All the hullabaloo and rhetoric aside, it was never a question of ‘would?’ but of ‘when’. The Finance (Supplementary) Bill, 2021 – aka the mini-budget – recently rammed through the National Assembly, represented a non-negotiable condition of the International Monetary Fund (IMF) for resumption of credit inflows under a $6 billion programme. The resumption of the programme, called the Extended Fund Facility (EFF) in the IMF jargon, is essential for keeping the economy afloat and for the country to meet its international payment obligations.
Both the sponsors or supporters of the mini-budget as well as its opponents were amply aware of such compulsions and probably never doubted for a moment that the bill, its merits or demerits aside, would be defeated. In politics, as in life, how we see and interpret the world depends on where we stand. When a party is in the opposition, its infatuation with national sovereignty and economic independence knows no bounds. When the same party or people enter the corridors of power and are faced with the hard realities and clear and present challenges, they start singing another tune. The biggest challenge always is to ward off the economic crisis on hand for which IMF credit appears to be the only viable course. ‘In the long-run we are all dead,’ famously remarked the economist John Maynard Keynes. So it’s the short-run that should foremost draw our attention.
At the same time, the bill was thoroughly discussed by the standing committees of both houses of parliament – being a money or finance bill, it needed the approval of the National Assembly only – with the treasury giving its nod to some of the amendments proposed by the opposition. Herein lies the strength of democracy.
Pakistan has been seeking assistance from the IMF fairly regularly. Since the Ayub regime of the 1960s, there has hardly been any government that did not draw credit from the IMF. In both 1988 and 1993, shortly before Benazir Bhutto was sworn in prime minister, the outgoing caretaker governments had inked a credit agreement with the multilateral donor and undertook to open up the economy to an extent which was unwarranted. As a result, the economy suffered premature de-industrialisation from which we have not been able to recover. Manufacturing-to-GDP ratio, which was 15 percent on average during the 1990s, fell to 12 percent and 13 percent over the following two decades. In 2020, the share of manufacturing in total national output dropped even further to 11 percent.
De-industrialisation together with a relatively high birth rate has had a two-fold obvious effect: The total demand in an economy is met either by domestic products or foreign products. When a people consume far more than they produce, the difference is accounted for by imports. Likewise, exports are a function of the productive capacity of an economy. In the face of de-industrialisation, export growth is outpaced by import growth, ushering in a trade deficit. It is a large trade deficit that creates balance of payment (BoP) problems and forces the government to borrow abroad.
Not surprisingly, in recent years, every elected government began its tenure by facing the question of whether to seek the IMF assistance. The PPP government in 2008 and the PML-N government in 2013 started off by concluding a credit agreement with the Fund. The PTI government, having flip-flopped on the question for months, decided to draw upon the IMF’s capital. As a rule, every government while running a programme with the Fund claims that the on-going programme would be the last and that after its completion they would break the ‘begging bowl’ once and for all.
On the other hand, on every occasion, the parties in opposition warn against obtaining credit from the Fund in the name of national sovereignty or on the strength of the argument that the IMF’s conditionality would sap the economy of whatever strength it had been left with. However, the government, regardless of which political party is at the helm, chooses to play ball with the IMF despite its tough conditions or performance requirement, which essentially remain the same, as realistically speaking, there’s no viable alternative.
Typically, an IMF programme sets both short- and long-run objectives. In the short-run, the credit inflows are calculated to help the economy ride out the BoP problem, which prompted it to go to the multilateral donor. An IMF programme improves the recipient’s credit ratings and makes it easier to draw upon other international borrowers. In the case of Pakistan, the short-run purpose is always achieved.
The long-term objective is to encourage restructuring of the economy. Hence, the aid, apart from repayment of the principal and the interest, is made conditional upon certain policy reforms. These include slashing fiscal deficit through in the tax-to-GDP ratio and cuts in ‘unproductive’ public expenditure, devaluation or depreciation of the domestic currency through a flexible exchange rate, liberalisation of trade and investment regimes, market-based pricing, tightening of the monetary policy, and overall deregulation of the economy.
Hence, the IMF-sponsored programmes have both political and economic implications. While accepting the IMF’s assistance, the borrowing country agrees to surrender part of its sovereignty to the Fund during the period of the arrangement. The Fund monitors the country’s fiscal, monetary and exchange rate policies with a view to ensuring that the agreed performance criteria are met. In this way, the IMF comes to exercise considerable influence on economic decision-making of the borrowing country.
The ultimate test of a credit programme is that the recipient wouldn’t need to subscribe to it again. The fact that Pakistan has to seek IMF assistance periodically – in recent years every five years coinciding with the election cycle – is testament that the long-term objective of IMF programmes has not been achieved. The reasons for that are fairly obvious.
Fiscal deficit is difficult to contain on both revenue and expenditure accounts. Businesses and celebrities by and large are averse to paying direct taxes. The wholesale and retail sector accounts for 19 percent of the GDP, but its share in total tax revenue is less than one percent. Thus the government has to rely on indirect taxes, such as customs duties and GST to plug the revenue shortfalls. The Finance (Supplementary) Act 2021 essentially entailed an increase in GST collection mainly by withdrawal of the exemptions earlier granted.
Indirect taxes are not only inflationary; they are regressive as well, as citizens irrespective of their income levels have to pay the same tax rate. Containing public expenditure is easier said than done as nearly 80 percent of the government spending is autonomous, that’s to say, it will be made regardless of the state of the economy. Hence, the axe almost always falls on discretionary spending, such as development spending, at the cost of the economy’s long-run productive capacity as well as social sector development.
The reserves build-up from the IMF assistance and the expected enhanced possibility of capital inflows from other donors may bring some stability, in the short-run, to the rupee-dollar parity (exchange rate). However, in the long run the exchange value of the rupee will be determined by the relative demand for (imports, debt servicing) and supply of (exports, foreign capital inflows) foreign exchange. A continuing adverse balance of trade will put pressures on the reserves and depreciate the rupee further.
The IMF-sponsored programme can at best have a marginal effect on scaling down trade deficit, which is primarily undergirded by productivity constraints. In fact, depreciation makes imports expensive and thus worsens terms of trade (the ratio of export and import prices). As a result, an economy’s ability to import capital equipment, which is essential for growth, is hampered.
The foregoing, however, doesn’t mean that in the long run the IMF credit is an evil or that structural economic reforms are impossible to bring about. The progress as well as management of the economy is constrained by the larger cultural and political environment in which it operates. Without a shift in this larger environment, meaningful economic reforms will be difficult to come by.
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The writer is an Islamabad-based columnist.