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Opinion

Economic notes

October 16, 2018
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Negotiating the IMF programme

Opinion

Economic notes

October 16, 2018

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After a considerable delay, the government has finally decided to approach the IMF. A Fund mission will soon be visiting Pakistan for negotiations. It is much easier to agree on a programme but far more challenging to implement it through its duration.

The delay has weakened our negotiating position for several reasons. First, the goodwill and aura of a new political party winning the election as the third force has dimmed, if not entirely faded. Second, it was unwise to signal that the IMF was not a preferred option compared to friendly assistance, betraying a desire to postpone facing the harsh realities of a melting economy. Third, the economic conditions have sharply deteriorated in the interregnum, hurting both the market’s and the investors’ sentiments. Finally, the decision to rush to the Fund was taken after the stock market had tanked and managers panicked: no option was left but to go to the Fund.

What are the various considerations that matter during negotiations? There are three key aspects of the programme: size, duration and conditionality. Regarding the size, it is linked to the quota Pakistan has with the IMF. At present, our quota is about SDR 2031 million (or roughly $2.9 billion). The maximum loan size for Pakistan was 700 percent of its quota in 2008. The last programme was close to 400 percent of quota. However, our quota has since increased and at 400 percent it would amount to about $11.6 billion. This should be the minimum that we should aim for. It may also be noted that we currently owe $6.4 billion from the previous programme. Accordingly, it is essential that we get a programme that is sufficient to repay to the Fund its previous loan and have some additionality as well.

Making the right choice about the duration of the programme is also an important matter. The choices are between a stand-by arrangement (SBA) and an extended fund facility (EFF). The former is a short-term intervention, which could be in the range of 6 to 22 months, depending on need. The latter is a three-year programme. Both have stabilising conditions but the EFF has fairly elaborate structural benchmarks and policy conditions. Given our circumstances, the recent undoing of the gains from a successful programme and the unfinished agenda that still remained from that programme, it seems that Pakistan would be better off seeking an EFF.

The programme conditionality is split in two parts. In the first part, there is a performance criterion comprising targets for such variables as fiscal deficit, reserves accumulation, domestic credit expansion and budgetary borrowings from the central bank. Building reserves is the lynchpin and the most significant measure of the success of the programme. But the other three, particularly the fiscal deficit, are the real instruments to achieve this outcome.

With the exception of domestic credit, our initial position in the remaining three variables is precarious. Therefore, we will be subjected to fairly stringent benchmarks to achieve. This is where the conditionality would pinch and lead to a slow-down in growth as well as an increase in inflation. It is expected that we would be asked to reduce the deficit to five percent in the first year and 3.5 percent in the last year. Here, it may be remembered that in 2016 we had amended, as part of the last programme, the fiscal responsibility law which now requires a tighter fiscal regime to reduce the debt to GDP ratio from 60 percent to 50 percent by 2032-33. Accordingly, the Fund would require strict adherence to the fiscal adjustment path stipulated under the law.

Equally challenging would be to meet the targets for reserves and budgetary borrowings from the SBP. For reserves, quarterly build-up would be required. The liberty to use reserves to support the exchange rate would no longer be there because a portion of the reserves would have to be acquired through purchases in the inter-bank market. Here again, we should expect pain as exchange rate adjustment would be inevitable.

The borrowings from the central bank have gone haywire and stand at Rs5 trillion compared to Rs1.4 trillion on June 30, 2016 at the conclusion of the Fund programme . A more worrisome aspect is the excessive concentration of government debt in short-term treasury bills (TBs) and that too in three-month maturity. The high refinancing risks and disorder in the public debt market require immediate correction, which would be a big challenge.

The second part of the conditionality relates to structural benchmarks on key economic policies. Taxation, expenditures, debt management, circular debt, energy prices, banking & finance, the central bank’s independence and corporate governance are some of areas where distortionary policies will have to be corrected. Nothing would be more helpful for the government than to make and get its own home-grown plan of economic reforms in the structural benchmarks. Such a plan would create ownership of reforms and prevent inclusion of unfamiliar benchmarks that may pose unforeseen problems during implementation.

Tax reforms and circular debt settlement will be the most prominent areas of reforms. Clearly, the government has so far not unveiled any plan. For the third consecutive year, FBR revenue growth has been a miserly eight percent. Such growth would severely limit its ability to undertake any meaningful development expenditure. On the circular debt, unlike the PML-N, which had settled the debt at the very outset, the PTI has no such plan except a report by Senator Shibli Faraz which has made such a recommendation. The government would do well to fill this gap.

For a long time, Pakistan was labelled as a single-tranche country. This meant the country would negotiate a programme, get the upfront support and perform at most for a single tranche and then leave the programme by expressing inability to bear the political cost. More than anything else, it is here where the government’s ability to steadfastly traverse a formidable journey of economic reforms will be tested.

The writer is a former finance secretary. Email: [email protected]

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