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The IMF ride


May 26, 2019

The kneejerk reaction of markets to the announcement of a $6 billion deal between Pakistan and IMF staff mission (which is yet to be approved by the management and executive board of the Fund) seems to have subsided.

Under this deal, Pakistan is committed to – among other things – managing public enterprises and energy sector losses; reducing inflation (monetary policy); mobilizing tax revenue; following market-determined exchange rate; strengthening institutions and governance, continuing anti-money laundering and combating terror financing.

To understand the initial reactions of the market, one must remember that IMF programmes generally come with the demand on the government to take some prior actions (prerequisites). The approval of the current package too is subject to the timely implementation of prior actions and confirmation of international partners’ financial commitments (Saudi oil supply on deferred payment was one such commitments). As the details of the current deal are still not in the public domain, one is not sure about the prior actions that the government of Pakistan must take before the IMF Board’s meeting.

Appreciation of the value of the dollar after the deal might have been a prior action. However, the absence of any communication from the government on this issue gave ample cushion to speculative buying of the dollar, leading to further depreciation of the rupee.

Speculative buying turned into panic buying when the dollar kept appreciating despite the prime minister’s clear instruction to leaders of the Forex Association to keep the exchange rate at around Rs144 per dollar. In my opinion, this meeting was completely uncalled for, and if required, the relevant director of the State Bank rather than the PM should have met with the forex dealers’ representatives.

The cascading effects of the depreciation of the rupee negatively affected the stock market, which was also adjusting to a tightening monetary policy. On brokers’ demand, the government had to announce a “market support fund”.

The good news is that, after the initial turmoil, things are settling down. The rupee has stabilized and so has the stock market. Operationalization of the $3.2 billion “supply of oil on deferred payments” deal from Saudi Arabia is further good news and will help ease off some pressure on dollar-based payments. Expected inflow of remittances during Ramazan and over Eid will also provide some relief to forex reserves and supply of dollars in the open market.

The short-term crisis is under control, but the economic volatility is not over yet. The State Bank of Pakistan injected $24 billion from 2013-2017 to keep the exchange rate stable. Based on given current account balance and markets development over FY17-19 (so far), it is estimated that the SBP injected another $20 billion in the forex market to keep the rupee stable. This makes $44 billion forex interventions from the SBP during the last six years. Having a strong rupee through borrowed dollars is neither sustainable nor an indicator of a strong economy. The SBP would not be able to make such forex interventions under an IMF programme so we need to learn to live in a realistic exchange rate regime.

This would imply curbing the demand for the dollar, especially curbing speculative buying. Speculative buying can be reduced if we provide alternative venues of investment to those who have the capacity to buy and hoard dollars. One can argue that economic uncertainties during the last 10 months and restrictions on non-filers to invest in real estate had virtually led to dollarization of the economy. In the short run, to bring those dollars back in circulation, the government should relax the real estate investment policy in the next federal budget. This would help in improving the demand-supply imbalance in the open market.

Reducing public enterprises and energy-sector losses would be another source of economic and political volatility. Theoretically speaking, balance sheets may be cleaned through selling off assets, getting rid of liabilities, or both. However, practically speaking, the liabilities of loss-making enterprises are employees who would lose their jobs after privatization. Likewise, the liabilities for the energy sector include consumers who are benefitting from subsides and concessional tariffs. To deal with these liabilities, we not only require political will and political consensus but a clear compensation plan for those who would lose their jobs or those who would be negatively affected by energy tariff hikes.

A tightened monetary policy to reduce inflation can be one of the prior actions. However, its pace and sequencing need to be adjusted. The type of inflation being faced in Pakistan is cost-push and not demand-driven. In our circumstances, an over-tightened monetary policy may not give the desired results. Rather, the increased interest rate is increasing our domestic debt service which has reached Rs1.28 trillion in the first nine months of the current fiscal year – and hence is a major contributor to our historic fiscal deficit.

Mobilizing tax revenue without over-burdening existing taxpayers (as claimed by the chairman of the FBR) would be a real challenge for the new economic team. Here, too, one requires political consensus as well as strong political will to bring taxable tax evaders into the tax net. The proven shortcut, so far used by all governments, of relying on indirect taxes would lead to cost-push inflation and increase political and economic volatility.

The commitment to continue anti money laundering efforts and combat terror financing is commendable and, in our interest, irrespective of an IMF programme. One hopes that getting cleared from FATF grey list will not be one of the prior actions for the IMF package.

The detail of what our successive governments committed with the IMF in the last 21 programmes is available on the IMF portal. Had we implemented half of what we committed in past programmes, most of the structural issues facing our economy would have been addressed by now.

Implementing an IMF programme does not only require administrative and policy measures, it also requires perception and expectation management. Going forward, we should expect a bumpy ride. To avoid further kneejerk reactions; the government needs to communicate in an effective and transparent manner on why we need to take this bumpy ride. What is expected on the way? How strong are our shock absorbers (effective social safety nets and social protection measures), and where are we planning to reach at the end of the ride? The clearer and candid the communication, the more realistic would be the expectations, and the less there will be discomfort of adjustment.

The writer heads the Sustainable Development Policy Institute. Twitter: @abidsuleri

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