Fair game for the IMF

The IMF and the government of Pakistan have reached an agreement on yet another arrangement after a separation and then divorce from the previous standby arrangement between them. This is not the first time that they have tied the knot again after some period of separation from each other but is in fact the pattern of their relationship witnessed in the last three decades or so.

When in balance of payments difficulties, the government of Pakistan approaches the IMF for financial assistance with a promise to undertake some policy reforms without their genuine ownership. As soon as it finds some breathing space, the government delays or abandons the implementation of such reforms and, blaming the IMF for its harsh conditionality, takes leave from it till another balance of payments crisis emerges.

This time, the previous standby arrangement has been followed by a new three-year Extended Fund Facility of some $5.3 billion or 300 percent of Pakistan’s quota in the IMF. It is no coincidence that this amount is exactly equal to the outstanding loan of about the same amount (299 percent of Pakistan’s quota as on May 31, 2013) that was due to be repaid to the IMF in the next three years.

The IMF press release gives no details on the phasing of disbursement of the new loan but it can be assumed with some degree of certainty that it will closely follow the timing of repayment of the outstanding amount to the IMF. While the IMF will not concede it openly, the fact is that it has decided to restructure its outstanding loan at a lower interest rate with a longer repayment period.

It may be mentioned that the main task of the IMF is to provide temporary financial assistance to a member country that is faced with serious balance of payments difficulties so that during the period of its assistance the country adopts policies to structurally improve the balance of payments situation on a durable basis.

The IMF assistance is supposed to be for a short duration and the country is expected to recover from its balance of payments crisis during that period through policy reforms. The IMF is also mainly staffed by professional economists who are expected to provide sound economic advice to the country authorities in designing their reform programme.

Contrary to its mandate, the IMF has been involved with Pakistan almost continuously for the last three decades and has failed to take the country out of its balance of payment crisis on a durable basis through its economic policy advice and economic programming.

In an article in this newspaper (‘IMF follies in Pakistan’, June 19, 2013) I had suggested that the IMF should review its poor record of performance in Pakistan and revise its approach so that it achieves the basic purpose for which it was created.

I had, in particular, emphasised that it should replace its accounting approach to economic programming with an analytical one focused on changing the fundamental direction of the economic policies. The IMF had been walking on the fringes for a long time by setting some quarterly credit ceilings and fiscal and reserve targets based on cooked up statistics without any durable positive results.

Unfortunately, the IMF has done what it was hoped it would avoid doing, given past experience. The Fund’s mission arrived with a brief to take whatever the government gives in terms of economic programme so as to restructure its outstanding loan and stretch out its repayment over a longer period to avoid a debt default to the IMF.

This was convenient for the new government, which wanted to avoid the spectacle of debt default early on its watch but at the same time did not want to take difficult policy decisions in its honeymoon period of governance.

Pakistan’s finance team managed to juggle statistics well, as it always does, to set laudable budgetary targets and the IMF mission plugged those statistics in its accounting programme to come up with an alibi for the restructuring of its outstanding loan to avoid a potential default to it by the country. The economy has been left hanging in a condition of stagflation.

Both the IMF and the government know what needs to be done to take the economy out of its present mess. But the government is not prepared to take the political risks of putting the burden of reforms on those whose voting blocks brought them to power, and the IMF does not want to risk default by insisting on the real structural reforms.

To remind the IMF and the government, let us summarise what really needs to be done to salvage the economy and put it on a path of sustainable high growth with relative price stability and balance of payments viability.

• Broaden the base of the income tax to cover all sectors of the economy – including agriculture and services – document the economy and collect income taxes from all based on sound public finance principles of equity and efficiency. First, all people at a given level of income must be taxed equally regardless of the origin of income. This is called horizontal equity in public finance. Second, make the effective tax structure progressive so that people with higher incomes pay a higher marginal income tax rate. This is called vertical equity in public finance.

Third, consolidate the tax base by eliminating tax loopholes, concessions and exemptions and reduce the maximum tax rate to make the incentive for tax evasion unattractive. Fourth, reorient tax administration and stop tax corruption so as to improve tax collection. Fifth, make the provinces increasingly finance their expenditure by their own tax effort.

If these reforms require a rearrangement of fiscal federalism, do it or if it requires constitutional amendments undertake them. After all, the constitution has been abrogated quite frequently and amended more than twenty times to protect the political power base and vested interests. The constitution could also be amended to protect the economy from collapse.

• Introduce a generalised consumption tax of the value-added variety on all consumption except food items and a few other essential goods. That will help the government reduce taxation on savings and financial transactions and reliance on several minor nuisance taxes. The existing minor taxes hurt financial intermediation and savings, are harmful for economic growth and hinder progress towards self-reliance.

• Introduce massive austerity in expenditure including that on defence and the palatial lifestyle of bureaucrats and politicians. All governments should begin to live within their means and the same may be followed by the people through the demonstration effects of austerity in governance. Ordinary citizens could not be more pleased to see the rulers living like them if they decide to do so and they would not be more unsafe and insecure than than they are at present.

• Restructure and sell sector all loss-making public sector enterprises to the private sector – even if they fetch no price. At least the monumental recurring losses that are a heavy burden on the budget could be reduced.

• All price subsidies should be removed while encouraging competition in the private sector and promoting private savings and investment that in combination generate more employment and accelerate the rate of economic growth. The culture of reliance on patronage and beggary should be replaced by more productive employment and self-reliance. The present system nourishes corruption and favouritism, while at the same time it hurts the dignity of the poor.

• Dismantle the underground economy by enacting new legislation and adherence to rule of law through its blind enforcement on the rich and the poor, the powerful and the weak.

• Have a new economic development strategy that promotes skills in the educational system, promotes export led growth, discourages reliance on imports and reduces the widening economic disparity.

Without massively restructuring economic and governance policies we will continue to be international beggars bartering our dignity and sovereignty as a nation for a few billion dollars. At the same time, we will continue to play a futile game of hide-and-seek with the IMF.

The writer is a former governor of the State Bank of Pakistan.