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October 11, 2018

IMF and home-grown solutions


October 11, 2018

The uncertainty about the government’s economic recovery strategy is over, with the formal announcement that Pakistan will be negotiating an arrangement – the eleventh since 1990 – with the IMF for macroeconomic stabilisation.

IMF, Pakistan to meet as Islamabad seeks bailout

The first reaction to this decision came from forex market where the value of the rupee against the dollar nose-dived due to the speculative buying of dollars by investors. In normal circumstances, the State Bank of Pakistan could have intervened (by pumping a few million dollars in the market) to stabilise the value of the rupee. However, depleting foreign exchange reserves is one of the factors that compelled the government to approach the IMF, so on October 9 the State Bank could not intervene in the currency market and we saw the rupee losing Rs9.50 against the dollar in a single day.

The decision to approach the IMF will have some negative implications, at least in the short-to-medium term, both for the people (who will face inflation due to contractionary economic policies) as well as for the government (which will lose political capital). However, going to the IMF was a must to stabilise the country’s economy which is badly hit by chronic structural problems such as fiscal deficit, current account deficit, balance of payments crisis, trade imbalance, energy circular debt, issue of loss-making public-sector enterprises, low tax-to-GDP ratio, and low investment-to-GDP ratio, to name a few.

To cope with the economic issues facing Pakistan, the government had three options: raising money through sale of euro/dollar bonds, seeking assistance/loan from friendly countries – mainly Saudi Arabia and China – and/or going to the lender of the last resort ie the IMF. Selling bonds would have been a difficult preposition without getting our credit rating improved or without a letter of comfort from the IMF. Seeking assistance or loan from friendly countries comes with its own non-economic repercussions. Pakistan’s chronic economic problems have eroded its bargaining power. There were also apprehensions from some circles that assistance from Saudi Arabia may bring the Persian-Gulf tensions between Saudi Arabia and Iran, and between Saudi Arabia and Qatar, to Pakistan. Thus, the viable solution was going to the IMF, which is specifically designed to assist its member states at the time of macro-economic instability.

Once Pakistan formally approaches the IMF for the stabilisation programme, a team of the IMF will then start negotiations on the possible contours of that programme. A ‘home-grown’ solution to Pakistan’s economic woes would be negotiated, and the IMF would agree on providing an amount (based on our quota in the IMF) to Pakistan. Let us see what those home-grown solutions may be.

The home-grown solution to circular debt would be power-sector reforms, improved recovery of electricity bills, reduction in transmission losses and switching to affordable sources of energy. The high prices of fuel in the international market would increase the cost of domestic energy. The government can offer subsidies on gas, oil and electricity prices if it has more income than expenditures, but with the current fiscal deficit it would have to pass on the prices to the consumers (with some safeguards for life-line consumers).

The solution for low tax-to-GDP ratio should be to enhance and expand the tax base by bringing those in the tax net who earn beyond the tax exemption limit but don’t pay taxes. Like the previous government, the current government can also increase FBR revenue without expanding the tax net, but that would mean taxing the existing taxpayers or relying on indirect taxes. Both should be avoided by the PTI government if it is sincere to its agenda of expanding the tax base.

The solution to the issue of loss-making public-sector enterprises would be to turn the likes of PIA and the Pakistan steel Mills into commercially viable entities, either through public-private partnership or via privatisation. The solution to increased imports would be to discourage unnecessary imports without compromising on the import of raw material that may improve our exports.

The way to stabilise the rupee’s value against the dollar would be to build our foreign exchange reserves through expert proceeds, through foreign direct investment (FDI). Trying to stabilise our rupee value through borrowed dollars is never a sustainable solution and, in the absence of our own ‘earned’ dollars, we may have to see the rupee losing its value against major currencies. Due to projected inflation, the State Bank will have to increase its base rate (which is already 8.5 percent now). None of the above is a measure that this government would not have taken if it were not going to the IMF.

By going to the IMF, Pakistan would agree to implement the above-mentioned solutions in a systematic manner and report its progress to the IMF. In return, it would get a few billion dollars to support its balance of payments. It would also get a letter of comfort from the IMF which would improve its credit rating and enable it to engage with other multilateral lenders. An improved credit rating would also help Pakistan sell the proposed euro and dollar bonds and attract investment to Pakistan.

Here one should keep in mind that, to reduce the impact of the side effects of the IMF programme, the government can sell the social protection and poverty reduction agenda in its manifesto to the IMF and get some cushion to spend on pro-poor strategies when negotiating the fiscal deficit targets. It is pertinent to mention that the IMF has started giving importance to social protection in its member countries; the Pakistani government can use this as a lever during negotiations.

We must also watch for possible non-economic conditions by the IMF, which may come from its largest shareholder, the US. For that, Pakistan needs to lobby with the other seven countries that hold one seat each on the IMF board. China, Saudi Arabia, Russia, Germany, France, UK and Japan should be engaged proactively to ensure safeguards for us against any irrational demands by the US.

During the last 21 arrangements with the IMF, Pakistan was only able to conclude one programme (by the last government) and that too with waivers on circular debt and privatisation. If the current government can really implement its home-grown solution, then it can put the economy on track for the next few decades. The real challenge is not to go to the IMF, but to implement the ‘home-grown’ solutions that our government will itself propose to the IMF.

The writer heads the SustainableDevelopment Policy Institute.

Twitter: @abidsuleri

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