Doing without the IMF support

By Aftab Ahmad

In a recent Cabinet meeting, the hope was expressed that the current IMF programme might be the last one and that the economy would be able to function without the IMF support after the conclusion of the current Stand-by Arrangement (SBA), at the end of the current year. However, in the absence of required steps taken by the government, the aforesaid resolve should be called no more than wishful thinking. In the past, IMF support was needed from time to time, to improve the country’s deteriorating balance of payment (BOP) position or because of resource constraints, which became unbearable in the event of an external shock or a natural calamity such as an earthquake, flood or famine etc. The position remains unchanged, as the country still suffers from a vulnerable BOP position, as well as resource constraints.  

Pakistan’s economy was in a much better shape than at present during the 2001-05 period. Still the economy could not bear the shocks resulting from the devastating earthquake of 2005, global food inflation and the unprecedented surge in world oil prices in 2008. Foreign exchange reserves of $16 billion deteriorated rapidly and the country had to fall back on IMF crutches towards the end of 2008, to avoid default on its international obligations.

When the international oil prices had ballooned to $147 a barrel in July 2008, why did the economies of China and India remain unaffected? It was inter-alia because China had foreign exchange reserves of $2,000 billion and India over $200 billion, at that time. Although, China’s exports registered a negative growth during the global recession – as in case of Pakistan – its economy was able to bear the shock. China’s resource position remained strong and the Chinese government was able to launch a massive stimulus package to neutralize the effects of the global economic slowdown on its economy. Even India’s economy was able to bear the shock and it is now gradually returning to its 7-8 per cent yearly GDP growth.

The question arises why Pakistan could not increase its revenue resources and build its foreign exchange reserves like other countries in the region, so that it would not have to fall back on the IMF support, again and again. There are many reasons for this failure. One, ours is a consumption-oriented society due to which the country’s national savings rate has always been the lowest in the region. For this very reason, successive governments have never been able to cut their non-development expenditure and they have preferred to reduce the development expenditure, instead. Two, the rich and wealthy in the country do not want to pay their due income taxes. The agriculture sector has a larger share in the GDP than the manufacturing sector. However, the manufacturing sector contributes more than 50 per cent to government revenues, while income from agriculture sector has always remained exempt from tax payment, which has no justification. As a result, the economy always suffers from resource constraint.

Three, due to rampant corruption and poor governance, over-invoicing and under-invoicing could not be checked so far and the exporters often do not bring their export proceedings to the country in time. Four, industrial development in the country is still in the primary stage due to which we do not export any hi-tech and high value items. We have also failed in achieving import-substitution, to the required degree. As a result of the above, trade/current account deficits are a permanent feature and the country’s foreign exchange reserves have also remained at a lower level.

As regards Pakistan’s dependence on the IMF, the country has remained a regular user of the IMF facilities, as laid down in the book entitled ‘Pakistan under IMF shadow.’ As stated in this book, Pakistan had joined the IMF in July 1950 – three years after its birth. For the first time, the country had sought IMF financial support under the SBA in December 1958, to overcome its BOP difficulties. Nearly 50 years after the aforesaid happening, Pakistan had once again sought the IMF’s BOP support in 2008. It shows that we had not learnt any lessons from history and had failed to develop the capability to do without the IMF support during the last five decades.

It was also in 1965 and 1968 that the country had to avail itself of the IMF facility under the SBA when the BOP came under an added pressure due to defense goods and food imports. The IMF assistance helped in improving the BOP situation, for the time being.

In 1974-75, the country’s import bill rose substantially due to increase in oil prices by the Organization of the Petroleum Exporting Countries (OPEC) in 1973. The deteriorating BOP situation forced Pakistan to avail IMF support in 1972, 1973 and 1977. In 1979, the international oil prices witnessed a second hike. At the same time, budget deficit also had increased alarmingly as revenue had stagnated and expenditure had gone up. As a result, Pakistan had to use the Extended Fund Facility – newly created by the IMF- to overcome its BOP and budget difficulties. The three-year (1980-83) facility was, however, suspended within two years due to non-compliance of IMF conditionalities.

Pakistan did not seek IMF support from November 1983 to November 1988. However, IMF assistance was repeatedly sought during the 1988-1999 period, although none of the IMF programs during that period could be successfully completed due to non-compliance of IMF conditionalities by the then governments. During the aforesaid period, Pakistan’s economy constantly remained under pressure. Tax collection lagged far behind the growing expenditure. Most of the government revenue was consumed by debt-servicing and defense, with the result that development spending continued to decline. Public debt as a percentage of the GDP grew. Increasing indebtedness, together with higher budget and current account deficits, resulted in depletion of foreign exchange reserves and depreciation of Pak rupee. In October 1999, when the new government took over, the threat of a default prevailed. Accordingly, the new government sought IMF support to overcome its economic difficulties. The new arrangement with the IMF was for the 2001-04 period. Although the IMF conditionalities were quite tough, the new government ensured compliance of all conditions agreed with the IMF, to show its legitimacy and capacity to deliver. Due to this and favourable aid environment in the wake of 9/11, the aforesaid IMF program showed good results. Fiscal deficit was brought down to 3.3 per cent in 2005, while the current account showed a surplus in 2002, 2003 and 2004. Government’s indebtedness was reduced from about 90 per cent in 2001 to 62.5 per cent of the GDP in 2005, while foreign exchange reserves continued to grow and ultimately reached $16 billion at the end of 2007.

However, after successful completion of the IMF program, the government could not successfully manage the economy when left to do so, on its own. Macro-economic stability achieved during previous years was lost. In a bid to boost GDP growth, car financing and consumer financing policies were introduced. In addition, the government followed an expansionary fiscal policy. As a result, the consumer demand witnessed an extra-ordinary upsurge. Fiscal, trade and current account deficits went up. Later, the devastating earthquake of 2005, global food inflation and an unprecedented rise in international oil prices aggravated the government’s difficulties. Foreign exchange reserves, which stood at $16 billion in December 2007, slumped to $6 billion in November 2008, when the present government had to seek IMFBOP support, to avoid a default on its international obligations.

The brief history of Pakistan’s relations with the IMF during the last 50 years, summarized in the preceding paragraphs, shows that Pakistan had to approach the IMF for help again and again since its weak resource position could not bear any internal or external shocks. It, also, shows that the government could not successfully manage the economy when it was left to do so, on its own. The remedy, therefore, lies in improving the resource position to a level where the economy would be able to bear all internal and external shocks. To achieve this objective, it would be necessary to tax each and every income, irrespective of its source and reduce the government’s non-development expenditure to the minimum. To build the foreign exchange reserves, it would be vital to boost exports earnings and bring down trade and current account deficits to a sustainable level.

The book ‘Pakistan under IMF shadow’ suggests the following benchmarks to be followed by the government in order to avoid a situation where IMF support would be unavoidable. Fiscal deficit should be maintained around 3 to 3.5 per cent of GDP, while current account deficit may be kept below 2-2.5 per cent of the GDP. The country’s foreign exchange reserves may be maintained at a level equal to 4-6 months of annual imports, while public debt should preferably be kept below 40 per cent of the GDP – with external debt being less than 20 per cent of the GDP.