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IMF – No half measures

Last week it appeared that the economic reality is finally sinking into the government high-ups. The statement of Saudi finance minister in Davos on not supporting countries (like Pakistan) unconditionally proved to be a wake-up call for the twin cities. Meanwhile, the UAE (United Arab Emirates) rollover of $2 billion is likely conditional (on non-usage) and rumors are that around $2 billion Chinese money in reserves is only for CPEC (China Pakistan Economic Corridor) use. Perhaps, to create space in reserves, SBP (State Bank of Pakistan) swapped against the FE25 deposits to slightly increase its reserves to $4.6 billion.

The government has requested the IMF (International Monetary Fund) mission to come soon and conclude the pending 9th review. There is certain set of economic steps that are required by authorities to take for the IMF mission to come to Islamabad to finalise the all-important SLA. However, these have political repercussions. Nawaz Sharif wants a guarantee by the establishment on the government’s extension for a year. That is not happening. In response, Nawaz’s view is to dissolve the national assembly, and let the caretakers take care of the IMF. In contrast, PM Shehbaz Sharif’s view is to move step by step, i.e., swallow the bitter pill of the IMF and then make the next strategy.

That is why the PM is taking the driving seat on the IMF negotiations. It’s highly likely that the IMF mission will come and discuss the terms of the 9th review. The foremost condition of the IMF is to have one exchange rate in the country. It’s the first line of the EFF (extended fund facility) to have flexible and market-based exchange rates. The IMF might not like the slow speed of depreciation. And this could become the bone of contention for the success of the IMF review.

To counter that, the authorities may take a hawkish stance on interest rates in today’s monetary policy decision, as interest rates have less significance politically. There is a trade-off between the exchange rate and interest rates and a higher increase in interest rates may warrant less depreciation of the exchange rate. Let’s see how it would work out. If that is the route the government is taking, expect a higher than 100 basis points (bps) (market expectations) increase in the policy rate today.

Having said that, there are other conditions where the Fund might have a varying view from the government. One is to have additional tax measures of around Rs200 billion. The IMF is fine with the number, although the fiscal slippages are higher, but by using some adjustors for floods related expenditure, Rs200 billion could be agreeable.

However, the IMF may not like the proposition of withholding tax on cash withdrawals from banks. That is not a good tax, but its finance minister Ishaq Dar’s favourite. Last time, when this tax was imposed by Dar in 2015-16, the currency in circulation (CIC) to monetary aggregate (M2) ratio increased from 22 percent to 26 percent in a year. The ratio peaked at 29 percent in 2019-20 and after its removal in 2022-21, the ratio is down to 27 percent in a year. CIC is already too high; it’s not a wise decision to impose tax on cash withdrawals again, and IMF should not accept it.

The Fund is also not happy with government strategy to impose one-off taxes on banks and big companies. One, there is a limit to what these companies can pay in taxes in a difficult economic situation. Two, the IMF would like to see sustainable taxes. One example is to increase the GST rate to 18 percent. In addition, there should be a tax on traders and retailers which was imposed by the then finance minister Ismail Miftah but later was rolled back on Maryam Nawaz’s request on twitter. Other proposed taxes like withholding tax on real estate sale, excise duty (or other prohibitive tax) on sugary drinks and 10 percent GST on petrol are fine. In non-tax revenues, the government might increase the petroleum levy on diesel by Rs17.5 to Rs50/liter.

Then the government is likely to increase the power and gas tariffs to fill the growing circular debt both in power and gas sectors. The government wanted to increase power tariff by Rs4.5/unit while the demand was Rs10/unit and it’s likely the deal would be done on Rs7.5/unit- around 20-25 percent increase. On gas, expect much higher increase in the percentage terms.

Time is running short. The SBP perhaps has around $500 million of usable reserves in the kitty. IMF review must be concluded by the end of January. Otherwise, a messy default is in the waiting. There could be severe shortages of essentials – like petroleum products, long hours of load shedding, medicines, and food shortages. Petroleum division has warned SBP that in case of not entertaining PSO’s and others’ L/Cs, there would be shortage of petroleum products.

The plan for the last few months was to choke the imports and live for a few months in the absence of inflows. It was started by Miftah in July 2022 by restricting imports of engineering goods and machinery. At that time, there was no fixation of currency. Now the import restriction policies have not only doubled up, but Dar has also fixed the currency at artificial levels. That is a double whammy. The IMF has extreme dislike for capital controls. And these must be tapered off in order to go to the IMF programme.

There is too much to do which is too urgent. That is why strong signaling is imperative. Keep a close eye on the monetary policy committee decision today and movement of exchange rate this week. The government needs to shore up reserves and restore its lost credibility. There should be no half measures now.

Ali Khizar, "IMF – No half measures," Business recorder. 2023-01-23.
Keywords: Economics , Economic change , Government strategy , IMF programme , IMF contract , IMF strategy , Economic policy , State Bank , Pakistan

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