Contradictions in economic policy stance and a way forward

In its policy prescription, the International Monetary Fund (IMF) has been pushing Pakistan for adopting procyclical policies, that is, asking the country to cut spending, raise policy rate, and increase taxes during a low growth, high inflation scenario at the back of a recession-causing pandemic, and a severely damaging, and primarily climate change caused catastrophic flooding.

The contradiction of procyclical policy is that while the country, firstly, needs to make health-, and climate-related investments to be resilient enough to effectively deal with climate and pandemic crises in addition and, secondly, requires making much greater stimulus spending for more inclusive growth to lower the otherwise rising poverty and inequality levels, and thirdly, to make non-austerity interventions – lowering policy rate to increase fiscal space, reducing, in turn, debt repayments burden, and decreasing cost of borrowing for much-needed greater investments – to increase industrial production and export earnings to increase the otherwise low level of foreign exchange reserves, and in turn, reduce an otherwise significant imported inflation component.

One side of the policy argument, which apparently is quite mainstream, is that expenditures need to be curtailed by procyclical policy, when it is quite clear that increasing taxes and policy rate, on one hand, raises the cost of production, which negatively impacts export competitiveness, and industrial production. Both, in turn, reduce growth and have a reducing effect on foreign exchange reserves as well in addition to contributing to inflationary pressures. High inflation has not only increased the cost of living and production, it has also led to significantly reducing the real wages.

A recently released ‘Global wage report 2022-2023: The impact of inflation and COVID-19 on wages and purchasing power’ by International Labour Organization (ILO) indicated in this regard: ‘This edition of the Global Wage Report shows that wages and the purchasing power of households have been dented considerably during the past three years, first by the COVID-19 pandemic and then, as the world economy started to recover from that crisis, by the global rise in inflation.

Available evidence for 2022 suggests that rising inflation is causing real wage growth to dip into negative figures in many countries, reducing the purchasing power of the middle class and hitting low-income groups particularly hard.’

On the other hand, while it makes sense to adopt administrative measures to curtail import demand – where a highly cautious policy is needed so that import of raw materials for exports, and production of essential items is not affected at home – compressing import demand through procyclical policy has a broader compression effect than intended, hurting overall exports growth, and increasing imported inflation at the back of negative effect on exports hurting reserves buildup, and domestic currency strengthening prospects.

Procyclical policy also increases the debt burden, increasing domestic debt repayments through the channel of higher interest rate working directly to this effect, and more indirectly in the case of external debt repayments, whereby higher interest rates having a reducing effect on Rupee strengthening, through lower exports and less reserves buildup. Lesser exports, and greater external debt repayment needs also accentuate the balance of payments (BoP) crisis.

It is ironic then, that the procyclical policy stance being pursued by the IMF, and mainstream policy, in effect has more damaging effect on efforts to reduce BoP crisis, and lowering debt default risk, than the credibility for attracting foreign investment, and other bilateral inflows, that remains a significant objective of government to remain in an IMF programme!

Debt burden has not only increased a lot in Pakistan over the pandemic, and supply shocks, and the excessive monetary tightening policy applied at home and overall globally, the situation has worsened exceedingly for many developing countries.

A December 3, New York Times (NYT) published article ‘Defaults loom as poor countries face an economic storm’ highlighted in this regard ‘Developing nations are facing a catastrophic debt crisis in the coming months as rapid inflation, slowing growth, rising interest rates and a strengthening dollar coalesce into a perfect storm that could set off a wave of messy defaults and inflict economic pain on the world’s most vulnerable people.

Poor countries owe, by some calculations, as much as $200 billion to wealthy nations, multilateral development banks and private creditors. Rising interest rates have increased the value of the dollar, making it harder for foreign borrowers with debt denominated in U.S. currency to repay their loans.

Defaulting on a huge swath of loans would send borrowing costs for vulnerable nations even higher and could spawn financial crises when nearly 100 million people have already been pushed into poverty this year by the combined effects of the pandemic, inflation and Russia’s war in Ukraine.’

Moreover, the World Bank recently released ‘International debt report 2022’ which further highlighted the seriously dangerous debt crisis facing developing countries in the following words: ‘The external debt service payments on public and publicly guaranteed debt by the world’s poorest countries are expected to surge by 35 percent from 2021 to over US$62 billion in 2022. Debt service payments take away scarce fiscal resources from health, education, social assistance, and infrastructure investment.

Payments scheduled for 2023 and 2024 are likely to remain elevated because of high interest rates, maturing principal, and the compounding of interest on Debt Service Suspension Initiative deferrals. The increased liquidity pressures in poor countries go hand in hand with solvency challenges, causing a debt overhang that is unsustainable for dozens of countries.

