Will Pakistan ever break free from the IMF cycle?

“You can’t solve a problem with the same mindset that created it.” This quotation, attributed to Albert Einstein, reflects the perpetual cycle of mismanagement and poor governance in Pakistan. The economy seems stuck in a rut, facing one crisis after another and needing immediate redress.

Our “rigidity of mindset” is perhaps to blame: the people who created this situation (and have been responsible for previous crises) are trying to solve it (with an “approach” that seems to look back more than it looks forward).

We seem so fixated on our “naiveté” that, after digging ourselves into an economic hole, we continue to dig away with gusto while looking back at our past instead of moving forward towards reform. Despite several bailout programmes, our economy continues to stagnate. The declining purchasing power and subsequent cost of living crisis have burdened the masses, while the current IMF programme, with its emphasis on taxation, may prove to be a long dark shadow over prospects for substantial and genuine growth.

The problem lies not with the IMF but in the build-up to the situation where we run from pillar to post to seek financing and rejoice in getting loans to service previous loans.

In 2023, Pakistan narrowly evaded defaulting on its debt—a common theme in the country’s turbulent financial history—thanks to an emergency stopgap arrangement with the International Monetary Fund. But the arrangement does little to address the fundamental problems that have brought the economy to this precarious juncture. Pakistan’s GDP growth for 2022–23 was a paltry 2.4 percent, lower than the 2.6 percent growth of its population.

While the country’s anti-inflationary measures have provided some respite, poverty is on the rise, and the economy is still in a coma. The fiscal deficit has remained stubbornly at about 7 percent of GDP, with revenues of only about 12 percent of GDP (tax revenues account for only about 10 percent of GDP). Meanwhile, state-owned enterprises and the energy sector remain perennial problem children.

Pakistan’s external account caused the most concern. A nasty combination of low exports, virtually no foreign direct investment, and an import dependency that was downright scary pushed the country toward a near-default situation. The terms of this new $7 billion bailout are similar to those of the last one. The focus is on fixing Pakistan’s fiscal policies, which have long been a source of mismanagement and inefficiency. This time, however, instead of just going along with the IMF, Pakistan’s government has tried to make a show of implementing the promised reforms.

Additionally, a new national budgetary agreement between the federal and provincial governments of Pakistan is on the way. This agreement aims to improve spending coordination and ensure fiscal discipline. Although this and the other steps mentioned are positive moves toward reaching financial stability, the major question is whether Pakistan’s top political leaders have the will and fortitude to see them through.

We have talked about the stone tied to our neck in the form of state-owned enterprises (SOEs) and in detail in some of my previous articles. Many of these white elephants are where inefficiency reigns supreme. Pakistan Railways, Pakistan Steel Mills, and several power distribution companies remain perennial money losers. Despite efforts to privatize and restructure some of these industries, most SOEs remain addicted to public money for survival.

While the International Monetary Fund programme focuses primarily on introducing reforms in fiscal policy and taxation, it also clearly expresses the need for reforms in governance and transparency in state-owned enterprises. But history teaches us that without clear and consistent political commitment, these reforms tend not to hold. The dilemma of state-owned enterprises represents very well the broader governance difficulties that Pakistan faces and that, tacked together, add up to an inadequate governance system: inefficiency, political interference, and a lack of accountability that stop these entities from functioning as they should.

A long-term plan is essential for resolving Pakistan’s energy crisis. The plan must address not only the supply side of the equation—boosting energy production from a mix of sources, including hydropower, coal, natural gas, and renewables—but also the demand side. This means curtailing inefficient and excessive energy use in households and the industrial sector (a good place to start is with the textiles and garment factories that account for half of the country’s exports and mostly benefitted from extensive subsidies in the past).

Equally important is overhauling the transmission and distribution network, tackling the line losses and theft that is responsible for about one fifth of the burden that a consumer faces today, our transmission and distribution network is the main reason for the dangerously unbalanced supply-demand equation. Over time, the combination of these two strategies—reforming transmission and distribution and making energy use more efficient—will lead to better outcomes in the power sector.

Despite the use of policies and subsidies to increase exports, their impact has been minimal. Exports of the high-value goods that could really drive economic growth are largely absent. Our traditional export sectors have feasted on the subsidies and became complacent, showing no appetite for innovation and modernization.

We need to reduce the excessive reliance on low-value goods in the textiles and diversify the export portfolio.

The stagnation in exports has, of course, worsened the external account crisis. However, the problem goes beyond just not sending the right stuff to market. The real underlying problem is governance. Pakistan’s elite capture is not just an economic issue, but also a political one. By securing all kinds of favorable policies and subsidies, a narrow group of people has captured the game for its own ends, all to the apparent detriment of the expansion of high-value exports.

This rent-seeking culture stifles competition and innovation, preventing the establishment of new businesses and industries. An elite class deeply entrenched in the economy has long enjoyed the benefits of tax breaks, subsidies, and favourable contracts with the government. The rest of the population appears to live in a parallel universe: a shortage economy, with basic services and opportunities in short supply. Rent-seeking wastes taxpayers’ money. What can be done? Obviously, the IMF’s instruction to broaden the tax base is a good starting point, but it is not sufficient by any means.

The roots of Pakistan’s economic problems run deep, grounded in governance failures and the elite capture of public resources. The IMF programme offers a stabilization roadmap, but real change requires much more—not just the superficial reforms we’ve seen too often in the recent past.

Pakistan needs to address the underlying causes of its economic problems by reducing public spending on inefficient State-Owned Enterprises (SOEs) by at least half, privatizing unfixable inefficient SOEs, and restructuring the remaining SOEs into well-managed enterprises that serve a public purpose.

Next, expanding the tax base beyond the traditional sectors is imperative. This means bringing into the tax net all kinds of economic actors, including the powerful elites who evade taxes with impunity. Their contribution plays a crucial role in financing all basic services. Thirdly, it is crucial to implement the governance reforms in a manner that guarantees the transparency and accountability of these institutions. In the absence of strong institutions, the economy is bound to lapse back into the same mismanaged cycles that have given rise to so many crises in the past.

The path to recovery will be long and tough for Pakistan, but with the reforms and the right attitude, the country can find its way to economic viability. The IMF bailout is only the first step; real change will occur only when Pakistan takes on its long-standing governance and economic issues.

Copyright Business Recorder, 2024