Financial discipline and the IMF

Our sovereignty will remain compromised until we implement effective fiscal reforms

Financial discipline and the IMF


he annual budget is an important document through which the government indicates the financial direction of the country in terms of generating the revenue required for running the state. The current coalition government presented its first budget on June 10, at a time when the country is facing huge twin deficits and is desperately looking forward to foreign financial assistance with low expectations of relief.

The most immediate task at hand is securing a financial lifeline from the International Monetary Fund (IMF) to avoid the risk of default. However, it seems that the economic team of Prime Minister Shahbaz Sharif has disregarded IMF directions and the commitments made by Pakistan to the IMF under the Extended Fund Facility (EFF). This deviation has endangered the fate of the EFF.

In its staff-level report published in February 2022, the IMF had highlighted the consequences of delaying the process of reforms. It said it would increase public debt and gross financing needs and lower foreign exchange reserves. The report also said it would jeopardise programme objectives and erode repayment capacity and debt sustainability.

The government failed to execute the clear reform directions and mandates from the global lender. Rather, it negated these terms thereby creating hurdles to meeting our fiscal needs. Pakistan had agreed to initiate a process of reforms in personal income tax and to harmonise the general sales taxes. It had also agreed to broader reforms in tax administration and public financial and debt management. Instead, the government acted otherwise, offering relief in personal income tax to individuals falling in several income brackets. The government also sought to provide relief to the stock market players at a cost of about Rs 8 billion.

As a revenue measure, the government introduced a capital value tax (CVT). Motor vehicles valued at more than Rs 5 million will attract the CVT at 2 percent and movable or immovable assets exceeding Rs 100 million held outside Pakistan by a resident will be subject to 1 percent CVT. Pakistan is considered as a tax haven for the rich. In the past, several amnesty schemes have been introduced to facilitate the privileged classes by enabling them to legalise their wealth.

The previous government’s financial mismanagement impacted the overall growth of the country. At the time of signing the IMF staff-level agreement on economic development and policies under the EFF for the release of SDR 750 million (about $1 billion) GDP growth for the current year was projected at 4 percent.

Based on the final results published by the National Accounts Committee, the GDP growth recorded was 5.97 percent. High GDP growth is known to lead to a current account deficit. The governments are then forced to take corrective measures to avoid a financial crisis. This results in an overall slowing down of the economy.

Accordingly, the growth target for the next year is 5 percent even as commodity prices are going up globally. The government might fail to achieve the target projected by the finance minister in his speech.

The finance minister predicted that inflation rate for financial year 2022-23 will be 11.5 percent. However, rising commodity prices earlier due to Covid-19 and now on account of Russia-Ukraine war are likely to drive inflation higher. While he has projected lower inflation compared to the previous year, the finance minister has not shared his plan for fiscal reforms to control the fiscal imbalances.

In its staff-level report published in February 2022, the International Monetary Fund highlighted the consequences of delaying the process of reforms. It said this would increase public debt and gross financing needs and lower foreign exchange reserves. The report also said it would jeopardise the programme objectives.

The public, already finding it difficult to make ends meet, is now witnessing a new tsunami of inflation. Over a very short period, the prices of petroleum products have been raised by almost 40 percent. Electricity tariffs have also been raised significantly and the CPI is touching a new high of 13.8 percent. It appears that the finance minister is more inclined to raising fuel and electricity prices than implementing the IMF policy reforms programme.

The minister has projected the current account deficit for the next financial year at 2.2 percent without providing a clear road map for achieving this ambitious target. If a ban is imposed on imports, it will impact growth and cause an increase in unemployment. Besides, the government is planning to spend around Rs 800 billion during the year on development projects. Given all these factors, maintaining the current account deficit at 2.2 percent will be quite a challenge.

The projected fiscal deficit for the upcoming year is around 4.9 percent. The government is expecting a Rs 7 trillion revenue collection through the Federal Board of Revenue (FBR). Although this is not an unreasonably high target, the current policy rate and hike in utility prices are set to impact the profitability of small and medium enterprises (SMEs) as well as the common man and adversely affect tax collection.

The finance minister seems to have overlooked the effect of almost Rs 1,400 billion ($7 billion) owed to China and the global lender. The government is expecting to collect an amount of Rs 750 billion through the petroleum development levy (PDL) in the coming financial year. This does seem exaggerated. The highest amount recovered in PDL ever was Rs 425 billion (in 2021) when crude oil prices were under $60 per barrel. Now that oil prices are already high, a PDL collection of Rs 750 billion can only add to the misery of the common man. Estimates of a provincial surplus of Rs 800 billion also seem unrealistic. The gap, most probably, will be bridged by leveraging funds from lenders.

With the current levels of fiscal and current account deficits, we cannot continue the ad hoc approach of borrowing to bridge gaps. Debts are ballooning with each passing day and currently, 41 percent of the budgeted expenditures is allocated for interest payments. Rather than taking concrete steps to formalise economy, the government has created a further gulf between corporate and non-corporate/ informal business sectors.

The current budget offers simplified and nominal taxes for retailers through electricity bills as compared to a 29 percent tax on profit for retailers. Extending a fixed tax regime rather than profit-based taxation can promote informal sectors and cash-based dealings which will prevent documentation of the economy. The resulting increase in domestic and foreign debt will further impact government estimates. The fiscal debt might therefore surpass 6 percent of the GDP.

The coalition government inherited many of these problems and cannot be blamed for the current situation. They are aware that the country is in an IMF programme and that the previous government violated the terms of agreement executed with it. They are also aware that there is a long list of pending fiscal reforms that require a strict policy for fiscal adjustment, adoption of strong revenue measures, including implementation of reforms in personal income tax and general sales tax, enhancing efficiency in spending, improving public financial management by introducing new coordination mechanisms, handling public debt and privatisation.

The reforms also require measures for poverty alleviation and social protection to achieve sustainable development to reduce our dependence on global lenders. Mere criticism of the previous government for signing an agreement to raise fuel and electricity prices will not help in the long run. Our sovereignty will remain compromised until implementation of fiscal reforms.

Abdul Rauf Shakoori is a corporate lawyer based in the USA

Huzaima Bukhari, a lawyer, is adjunct faculty at the Lahore University of Management Sciences (LUMS)

Financial discipline and the IMF