According to a news item in Business Recorder, Pakistan has assured the IMF, as per the recent Letter of Intent of the current SBA issued on 26th August, to rationalise the interest rates on its refinancing schemes and eliminate the element of subsidies resulting from below-market interest rates.
The revised understanding stipulates that the mark-up rates on the Export Financing Scheme (EFS) and the Long-term Financing Facility (LTFF) for the export-oriented units would be increased, in steps, to the level of the weighted average yield on six-month T-bills and yields of the same tenor for Pakistan Investment Bonds (PIBs) respectively.
The process of increasing these interest rates would begin in September, 2009 and mark-up on EFS and LTFF would be gradually enhanced to reach the level of 2 percentage points below the yield on six-month T-bills and PIBs by September, 2010. The cut-off date to ensure identity in the rates, on these subsidised schemes and the above-mentioned government paper, would be September, 2011.
It is expected that after complete removal of subsidies, the mark-up rates on EFS and LTFF would be some 4-5 percentage points higher than the current rates. In other words, the present rate of 7.5 percent would go up to the level of 11-12 percent, by the close of September, 2011. The first reaction of such a step is not difficult to anticipate. It would be resisted by the exporters' lobby with all the force at their command.
Under the existing terms of EFS and LTFF, banks are providing loans to exporters at a maximum rate of 7.5 percent, against which they are eligible to get refinance from the State Bank at a rate of 6.5 percent. Since the exporters have been getting this facility for a long time, they are very much used to it and would oppose the new mechanism on the ground of undermining the country's depleting exports.
On the face of it, such an argument would appear to be convincing and the government and the State Bank would have a tough time to sell the idea. But since the conditionality of bringing the mark-up on EFS and LTFF at par with the six-month government paper till September, 2011 has already been accepted by the authorities, there would be no alternative, but to go ahead with the implementation of the measure.
Any dithering on the matter would worsen our relationship with the IMF - an institution which is very important for ensuring the smooth flow of resources from bilateral donors, other multilateral institutions and the global money market. A very important question, often raised by the analysts and various stakeholders, is the rationale of insisting on taking such a step by the IMF and other multilateral agencies. Frankly speaking, the topic is hotly debated the world over and there is no straight answer to the question.
Theoretically, institutions like the IMF justify such a step on the ground of allocative efficiency. It could be proved that the optimal use of credit could only be ensured and overall productivity in the economy enhanced by the free interplay of market forces in which there is no room for subsidised credit. Enhanced productivity in the economy will automatically accelerate the growth rate and boost exports.
The consolidation of the credit market would also lower the interest rates in the non-subsidised sectors and could increase the deposit rates to an extent which is probably the need of the hour in Pakistan. Besides, money is fungible and, subsidised credit could always be misutilised.
Those who differ with such a point of view argue that the withdrawal of subsidised credit facility could hurt exports and the IMF should not force the underdeveloped countries, like Pakistan, to take such steps if it cannot persuade the developed countries to eliminate subsidies, particularly on their agricultural products.
All of these are valid reasons to justify a particular strategy. Coming specifically to Pakistan, the IMF and all other donor agencies have always prevailed upon the authorities to shift away from segmentation of the credit market and move towards its consolidation. In fact, such an objective was, more or less, achieved in the past. The present agreement with the IMF to phase out subsidised export credit in stages appears to be a step towards the same direction.
After the measure is implemented, Pakistan has to rely more on other export expansion measures like frequent tariff and exchange rate adjustments etc, which may not be a bad idea. Every country has to choose an option which is best suited to its circumstances. Nevertheless, withdrawal of subsidies is more compatible with the working of a free market economy.
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