IMF first programme review

The IMF has recently released a press note following the completion of the first Programme Review by the IMF Staff Mission in its visit to Pakistan. The good news is that the review was successfully completed and agreement was reached with the Authorities. All performance criteria for end-September were met with comfortable margins and progress continues towards meeting all structural benchmarks. The Staff Mission is of the view that 'the government policies have started to bear fruit'.

However, in the typical IMF fashion, positive statements are interspersed with negative observations. For example, the press note states that 'domestic and international risks and structural challenges persist'. This is not going to provide comfort to potential lenders to Pakistan. This observation is consistent with the earlier remark by Moody's that Pakistan has a high External Vulnerability Index.

The press note has exhorted Pakistan to move strongly on three fronts. First, it states that there is 'need for continuing to broaden the tax base by removing preferential tax treatments and exemptions.' This statement has been made in the face of capitulation by the Government to traders during the visit of the Mission. Therefore, the question is whether the Government has agreed to make some moves on the taxation front in coming weeks.

Second, emphasis by the IMF has been laid on advancing the strategy for electricity reforms. Third, the Government has been urged to strengthen efforts to strengthen governance and operations of State-Owned Enterprises (SOEs).

The IMF Programme contains the following as yardsticks of performance during a Programme Review:

• Performance Criteria

• Continues Performance Criteria

• Indicative Targets

• Structural Benchmarks.

The IMF staff review highlights that in the first quarter of the Extended Fund facility, Pakistan has performed well on the performance criteria but has not been able to meet some indicative targets and structural benchmarks.

The single most important question is how the primary deficit performance criterion has been met in the presence of a significant shortfall in FBR revenues of almost Rs 106 billion in the first quarter. The answer will be obtained when the data on Fiscal Operations is released by the MOF for the first quarter of 2019-20. Presumably, the primary deficit has been restricted by higher non-tax revenues and/or cutbacks in expenditure, especially on development.

Fortunately, there was a soft target for the size of the primary deficit in the first quarter of 2019-20. It was set at Rs 102 billion which was more than twice the actual deficit of Rs 48 billion in the first quarter of 2018-19. Why this was done is not clear.

The other key quantitative performance criterion is the level of net international reserves. This is probably the market test of the ultimate success of the Program. Here again, for inexplicable reasons, a soft target was set for the first quarter at minus $18.5 billion, compared to minus $17.5 billion at the start of the year. Net reserves were expected to decrease despite the injection of $991 million as the first release by the IMF in the Programme.

Therefore, there are no grounds for complacency. Subsequent quarters will involve the implementation of much tougher conditionalities. First, the indicative target for FBR revenues involves achieving successively a higher growth rate every quarter in 2019-20. The target growth rate was 28.7 percent in the first quarter, which was not achieved. The second quarter, from October to December, requires a higher growth rate of 34.6 percent. This rises to 52.9 percent in the third quarter and to 55 percent in the last quarter of the year.

Already, apparently there has been a shortfall of over Rs 60 billion in the month of October. Given FBR's present performance there is the likelihood that the shortfall for the full second quarter could exceed Rs 170 billion, leading to cumulative shortfall of almost Rs 280 billion in the first half of 2019-20. This could rise exponentially by the end of the year.

There is also the problem of a sharp curtailment of the primary deficit in the second quarter. Not only is to be reduced from the target of Rs 102 billion in the first quarter, which has been achieved, to Rs 48 billion there is also the need to bring it down by 63 percent in relation to the level o f the primary deficit of Rs 116 billion incurred in the second quarter of the previous year.

The big question is will MoF be able to accomplish the primary deficit performance criterion by December 2019. IMF has also simultaneously emphasized on the need to maintain development and pro-poor spending at budgeted level. There is a limit to how far non-tax revenues can be enhanced, especially since privatization receipts cannot be treated as revenues but as a source of financing the deficit. A further cut in development spending will slow down the growth process in the economy and increase unemployment.

Therefore, there are two unanswered questions at this stage. Have the targets in the performance criteria been subjected to some revision. For example, has the FBR revenue target been revised downwards? If so, then the consequential impact on the primary deficit should also be allowed for. As opposed to this, the original FBR target is intact and has the Government agreed to impose additional taxation measures during the course of the year?

Turning to the performance criterion related to the level of net international reserves it has been highlighted above that a deterioration in the reserve position by almost $1 billion was allowed for in the first quarter. However, the on-going second quarter is expected to achieve an improvement of almost $2.2 billion by end-December.

How will such a big improvement take place? Will gross reserves of the SBP increase or the external liabilities decline? Pakistan has to repay $1 billion of Sukuk bonds this month. The flotation of new Sukuk/Eurobonds has been delayed. Now with the success in the first IMF Review they should be offered of up to $3 billion. Without achieving this the prospect for meeting the performance criteria on net reserves looks very low. Of course, the SBP has been pushing for the inflow of 'hot money'. But up to end-October only $510 million has reached Pakistan and that too in short-term treasury bills.

The IMF press note indicates that one macroeconomic projection for 2019-20 has been revised downwards. Initially, it was expected that the rate of inflation would average 13 percent in 2019-20. It has now been brought down to 11.8 percent. This would be a welcome development if it happens. However, an electricity tariff increase is pending. A large fuel adjustment charge of almost Rs 2.50 per kwh has been levied for September. International oil prices are beginning to show a rising tendency. The domestic cotton price has gone up sharply in the face of a big crop failure and ban on imports from India. This will have downstream effects on pricing of textile products. On top of all this, there is the hangover of over Rs 3 trillion of borrowing from the SBP last year and the resulting monetization of the deficit. This will have the full impact on inflation with a time lag.

The Ministry of Finance must be commended for managing the budgetary process well in the face of a big and growing shortfall in FBR revenues. We look forward to the same performance in successfully completing subsequent reviews. However, the emphasis must now shift more towards implementation of the reforms embodied in the structural benchmarks of the Program.

(The writer is Professor Emeritus at BNU and former Federal Minister)