Swallowing the bitter pill

The staff level agreement with the IMF for carrying out ‘deep structural reforms’ indicates that the Fund’s over-arching goal is to turn the primary budget deficit, estimated by independent economists to be in the range of 2-3 percent, into a surplus of 2.5pc. And then build enough dollar reserves so that huge debts piling up at unprecedented pace can be repaid.

Apart from fresh borrowings by the PTI-government at a rapid pace, foreign debt has increased by Rs1.4 trillion on account of recent devaluations, Special Secretary Finance Umar Hameed Khan told a National Assembly panel recently.

The IMF sees the next year’s financing gap at $12 billion. Independent economists say that the primary budget surplus target is too ambitious to materialise because the huge additional tax mobilisation of Rs600bn set for next fiscal year is not possible during faltering economic growth.

To achieve the target either development or defence spending or both have to be cut, says Miftah Ismail, a PML-N leader. The IMF statement however stresses the need for ‘preserving essential development spending’.

Economist Kaiser Bengali says the remedy lies in cutting federal government expenditure where his research finds room for reduction of at least 20pc, which includes cut in defence budget.

The IMF statement says that the forthcoming budget for FY2019-20 is the first critical step of the authorities’ fiscal strategy. It will aim at cutting the primary deficit from 0.9pc to 0.6pc of the GDP supported by tax policy mobilisation measures to eliminate exemptions, curtail special treatments, and improve tax administration.

Some fear that incentives on major export items may be withdrawn. That explains the rationale for market-based exchange rate and further devaluation to promote trade the IMF way, says a financial analyst.

The proposed bailout is linked to timely implementation of prior actions and the agreement is subject to approval by the Fund’s executive board and confirmation of international partners’ commitment.

The prior actions have not been made public either by prime minister’s adviser on finance Dr Abdul Hafeez Shaikh or by the visiting IMF mission. An IMF official however explained to a senior journalist that prior conditions, for example, mean the adoption or approval of a budget that is conducive to stabilisation objectives of the programme.

Dr Shaikh, who was briefly associated in the fag end of negotiations with the IMF during Asad Umar’s tenure as finance minister, says the IMF tranche from the bailout amount will start after three months of the agreement when Pakistan fulfils prior conditions.

As the bailout is linked to international partners’ commitments, Dr Shaikh thinks it may imply rollover of the old foreign debt/deposits acquired from UAE, Saudi and China. Apart from the IMF Extended Fund Facility, additional $2-3bn per annum will be provided by the World Bank and the Asian Development Bank.

A huge transfer of resources is envisaged from the private to the public sector at a time when both domestic and foreign investments are at a low ebb

Dr Shaikh says “Pakistan will have to adjust its expenditure in keeping with its capacity, put an end to continuous bleeding of public sector, reduce subsidies to the rich and generate more taxes from the affluent.”

A huge transfer of resources is envisaged from the private to the public sector at a time when both domestic and foreign investments are at a low ebb. The fiscal space will be squeezed for planned expansion of manufacturing for import substitution, enhancing exports and removing trade imbalances. The reaction of capital market has been appropriately summed up in one of this newspaper’s headlines: ‘Stock market snubs IMF deal, plunges by 816 points.’

In the coming fiscal year a significant portion of the additional tax revenue mobilisation of Rs600bn will be in the form of tax exemptions. The exemptions are to end in two years. Another Rs100bn will be raised from a hike in power tariffs whose cost would be also be borne by the manufacturing sector.

The programme envisages “a comprehensive strategy for cost recovery in the energy sector and state enterprises will help eliminate or reduce quasi-fiscal deficits that drains scarce government resource”.

The ‘cost recovery’ approach tried in the past did not stop haemorrhaging state enterprises. Utility companies have not been made efficient to produce energy at regionally competitive prices.

Under the programme, at least two LNG power plants are listed for privatisation with estimated proceeds of Rs280bn. Renewed efforts will be made to restructure bleeding enterprises.

The IMF says the government has agreed ‘to focus on inflation instead of growth.’ The inflation rate was low during the moderate growth witnessed earlier as the rupee value was kept stable and central bank policy rate was conducive to economic growth. The steep rupee devaluation, big increases in energy prices and hike in central bank policy interest rates account for much of the imported and cost push inflation.

Critics question the need for further steep devaluation of the rupee as stipulated under the garb of market based exchange rate. They point out that the real effective exchange rate is currently at Rs104 to a dollar.

Similarly, the real interest rate is 375bps above the core inflation of 7pc. Going by speculations in the media the rupee will be further devalued by 20pc and policy rate increased by at least 2pc.

Quite puzzling is the IMF’s statement which says “decisive policies and reforms, together with significant external financing, are necessary to reduce vulnerabilities faster, increase confidence and put the economy back on a sustainable economic growth path with stronger private sector activity and job creation.” Putting ‘the economy back on a sustainable economic growth’! Something that has never happened before.


Published in urdupapa, The Business and Finance Weekly, May 20th, 2019

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