Negotiating a new IMF programme

Two weeks ago (June 11), I suggested that it was time for Pakistan to go to the IMF for balance of payments support as the country’s foreign exchange reserves had plunged to dangerously low levels. It was also suggested that, since the IMF mission was arriving in Pakistan on June 19 for Post Programme Monitoring, Pakistan should start negotiation for a new IMF programme and seek funding corresponding to the remaining amount owed to the IMF.

It is gratifying to note that unlike the previous regime, the present government has decided to seek a new programme, the size of which will be equivalent to the loan still to be repaid to the IMF. Emotionalism apart, this is in the larger interest of Pakistan’s economy and augurs a sensible approach to the financial management of the country for which the finance minister deserves appreciation.

Before I delve into the likely contours of the new programme, it is appropriate to describe the lessons learnt from the last programme (November 2008). Highlighting the deficiencies of the last programme will help the government negotiate a robust programme with the IMF.

During 2007-08, Pakistan was severely affected by a combination of domestic and external shocks of unprecedented proportions. Sharp global increases in food and fuel prices, policy inaction during the political transition to the new government, adverse security developments and global financial turmoil severely affected the economy. Accommodating fiscal and monetary policy badly affected external balance of payments, resulting in a steep drop in foreign exchange reserves.

Pakistan had no choice but to go to the IMF for balance of payments support. A stand-by arrangement (SBA) was approved by the IMF in November 2008 to help restore macroeconomic stability and ensure sustained economic growth and poverty reduction. The duration of the SBA programme was 23 months with size of the funding amounting to SDR 5.169 billion or $7.6 billion or 500 percent of quota which constituted exceptional access to IMF resources. The initial exceptional access was further augmented to a cumulative 700 percent of quota or over $11.0 billion at the second review of the programme.

Under the programme, Pakistan was to take action in four broad areas: i) tax reform; ii) power-sector reforms; iii) restructure and privatisation of the bleeding public sector enterprises (PSEs); and iv) autonomy of the central bank to enhance the effectiveness of monetary policy. Tax reforms were progressively focused on, putting in place a comprehensive value added tax (VAT) to provide a lasting boost to revenue. Various studies suggested that the VAT could increase revenue by up to three percent of GDP over the medium-term.

Lack of political support and resistance from the private sector, civil society and provincial governments emerged as major impediments to the introduction of deep-rooted structural reforms on the fiscal side. Power-sector reforms also failed to reduce power-sector subsidies and build-up of circular debt.

The PSEs continued to bleed owing to the lack of will of the political leadership, which used the PSEs as employment agencies. Some progress was made towards improving the autonomy of the central bank, but it fell short of the programme targets. Most importantly, fiscal decentralisation (NFC Award) during the programme period increasingly complicated fiscal policy implementation, resulting in large slippages in fiscal deficit targets.

What are the lessons from the previous programme? First, the size of the programme was too large for a country like Pakistan. Those who negotiated the programme during October-November 2008 were inexperienced people who never realised that the large sum the country was borrowing from the IMF would have to be repaid within a couple of years. Today, the nation is paying the price and the new government is seeking a new programme to pay back the money owed on the previous one.

Secondly, some of the programme targets were too ambitious to be implemented in the 23-month SBA. For example, the introduction of a broad-based VAT with minimal exemptions had been discussed for decades. Implementing VAT, or reformed GST, in a short period was a difficult task to achieve.

Third, the power-sector reform narrowly focused on raising power tariff alone. Empirical study has found that hike in power tariff promotes power theft with little improvement in revenue. Fourth, little or no efforts were made in the programme to improve governance. Fifth, a careful balance was required between the extent of reform and the implementation period agreed upon in the programme.

The new IMF programme must avoid making past mistakes. The contours of the new programme, as I envisage it, would be determined by a focus on four key areas: tax reforms, power-sector reforms, PSE restructuring and privatisation and fiscal decentralisation. On tax reform, there cannot be two opinions that adequate resource mobilisation to meet growing expenditure is one of Pakistan’s perennial problems. Resource mobilisation will form the building block of the new programme. However, care has to be taken – especially in the light of the fiscal decentralisation.

Emphasis should be on tax administration reform, given the usually low compliance rates. Implementing tax reform with a weak tax administration is bound to fail. Tax administration has been weakened to the core, infighting is widespread and the quality of staff – including those in senior positions – has deteriorated over the years.

Strengthening tax administration, therefore, should form the key reform agenda of the new IMF programme. Policy reforms could be diversified, including direct taxes in addition to further GST reform. Under direct taxes, all income, irrespective of source of generation, should be brought under the tax net.

In the presence of the existing NFC Award, there can never be a meaningful fiscal policy and achieving macroeconomic stability will be a distant dream. While the central authority representing the member country is essential, provincial governments will have to be taken on board to achieve the fiscal deficit target.

The initiatives of maintaining fiscal discipline and hence macroeconomic stability have now been shifted to the provinces after fiscal decentralisation. The federal finance minister will not be able to deliver on budget deficit targets without the firm support of provincial finance ministers. The IMF would, therefore, like to have a wide-ranging consultation with provincial authorities as well.

The present government is already working seriously to address the power-sector challenge. It has already prepared wide-ranging short-to-medium term power-sector reforms, including the issue of circular debt, which can form a part of the reform agenda for the IMF programme.

The government has already taken steps to restructure and privatise rotten PSEs – attempting to bring in new professional management on board with well-defined performance targets. Once the health of the PSEs improves, the government should consider privatising them. These plans can form the reform agenda for the new IMF programme.

Thus, resource mobilisation through broadening of tax base, strengthening of tax administration to enhance compliance rate, further reform in GST, addressing complications arising out of the new NFC Award, power sector reform, restructuring and privatisation of the PSEs, along with enhancement of the central bank’s autonomy may form the reform agenda of the new IMF programme.

Wide-ranging political support will be essential for the success of the programme for which the IMF may want the prime minister to co-sign the agreement. They have already indicated it several times during the previous regime.

The writer is principal and dean of NUST Business School, Islamabad. Email: ahkhan@nbs.edu.pk