The anatomy of a bailout

February 12, 2023

If the IMF conditions are bitter, why do we want another programme?

The anatomy of  a bailout


ike Sri Lanka, Zambia, Ghana, Egypt, and many other low and low-middle-income countries, Pakistan is again resorting to its last economic lifeline, i.e., the international monetary fund. The Prime Minister of Pakistanpublicly complained about the harsh conditions of the IMF and resolved to save the interests of the “common man” while implementing those conditionalities. The question arises if the IMF program is that bad, then why opt for one? A secondary question arises why IMF is against the poor and low-income earners.

Let us understand some basic factsaboutthe IMF and its program.

First thing first! IMF does not ask the countries to take loans from it. All of the countries mentioned above (and around 50 other low and low-income countries) went to IMF due to chronic self-inflicted economic woes. “Borrowing, overspending, falling short on revenue collection, balance of payment crisis, depreciation of the domestic currency, inflation,subsidies (overspending),and further borrowing,” and the vicious cyclecontinues until they face the situation in which their debt becomes unsustainable, and they have to go to IMF. Depending on how sincere the countries are in implementing the IMF program, IMF’s loan either prolongs this vicious cycle or helps to break it.

Second, the reasonnone of the governments in Pakistanpolitically own the IMF program despite approaching it twenty-three times is that all of them in their opposition days have opposed going to the IMF and carrying out policy and structural reforms. There are two political narratives on IMF in Pakistan. Any party/parties in opposition consider it the mother of all evils and vehemently criticizethe government for causing inflation through IMF program implementation. Any party/parties on treasury benches, blaming IMF for its harsh conditionalities, try to convince the people that implementingthe IMF program is the only way to rescue the economy.

Third, IMF does not propose conditions. It simply asks how the governments will balance their income with expenditures, how they willpay back their debts, and how they will address the chronic structural and policy issues haunting their economies. The recipient governments prepare a plan, often consisting of some politically non-popular measures, and commit to the IMF on its implementation.

Fourth, Pakistan only completed one program (2013 to 2016, and that too with a dozen waivers) and abandoned the other 21 programs halfway through because, in the “good old days,” Pakistan was a recipient of western dollars for supporting the western forces in Afghanistan. First during the war against the Soviet Union and then the war against terror. An easy flow of dollars was taking care of any balance of payment crisis. Pakistan never needed the IMF that badly. During the last IMF program, Pakistan had good relations with the Obama administration and a comparatively easy flow of dollars for CPEC projects. Hence it could safely sail through the IMF program.

Fifth, the PTI government could manage its first year in power without going to IMF, while the PDM government could not benefit from China's and Gulf countries' debt diplomacy. It is becausebilateral creditors don’t oblige individuals. They oblige governments. The kind of political uncertainty that Pakistan has been passing through since last year has put our bilateral creditors in a “wait and see” policy. They would not come forward with unconditional help in these circumstances. Hence they have linked their rollouts with Pakistan being under IMF discipline.

The sixth fact is that IMF is a technical intergovernmental body that evaluates the country’s financial health per its prescribed template. However, the largest shareholders of the IMF, dominating the decision-making of the IMF executive board, have their geo-political and geo-economic agendas.

To avail of an IMF bailout package, a country makes two types of commitments: quantitative targets (known as performance criteria and indicative targets) – mostly in domestic currency but some in US dollars, and structural benchmarks (structural reforms). Progress against these commitments is assessed during a review, and a report is presented to the IMF executive board, which decides whether to release the loan tranche. Unless the board approves a waiver, any missed commitment becomes a ‘prior action’ (mandatory measure) that a country has to take to get its loan tranche released.

Reaching a staff-level agreement for assessing which performance criteria and structural benchmarks have been met or missed is relatively straightforward. Getting a waiver from IMF executive board for missed milestones depends onrecipient countries’ alignment on the global geopolitical chessboard.

The IMF board is composed of 24 Directors, elected by member countries or groups of countries as per their shareholding in the fund. The United States, Japan, France, Germany, Italy, and the United Kingdom are the largest contributors to the IMF fund (IMF has roughly US$1 trillion to lend). The US holds the maximum shares (16.5 percent) in the IMF. In other words, Pakistan cannot afford to be on the wrong side of the western bloc and expect a waiver from IMF.

The anatomy of  a bailout

Reaching a staff-level agreement to assess performance criteria and structural benchmarks is quite straightforward. However, getting a waiver from the IMF executive board for the missed milestones depends on recipient countries’ alignment on the global geopolitical chessboard.

