PAKISTAN: A new beginning
Pakistan recently obtained yet another loan from the IMF. Will it fulfil hopes that this time it will make progress on reforms?
He may usually have a solemn countenance, but Pakistans finance minister has a reason to smile during his visit to Washington DC this year. For at least three years now, Pakistans delegation to the Annual Meetings of the International Monetary Fund and the World Bank has struggled to find its voice, caught between the turbo-charged politics at home and the countrys growing isolation on the international stage.
But this year an election has brought in a new government, with new faces and a refreshed mandate on the back of a commanding majority in parliament. Coupled with a looming withdrawal of American forces from Afghanistan which has reignited international concerns about stability in Pakistan and given the country another go in the global limelight the moment carries with it the promise of a new beginning.
In early September, the executive board of the IMF approved a three-year loan under the Extended Fund Facility (EFF) for Pakistan, worth $6.68 billion. In its latest Article IV consultation with Pakistan, released in August, the IMF was able to acknowledge at least one of the elements of the new dawn breaking over Pakistan. The convincing win provides a strong mandate to implement a bold reform agenda, wrote the staff, adding that the programme was off to a strong start with a raft of up-front actions already completed.
The prior actions already implemented include a large hike in power tariffs for bulk consumers, revenue measures equal to almost 2% of gross domestic product, an end to monetary easing and central bank intervention in currency markets, and an aggressive tax recovery drive.
Already, at the very start of its tenure, the new government has sparked the ire of the business community and seen the rupee lose almost 5% of its value in a matter of weeks. All of the measures announced in this budget were resisted by the business community for years, Siraj Kassem Teli, an important business leader in Karachi, said in a dramatic press conference held at the Karachi Chamber of Commerce and Industry immediately following the budget announcement in June.
The measures he was referring to included a massive expansion in the discretionary powers of the tax authorities, a raising of the General Sales Tax (GST) by one whole percentage point, as well as a raft of other taxes.
WEAK TAX COLLECTION
The tough measures were needed, according to the State Bank. Tax collection in the last fiscal year had a shortfall of Rs445 billion, almost a fifth of total target. Weak tax collection is the fundamental economic problem faced by Pakistan, the State Bank said in its last monetary policy statement in September, urging strong tax reforms and warning of inflation and lack of credit for the private sector as some consequences of failure on this front.
Growing domestic debt has been the inevitable consequence of this failure to undertake reforms in the tax machinery thus far. Last fiscal year, debt servicing costs rose above Rs1 trillion, 44% of total tax collection. Beyond the size, the composition of the debt is also a cause of concern, with a growing proportion in excess of 50% denominated as short-term debt, carrying roll-over risk.
Reviewing the growing domestic debt, the State Bank has warned of serious implications for debt sustainability and thus macroeconomic and financial stability.
But does the governments new budget, announced in June supposedly with one eye on the IMF, live up to the growing imperative to mobilize domestic resources? The budget deficit target has been set at 6.3% of GDP, down from 8% in the last fiscal year. A significant amount of the reduction is envisaged to be achieved by an ambitious revenue target and the containment of current expenditures at 15.2% of GDP.
Notwithstanding the dismay expressed by the business community over the revenue measures contained in the budget, the State Bank remains unimpressed. The budget assumes continuing inflows under the Coalition Support Funds a mechanism used by the United States to reimburse allies for military support services and 120 billion rupees from the auction of 3G licences in the telecom sector.
The government has struggled in realizing these over the last several years, contributing to fiscal slippages, the State Bank notes.
With the auction of 3G licences in the telecom sector, for example, the government budgeted Rs80 billion on this account last year, but failed to carry out the auction. This year, the first meeting of the Advisory Committee for the auction of the licences met early this month, according to various media reports, which said the proposals were finalized. Anusha Rehman, minister of state for information technology, was quoted as saying that the four mobile phone companies in Pakistan had shown interest in the auction.
Aside from budgetary considerations, the other major priority for Pakistan in the forthcoming year will be to build reserves. By September 6, when the first tranche of $544 million from the new EFF was received, reserves stood at $5.2 billion barely enough to cover five weeks of imports.
Most of the declines in the reserves are the result of debt repayments to the IMF. Pakistan has paid just over $3.7 billion to the IMF since repayments from a Standby Facility it signed in 2008 began a few years ago.
The 2008 Standby Facility was the largest that Pakistan had ever signed, at SDR7.2 billion, and was signed in the middle of a serious balance of payments crisis which saw the currency plummet and bank lending grind to a halt.
SDR4.9 billion was disbursed from that facility until 2010, when the programme went off track due to failure to implement key provisions, particularly the reformed Value Added Tax. Once repayments began, Pakistan found its reserves eroding quickly, and decision-making paralyzed by a mounting series of political crises.
In light of this history, and the use of an IMF facility to help meet the obligations from a previous facility, many commentators are of the view that the September EFF is more of a bailout than an adjustment-based loan. And that thought leads into a conversation which is gathering momentum: that Pakistans troubled political economy has been spawned, in large measure, in the cradle of bailouts of precisely this kind over the decades.
As early as January of this year, a former State Bank governor was willing to publically say the unthinkable. Can the Fund, for once, let us face the consequences of our actions or inactions? Shahid Kardar asked in a controversial opinion piece published days after an IMF team left Pakistan following an unusual two-week long stay.
That visit had fuelled fears that Pakistans dwindling reserves were leading the country towards an imminent balance of payments crisis precisely at a time when the country was preparing for a chaotic and violent general election. The teams visit was perceived as an attempt by the fund to urge the authorities to get onto a programme before the election cycle got underway in earnest with the arrival of an interim government. Kardar and many others like him were unimpressed, though, seeing the affair as playing into the hands of the vested interests that control the countrys dysfunctional political economy.
The strategy of successive governments has been to extract rents for our geo-strategic location, Kardar wrote, arguing that such rents and bailouts only meant postponing the real reforms that the country needs to undertake to arrest its slide into economic anarchy.
At the same time, in January, two former IMF staffers circulated a paper on the history of Pakistans relationship with the IMF, with the provocative thesis that repeated fund engagements had created a situation of Dutch disease without the oil.
The authors built on an earlier internal study of the IMF on prolonged users of fund resources, which had looked at Pakistan and concluded that the prime factor responsible for the countrys prolonged use of fund resources was that principal IMF shareholders... were not willing to take the risk of major turmoil in Pakistan that would necessarily be caused by an interruption.
To this understanding, the authors added a new element: defensive lending. Now that the IMF has lent such large sums, it is clear that defensive lending might be a factor in any new arrangement, wrote the authors.
All summer, the finance minister has been at pains to emphasize that the new facility being signed by Pakistan will not add to the stock of public debt, because it will be used to retire old debt, thus lending credence to the defensive lending hypothesis.
But far more than securing its debt servicing capacity, such prolonged recourse to fund-led bailouts could have grave longer-term consequences for the people of Pakistan as the countrys slide into fiscal and economic unviability continues without corrective action, wrote the authors.
Speaking to Emerging Markets, one of the authors of the paper, Ehtesham Ahmed says he is surprised by the lack of any meaningful structural conditionality in the new programme. This programme misses an opportunity for the government to undertake difficult adjustments under cover of a fund programme, and for the fund to ensure that Pakistan does not remain in the most-frequent customer category.
For its part, the fund is aware of the difficulties that lie ahead. The latest Article IV report speaks of significant implementation risks, given Pakistans track record, but finds comfort in the willingness of the new authorities to undertake critical upfront actions, long phasing of disbursements, and the strong mandate handed to them by the electorate.