Nearly 60 percent of countries subject to the Joint World Bank–International Monetary Fund Debt Sustainability Framework for Low-Income Countries are at high risk of debt distress or already experiencing it. In 2021, the debt stock of low- and middle- income countries rose by 5.6 percent to US$9 trillion, of which International Development Association (IDA) countries owe nearly US$1 trillion.’

Regarding the negative impact of austerity or procyclical policies on inequality and poverty, pushed by the IMF on programme countries, a December 2021 research paper ‘Poverty, inequality, and the International Monetary Fund: How austerity hurts the poor and widens inequality’ published by the Journal of Globalization and Development. The abstract of the paper pointed out: ‘In offering loans to developing countries in exchange for policy reforms, the IMF typically sets the fiscal parameters within which development occurs.

Using an original dataset of IMF-mandated austerity targets, we examine how policy reforms prescribed in IMF programs affect inequality and poverty. Our empirical analyses span a panel of up to 79 countries for the period 2002–2018. …Our findings show that stricter austerity is associated with greater income inequality for up to two years, and that this effect is driven by concentrating income to the top 10% of earners while all other deciles lose out.

We also find that stricter austerity is associated with higher poverty headcounts and poverty gaps. Taken together, our findings suggest that the IMF neglects the multiple ways its own policy advice contributed to social inequity in the developing world.’

The contradictory policy whereby the IMF and mainstream policy, on one hand, wish to handle a very dangerously unique confluence of economic crises emanating from both the aggregate demand-, and supply sides of the economy, with traditional, excessively demand squeeze focussed policies. This has happened when clearly the last decade in particular has provided enough basis of country experience – both developed and developing countries – in the shape of serious misgivings of neoliberal, procyclical, and austerity policies through unstable distribution of cheap finance, excessive build-up of debt, incapacitating of public sector and regulation, and increase in poverty and inequality; with effects overflowing the political domain as well with the rise of xenophobia, political radicalization, and centre-staging of parties at the extremes/margins of political spectrum.

The way forward is counter-cyclical policies, whereby, for instance, reducing policy rate to levels that internalize a more significant supply-side/governance policy effort. At the same time, tax policy does not rely on raising tax rates but on both placing short-term taxes on excessive and windfall profits, and increasing the tax base; in addition to doing away with unjustified tax exemptions, and carefully planned subsidies that protect the vulnerable and keep energy prices at relatively reasonable levels when compared with incomes, and cost of production related needed caps.

Moreover, a non-austerity policy is pursued, which will be enabled by a better rationalized monetary tightening stance, in favour of lesser rates than at higher levels, and in turn allows for greater public and private investments; while expenditure efficiency and greater fiscal space is also achieved with belt-tightening on unnecessary expenditures, and reduced domestic debt repayment needs.

Two important elements that allow pursuing a non-austerity, counter-cyclical policy are greater debt moratorium/relief provided under a well-functioning debt restructuring framework that includes both China and private creditors effectively with regard to providing a meaningful debt relief effort needed for developing countries, and within it, climate disaster- affected/more vulnerable countries.

The recent consensus on forming ‘loss and damage’ fund is an important step in this regard. Secondly, there is importance of special drawing rights (SDRs) in the overall support effort for helping the countries meet their balance of payments and stimulus needs, and also help in keeping the debt burdens under reasonable levels.

To start with, it has already been many months since the start of a widespread call for another release of enhanced SDR allocation to the tune of $650 billion, as was released in August 2021. Such an allocation is all the more important for developing countries to deal with the multi-crisis situation at the economic and environment front caused by pandemic, war in Ukraine, and the ravages of the fast-unfolding existential threat of climate change crisis.

Moreover, as is being suggested under the ‘Bridgetown Initiative’ formulated and further evolved under the leadership of the Prime Minister of Barbados, a yearly allocation of climate-related SDR support should also be started for climate vulnerable countries. As per the official document ‘Urgent and decisive action required for an unprecedented combination of crises The 2022 Bridgetown Initiative for the reform of the global financial architecture’ released on September 23, recommended in this regard: ‘The first step is to immediately provide liquidity to stop the debt crisis in its tracks. We call upon the Board of the International Monetary Fund to: 1. Return access to its unconditional rapid credit and financing facilities to previous crisis levels; 2. Temporarily suspend its interest surcharges; 3. Re-channel at least US$100 billion of unused Special Drawing Rights (SDRs) to those who need it, and; 4. Operationalise the Resilience and Sustainability Trust by October 2022.’

Copyright Business Recorder, 2022