During the last review (the seventh and eighth,which was completed in August 2022),the IMF staff,while accepting Pakistan’s request to extend the program to June 2023 and augmentit roughly by US$1 billion,alerted that risks to the program (both external and internal)remain exceptionally high. IMF also suggested a consistent and decisive program implementation to improve economic prospects.Some measures Pakistan was expected to takeincludesteadfast implementation of the approved budget for FY23 (read provincial surplus of Rs 750 billion and other revenue collection measures), adherence to a market-determined exchange rate, and a prudent monetary policy. Pakistan was also asked to expand social safety to protect the most vulnerable and accelerate structural reforms, including improving the performance of state-owned enterprises (SOEs) and governance.

Program implementation deteriorated shortly after the completion of the last review (August 2022).One can safely say that political tension led to grave fiscal slippages. Movingaway from a market-determined exchange rate led to an abrupt and steep depreciation of rupee versus US dollar.

It was not easy to successfully complete the last review either. Pakistan had missed two end-June 2022 performance criteria (PC)—on net international reserves (NIR: the gap between the State Bank of Pakistan’s total usable dollar reserves and the government’s dollar-denominated liabilities) and the primary budget deficit—as well as three continuous PCs were missed. Moreover, seven structural benchmarks (SBs) were unmet.The review noted that those gaps arose amidst challenging circumstances, including the Russia-Ukraine conflict, but also due to a waning decisiveness to push forward agreed reforms.The major issue is not that Pakistan made overambitious and unrealistic promises in August 2022 to continue the IMF program.The major problem is that we did not do enough since the last review and now would have to deliver everything we promised in one go.

So what is that Pakistan promised the IMF in August 2022?

In no particular order, Pakistan committed that the gap between the State Bank of Pakistan’s total usable dollar reserves and the government’sdollar-denominated liabilities for the current fiscal year wouldnot exceedUS$ 10.30 billion by the end of December 2022 and US$9.8 billion by the end March 2023. With only US$ 3 billion in reserves and more than US$ 20 billion’s liabilities for the rest of the financial year, it will be tough for Pakistan to meet this condition, especially when the bilateral creditors are shying away from lending. Pakistan will have to ask for a waiver and acceptall other requirements to avoid turningthis into a prior action.

Pakistan also committed a ceiling of Rs 924 billion fiscal deficit (difference between revenue and expenditure) after debt servicing (primary fiscal deficit). Debt servicing for the fiscal year 2022-23 was budgeted as 3.9 trillion rupees. However, withincreased interest rates it has shot up to Rs 5.2 trillion. Hence this QPC is also missed by a wide margin and may require a waiver or some drastic revenue mobilization measures.

The third red flag is the last five months’ policy to peg the rupee’s interbank exchange rate. That policy not only widened the trust deficit between the government and the IMF but also between the public and the Pakistani banking system.

I gave this longish background to explain the circumstances in which the government has to complete a set of prior actions and meet quantitative targets/structural benchmarks for securing the next tranche from the IMF.

Recovering the cost of energy (not selling it beyond the cost of purchase/generation), spending a maximum portion of new loans to service the existing loans (primary budget balance),Implementing the plan to establish an appropriate development finance institution to support the eventual phasing out of the State Bank’s refinance facilities; parliamentary approval of a new state-owned enterprises law in line with the IMF recommendations; implementingthe amendedOgra Act (giving the regulator an autonomy to determine the prices of fuel); avoiding the practice of issuing new preferential tax treatments or exemptions; and not manoeuvring the market-based exchange rate are some of the other structural conditionalities that the government has to meet in the run-up to general elections.

The structural benchmark on social safety nets and providing targeted subsidies are regularly applying the mechanism for periodic inflation updates of all BISP cash transfers and enhancing the value of educational cash transfers under BISP.

As mentioned earlier, the next loan tranche would be released after the staff-level agreement containing a memorandum of economic and financial policies (MEFP) is approved by the IMF’s executive board. This approval may take a few more weeks. However, signing a staff level agreement would give positive signals to the markets, support the value of the rupee against the US dollar, and facilitate an inflow of external assistance from friendly countries.

The good news is that averting a default looks very realistic if the PDM government can work on much-needed policy and structural reforms. The bad news is that it would not be our last IMF program.

Without politicizing the actions taken under this program, all political parties aspiring to form the next government after the elections should start preparing their plans for the next IMF program that Pakistan will be negotiating in the next fiscal year.

*This is an updated version of the piece. The earlier version has been removed

Dr. Abid Qaiyum Suleri heads Sustainable Development Policy Institute. He tweets @abidsuleri

The anatomy of a bailout