Beyond breaking the bowl

The $5.3 billion (which may go up by $2 billion) staff-level agreement with the International Monetary Fund is a classic case of borrowing afresh to work off the current debt. Notwithstanding the pre-poll pledges of the PML-N to break the begging bowl once and for all, Pakistan’s going back to the Fund is not surprising in the least.

Given the state of the economy and the need to repay the government’s obligations to foreign creditors, it was never a question of whether Pakistan would go back to the IMF, only a question of when. It could have been towards the close of the PPP tenure, during the caretakers’ rule, or, as it has turned out to be, at the beginning of the term of the new government.

Subject to approval of the IMF Executive Board, the fresh capital inflows will be available through the Extended Fund Facility (EFF). The last assistance (2008-2011) obtained by Pakistan from the Fund was under the Standby Arrangement (SBA) programme.

The EFF assistance is normally for three years, as in the case of the instant agreement, and has a longer repayment period, between four-and-a-half and 10 years, than the SBA for which the maximum period is five years. The EFF is designed for economies facing low growth and an inherently weak balance of payment (BoP) position as well as those suffering structural impediments. Pakistan, evidently, fits both these descriptions.

The details of Pakistan’s agreement with the IMF made public so far show that the IMF conditionalities do not go beyond what the government says is its ‘home-grown’ programme and what it had already committed to do in the budget for the current fiscal year.

A press release issued by the IMF dated July 4, 2013, gives a brief account of the measures that Pakistan will have to put into effect. These include fiscal consolidation (read: curtailing fiscal deficit), an improvement in tax collection as well as widening the tax base and putting in place an equitable tax system, doing away with tax exemptions, phasing out of the existing statutory regulatory orders (SROs), removal of untargeted subsidies, a comprehensive strategy for grappling with the energy problem, significant structural reforms in trade and economy (read: their further liberalisation) and restructuring and privatising public sector enterprises.

Two pertinent questions that arise here: What precisely made Pakistan go back to the Fund for assistance? Is the agreement with the IMF a recipe for the country’s macroeconomic problems?

A country’s request for IMF credit signifies two things in the main: that the economy is in a critical condition and needs immediate injection of capital; and that – given the political and economic costs of the Fund’s assistance – cash inflows from other potential sources are not coming through. This is not to suggest that assistance from other multilateral or bilateral sources has no strings attached to it.

However, because IMF conditionality is perceived to be tougher and unpleasant, its assistance is usually sought as the last resort. In an ideal situation, the country need not knock at the door of the IMF, or for that matter any other door, for credit. But then in an ideal situation, Pakistan’s economic heath wouldn’t be as bad as it is.

For the last few years, the economy has been facing low growth (three percent on average during the last five years) and high inflation (12.5 percent on average during the last five years). This has been accompanied by average trade deficit of $16.33 billion during the last five years putting pressure on the foreign exchange reserves in the face of meagre foreign direct investment (FDI) inflows.

As on July 5, 2013, the net reserves available with the central bank had come down to $5.5 billion from $10.15 billion nearly a year earlier. The declining foreign exchange reserves pushed down the value of the domestic currency, bringing the rupee-dollar parity beyond one hundred. To top it all, Pakistan has to pay back Rs 366.76 billion (nearly $3.7 billion) foreign loan, with previous IMF credit servicing having the lion’s share, and pay Rs89 billion as interest on external debt during the current financial year (2013-14).

Again, in an ideal situation affluent Pakistanis will bring back their dollars, Euros, pounds and francs. However, the foreign currency accounts that the well-to-do Pakistanis maintain abroad will not be repatriated back for two reasons: one, the bulk of the money is ill-gotten and if it is brought back questions will arise as to its source. Two, when a country is precariously placed both politically and economically, the dominant trend is capital flight rather than capital inflows.

As for assistance from Pakistan’s allies and friends, the same is generally contingent on various factors, notably a certificate of credit worthiness from the IMF. Though some quarters will have us believe that even in that event it was better to eat grass than swallow the IMF pill, such advice is no more than hollow political statements. In short, it is doubtful whether there was any alternative to swallowing the ‘bitter’ pill of the IMF’s conditionality-linked assistance.

Regarding the impact of the IMF-sponsored programme, it is a bailout and not a development package. The purpose is to help the country service its debt, make payment for imports, and build up its reserves. The assistance from the IMF will thus save the country from having to default on debt re-payment and make it possible to pay for imports. What we import from the IMF money is another issue. It may be essential goods like food, raw materials and machinery necessary for industrial development, luxuries like bulletproof cars for people in high places or defence-related equipment.

The World Trade Organisation rules allow a country facing a BoP problem to temporarily restrict imports. But do we have the political will to restrict import of non-essential or non-development goods? Or will the IMF allow the government to impose such restrictions? A country running an IMF-sponsored programme has limited policy space available to it.

The reserves build-up from the IMF assistance and the possibility of capital inflows from other donors will increase Pakistan’s credit rating and convey a positive signal to the domestic foreign exchange market and may bring some stability, in the short-run, to the rupee-dollar parity. However, in the long-run the exchange value of the rupee will be determined by the relative demand for and supply of foreign exchange. A continuing adverse current account balance will put pressure on the reserves and further depreciate the rupee.

Trade liberalisation, which is generally a component of IMF-sponsored packages, is potentially both beneficial and harmful. Reduced tariffs can help make exports competitive by reducing the cost of imported inputs. In that event, export promotion will generate employment and incomes. On the other hand, trade liberalisation may lead to de-industrialisation as domestic firms are priced out by cheaper imports. The result will be loss of employment and incomes.

The IMF programme may make the government undertake measures, such as widening of the tax net, which it would be reluctant to do on its own. Beyond that the package will – at best – provide a respite, not a credible solution, to the country’s economic woes. Such a solution consists in setting our own house in order.

The author is a freelance contributor. Email: hussainhzaidi@gmail.com