end. Ironically, the PPP did not make any serious attempt to push for reforms even at the beginning of the term, although it was PPP’s former finance minister Shaukat Tarin, who brokered the Stand-by Arrangement with the IMF.
The arrangement, revised to $11.3 billion from the initial sum of $7.6 billion, is the eighth IMF programme with Pakistan which met a premature death out of a total of nine. The only programme, Pakistan ever completed was in 2004 under the former military rule of General Pervez Musharraf when its economy was hovering in the high growth trajectory of seven percent on an average for five years in a row.
The vital goals under the IMF’s Stand-by Arrangement included the imposition of the integrated value-added tax (VAT), cutting down the budget deficit to 4.2 percent and below and scrapping all the untargeted subsides, including the ones given in the power sector. The programme had two objectives – “to restore macroeconomic stability and confidence through a tightening of macroeconomic policies; and to ensure social stability and adequate support for the poor and vulnerable in Pakistan.”
But the PPP-led government dragged its feet on all these fronts due to political considerations and opposition by strong vested interest groups, who were duly backed not only by the key opposition parties but even those in the ruling coalition. The initial goals agreed with the IMF were revised and readjusted scores of times, but the government still failed to achieve any one of them.
The strong resistance by businesses and traders forced the government to abandon its half-hearted attempts to impose the proposed VAT, and on paper got it replaced by a diluted reformed general sales tax (RGST). Then even the RGST plan was dropped, though the government promised to get it going by October 1, 2010. The government’s failure to impose the RGST simply means that all the plans to expand the country’s narrow tax base have been shelved – yet again. The powerful lobby of feudal lords, who like their fiefdoms also dominate parliament, effectively torpedoed the demand of taxing agricultural income. Thus, Pakistan has to remain contented with its slim nine percent or so tax-to-GDP ratio, which is among the lowest compared to economies of our size and even smaller in Asia and our own region.
The budget deficit target has been eluding the government from day one because of its inability to raise revenues and cut expenditures. During the last three fiscal years, the budget deficit has remained on the high side of six percent and above against the initial targets of 4.2 and below. Most economists call high budget deficits the “mother of all troubles” for an economy, which results not just in high inflation, but also macroeconomic instability. Curtailing the deficit is seen as a must to eliminate the financing of government expenditures by the State Bank of Pakistan (SBP). The heavy public financing by the SBP and other commercial banks fuels inflation and crowds out the private sector from the credit chain – as has been happening since this democratically elected government came to power in early 2008. No wonder that Pakistan’s public debt has soared to more than 11 trillion rupees at the end of the last fiscal from 4.8 trillion in June 2007.
The federal government has also failed to broker an agreement with the provincial governments that they maintain fiscal discipline – which remains necessary to the overall lowering of the budget deficit.
One of the key steps, which the government had to take to lower expenditure, was phasing out the energy subsidies. The power sector subsidies and losses cost the national exchequer around 350 billion rupees in the last fiscal year. According to the IMF programme, the reduction had to be achieved with the assistance of the World Bank, but courtesy the vested interests, Pakistan’s power sector continues to bleed because of the rampant electricity theft and distribution losses of up to 35 and 40 percent.
The election fever, for which political wheeling and dealings have already started, is unlikely to give any space to Finance Minister Shaikh to take any firm measures to lower budget deficit, curtail government borrowing, slash power subsidies or to expand the tax base. At the most, he will try to remain glued to the wicket and keep the economy floating in a run-up to the elections or worse he may quit – though the chances are unlikely – as his predecessors have done.
But what will be the implications of the government’s decision of walking away from IMF and not implementing reforms?
The worst part is that Pakistan is all set to remain stuck in the low growth and high inflation cycle for another three to four years at least –as the government has failed to take measures to turn the tide. This means that the poor will sink deeper into poverty on the one hand while on the other, more people will be joining their ranks because of unemployment, lowering of income and erosion in the purchasing power of the rupee – which will hit people with a fixed income the most.
Abandoning the IMF programme will also make it difficult for Pakistan to raise funds from other multilateral and bilateral donors.
At a time when even domestic investors are not betting on Pakistan's economy and have put investments here on hold or have redirected them to other parts of the world, the government’s decision to say “goodbye” to the IMF will shatter their confidence even further. Similarly, it will be much harder to lure foreign investors in an environment where they are already staying away from Pakistan.
The decision will prove a blow to the country’s privatisation programme, which remains stalled since the PPP government assumed power in early 2008. It is a bad omen because it means the loss-making public sector utilities will continue to remain a huge drain on the economy.
Pakistan economy is all set to remain in a mess and brace itself for tougher times in the mid- to long-term in the absence of an IMF programme and monitoring which helped the country’s financial managers to stay on course and resist the demands of their political bosses. But clearly, for the ruling coalition, elections are more important than the country’s long-term economic interests.