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Honeymooning with the IMF


April 1, 2015

There is high unemployment amidst a low rate of economic growth in Pakistan, plenty of poverty amidst pockets of prosperity, a poor state of the health and education sectors, low saving and investment rates, declining foreign investment, lower development expenditure if mega prestige projects are excluded, mounting external debt burden and a large trade deficit. One does not need to be an economist to conclude from these facts that the fundamentals of the economy are weak and the state of the economy is poor.
But the Ministry of Finance and the State Bank of Pakistan have been beating the drums of improvement in the economy in their statements and publications by referring to statistics relating to four areas of the economy. First, foreign exchange reserves of the SBP have gone up since the PML-N formed government. Second, the current account deficit of the balance of payments as a percentage of GDP has declined recently. Third, the budget deficit has been brought down substantially. Fourth, the rate of inflation has come down. Intentionally, and unprofessionally, both the Ministry of Finance and the SBP quote these developments as proof of prudent economic management.
As has been explained in these columns many times, some of the so-called improvements in the above areas represent data manipulation by the Ministry of Finance. But let us assume for the sake of argument that the statistics are not doctored. It should be clear that they do not reflect the impact of prudent economic management but a patchwork of ad hoc and one-off developments and manna from abroad.
There is no doubt that the PML-N government pulled the economy out of a potential foreign exchange crisis by entering into an EFF arrangement with the IMF. The IMF, in its own financial interest, proposed a programme of massive external borrowing from other bilateral and multilateral sources and from private international markets to ensure enough inflow of foreign exchange to get itself paid

back its large outstanding debt and to leave some to cover the current account deficit and build up some foreign exchange reserves.
If a household builds up a savings account by incurring debt larger than what is saved in that account, no accountant will certify that the financial health of that household has become sound. The finance minister, who is a trained accountant, does not look at the balance sheet of the economy in the same manner. He looks at the assets side of the ledger and propagates that the country has built up foreign exchange reserves. He refuses to look at the liabilities side to concede that he has created a bigger monster for the economy in the form of massive foreign borrowing, a part of which has to be used to increase the level of reserves and improve the assets side.
The way the decline in the current account deficit as a percentage of GDP has come about is not something to be cheerful about. The trade deficit continues to remain very large and the only saving grace has been increase in inflow of home remittances that has been covering an increasing proportion of the trade deficit to show a lower current account deficit-to-GDP ratio. But home remittances are not policy induced inflows and in fact represent the effort of workers gone abroad to earn income and finance their families left behind.
The fall in budget deficit is not real and represents a combination of statistical trickery, curtailment of development expenditure, maintenance of a quasi-fiscal deficit out of the budgetary statistics and holding back tax refunds to show the level of tax revenue more than what it actually is.
A movement towards a prudent fiscal policy would require an increase in the tax-to-GDP ratio, a fall in the inessential current expenditure amidst a steady rise in allocation of resources to health, education and social welfare, and a higher level of development expenditure on projects other than pet prestige projects of the prime minister. Then there is a need for resolution of the circular debt problem on durable and policy-based structural reforms. The bleeding of the public sector enterprises needs to be stopped through their restructuring or privatisation. In the absence of any visible move in these areas, the assertion about fiscal consolidation may be a politically correct statement but is professionally invalid.
The rate of inflation has declined temporarily due to a substantial fall in world commodity prices, particularly of oil, and maintenance of an appreciated real effective exchange rate. The former is a onetime factor and reversible and the latter represents a poor economic policy for a country that needs to promote an export-led economic growth. It makes no economic sense to keep the nominal rate of exchange unchanged in relation to the US dollar while the dollar has appreciated fast on the strength of the US economy in relation to all other currencies, and Pakistan’s exports to non-dollar countries have declined. A weak rupee riding with a strong dollar leading to a substantial appreciation of the real effective exchange rate of the rupee represents very poor economic management.
In the monetary area, the growth in money supply continues to be at about three times the real growth of the economy, the government continues to massively borrow from commercial banks by using the discount window of the SBP to finance it, the private sector continues to be crowded out by excessive government borrowing from the banking system, depositors continue to be taxed implicitly by a combination of low real rate of return and imposition of zakat tax on them, and banks continue to reap huge profits by borrowing from the SBP at a low rate and lending it to the government rather than the private sector. Such a monetary environment is bound to keep the inflationary pressures strong even with favourable price developments emanating from abroad.
In the above background, the press release issued by the IMF on March 27, 2015 after the completion of the sixth quarterly review of performance of the government under the EFF is more political than professional in its contents. In the words of its acting chair and deputy managing director, “the authorities’ strong performance under Pakistan‘s Fund-supported programme is to be commended”.
This commendation is based on the IMF view that “fiscal consolidation is under way – monetary policy remains prudent – and foreign exchange reserves are increasing”. The IMF has used the language of the government in endorsing its policies. But we have explained above that such statements are totally misleading, if not professionally invalid, whether they come from the government or the IMF.
The IMF is currently being pushed by its largest shareholders to keep the present government afloat by maintaining an operational programme with Pakistan by hook or by crook. It will continue to do so as long as it serves the economic and military interests of the western countries. But in the process, the IMF has lost its standing at least among the professional economists.
Those who believe that a soft attitude of the IMF is intended to help Pakistan overcome its economic difficulties are living in a fool’s paradise. When the political situation changes, the same IMF will again wear its professional hat and begin to criticise the government for not undertaking structural reforms. For the time, the government can enjoy its honeymoon with the IMF at the cost of the economy and the people of the country.
The writer is a former governor of the State Bank of Pakistan.
Email: [email protected]

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