Reflections on prior actions

Pakistan and the IMF have reached a staff level agreement for a $5.3 billion bailout programme, which is likely to be presented to the executive board of the IMF in early September for approval. However, before the programme is presented to the board, Pakistan will have to take several measures as prior actions which are meant to test the resolve of the government in undertaking critical reforms during the programme period.

Before I delve into the details of the prior actions, a few words regarding possible augmentation of the IMF loan from $5.3 billion to either $6.6 billion or $7.2 billion are in order. At the time of signing the staff-level agreement, the finance minister inexplicably claimed that the new loan would not increase the country’s indebtedness as it would be used for repaying the remaining loan of the IMF.

Seeking augmentation of the loan is not desirable for several reasons. Firstly, it will increase the country’s debt burden. Secondly, it will hurt the reputation of the finance minister as he will be seen as backing off from his claim. Thirdly, this government will be committing the same mistake as that committed by Shaukat Tarin during the previous government. Pakistan borrowed so heavily from the IMF that it faced serious repayment difficulties and was eventually forced to go to the IMF for a new programme. We should not seek augmentation. It will create complacency on our part towards building up foreign exchange reserves.

The IMF on its part must evaluate Pakistan’s debt carrying capacity before agreeing to augment the loan. The IMF staff had expressed their concern about Pakistan’s capacity to repay the loan when the previous regime under the leadership of Shaukat Tarin sought augmentation. Their assessment proved to be correct as Pakistan failed to enhance its debt-carrying capacity and was forced to seek new assistance to repay the old loan.

The IMF has asked the Pakistani authorities to implement five prior actions before the staff level agreement is presented to the board. These prior actions include: i) fiscal package; ii) electricity price adjustment; iii) launching of a tax reform initiative; iv) certain central bank initiatives; and v) commitments by the Council of Common Interests (CCI) on the fiscal reform package including generation of surpluses by the provincial governments. These prior actions emerged as a direct result of three disappointments pertaining to the previous programme experienced by the IMF. These disappointments included lack of progress in raising tax revenues, in addressing the power-sector losses and in governance problems especially in taxation and the power sector.

Fiscal indiscipline has been the root cause of Pakistan’s macroeconomic instability. Failure to mobilise adequate resources on the one hand and senseless spending on the other have led to the persistence of a large fiscal deficit. Any programme with the IMF is, therefore, bound to focus on resource mobilisation and expenditure rationalisation. Under the fiscal package as a prior action, Pakistan will have to take measures amounting to 1.5 percentage point of the GDP, with 0.8 percentage point on revenue side and 0.7 percentage point on expenditure side. The purpose is to bring the fiscal deficit down from 7.5 percent of GDP (excluding one-off expenditure) last year to 6.0 percent this year.

The government has already taken measures on the tax side in the budget and has taken additional measures recently to increase revenue such as increasing the GST rate on CNG by 6 percent. Furthermore, the government has also raised electricity tariff, which will generate additional revenue from sales tax and withholding tax. On the expenditure side, the government has taken measures to reduce power-sector subsidy as well as to reduce other current expenditure. Thus, the government appears to have implemented the first prior action.

As regards the electricity price adjustment (second prior action), the government has increased electricity tariff for industrial, commercial and bulk consumers in the range of 22 percent to 64.6 percent with effect from August 1. This is the largest increase in power tariff in the country’s history. This measure will fetch Rs170 billion for distribution companies and is expected to contribute to the reduction in tariff differential subsidy. Thus, the second prior action has also been implemented by the government.

As regards the third prior action (launching of a tax-reform initiative), it is not clear whether it has been implemented or not. As of today, the government has relied heavily on the existing taxpayers as well as the existing tax base. No credible measures appear to have been taken in broadening the tax bases; no new areas of economic activity have been brought under taxation.

Domestic-resource mobilisation has been a critical element of the IMF programme since 1988. It is unfortunate that the IMF has failed miserably in the last 25 years to increase Pakistan’s tax-to-GDP ratio under its programme. It allowed successive governments to maintain the status quo and yet provided resources to them. Is there any accountability in the IMF? Perhaps not.

On central-bank initiatives (fourth prior action), the State Bank of Pakistan is required to take at least two measures, that is to pursue a flexible exchange-rate policy and tighten monetary policy by raising the discount rate. The SBP has already implemented the first measure by withdrawing itself from intervention in the foreign exchange market. Consequently, Pakistan’s exchange rate depreciated from Rs98.5 per dollar on June 1 to Rs102.9 per dollar on August 16 – a loss of Rs4.4 per dollar in exchange rate. The second measure of raising the discount rate in the region of 100-150 bps will be taken in the coming monetary policy announcement. Thus, the fourth prior action will have been completed by end of August as well.

The last prior action requires approval of the CCI on the government’s commitment to fiscal measures including fiscal reforms. This prior action is highly critical for the success of the IMF programme. From the IMF perspective, the 7th NFC Award has increasingly complicated the implementation of fiscal policy. If not properly managed, this award will complicate macroeconomic stabilisation, create risks of expenditure slippages and may compromise incentive to raise tax collection at all levels.

This issue was discussed recently in meeting of the CCI, but no firm decision was taken. According to the sources, the minutes of the meeting state that “provinces will strive to generate surpluses”. From the perspective of the provincial governments, the latter are always striving to generate surpluses. If they have failed, it is not their fault as the federal government never provided them with the budgeted resources.

On the whole, the government appears to have taken measures to comply with majority of prior actions. I am confident that the IMF staff will present the agreement to its board. Most probably, the board is likely to approve the new programme by early September. The global leaders do not want to create economic instability in Pakistan either at this critical juncture in history.

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