Planning a non-austerity, pro-growth IMF programme

In its April 2023 flagship World Economic Outlook (WEO) report, the International Monetary Fund (IMF) pointed out that economic growth enables countries in a better way to service debt repayments, and for which fiscal consolidation should be done in a counter-cyclical way, that is during economic expansion, taxes should be enhanced, and expenditures lowered.

Moreover, fiscal consolidation works best when growth-enhancing structural reforms are adopted. The Report pointed out in this regard: ‘adequately timed (for example, during economic expansions) and appropriately designed (for example, more expenditure- than revenue-based in advanced economies) fiscal consolidations have a high probability of durably reducing debt ratios.

The debt-reducing effects of fiscal adjustments are reinforced when accompanied by growth-enhancing structural reforms and strong institutional frameworks. At the same time, because these conditions and accompanying policies may not always be present, and partly because fiscal consolidation tends to slow GDP growth, consolidations on average have negligible effects on debt ratios.’

Yet, the lesson of the study conducted by IMF’s own research department has not made its way into the programme conditionalities that the operational/lending side of the institution browbeats recipient countries into following.

Noted economist, Jayati Ghosh writing in this regard, pointed out in her April 2023 Project Syndicate (PS) published article ‘Schizophrenia at the IMF’ as follows: ‘It has taken far too long, but it seems that the International Monetary Fund has finally internalized some hard truths about sovereign-debt reduction.

Chief among them is that growing economies have an easier time repaying. As such, fiscal consolidation – the organization’s favored strategy – undermines efforts to reduce debt-to-GDP ratios because it inhibits economic growth. …The IMF’s latest World Economic Outlook presents the results of its own investigation into various debt-reduction programs undertaken by 33 emerging-market economies and 21 developed economies between 1980 and 2019.

“On average,” the authors note, “consolidations do not lead to a statistically significant effect on the debt ratio.” Instead, they find that higher GDP growth – “as captured by positive demand and supply shocks together” – is “an important force” responsible for roughly one-third of the observed debt reduction during that period.

The analysis even recognizes that fiscal expansion improved debt ratios in several cases, largely due to its positive effect on GDP growth.’

This disconnect between IMF’s own research, and the mindset of decision-making at the operational side, is unfortunate to say the least, given countries need to have greater growth to have more taxes, and exports to overall have less twin deficit gaps to fill, and more capacity to service debt.

Higher economic growth, and greater fiscal space in turn, is all the more needed to deal with the existential threat of climate change crisis. Climate change-, and ‘Pandemicene’ resilient economies need greater investment, and programme countries, especially those like Pakistan that are both highly climate change vulnerable and acutely debt distressed, therefore, all the more need counter-cyclical, pro-growth IMF programmes.

As the current standby programme concludes around April this year, it is highly likely that Pakistan – given its high gross financing needs for both imports and debt repayments – will be entering into another, much longer-natured IMF programme. Most likely this will be an enhanced fund facility (EFF) programme, which will also be focused on improving economic growth prospects.

Hence, the government in its negotiations with the IMF should highlight IMF’s own research, which calls for counter-cyclical policies, and in the case of a country that is at a low-growth trajectory would mean less emphasis on fiscal consolidation, and more on non-austerity policies – lesser taxes and greater expenditure.

Moreover, to enable this pro-growth policy, governance – and incentive structural reforms will have to be planned so that there is better revenue collection through legislation planned to enhance tax base, and better energy-related collections/lower line losses, and not indirect taxes and tariffs. This means country will have to give commitment to the IMF that it will take these steps, which should be possible as an elected government would have been in office by February.

On the IMF side, the institution should bring to table greater allocation of special drawing rights (SDRs) on the lines it did in August 2021 – when it made an enhanced allocation of $650 billion – but with a needs-based allocation formula (and not one that is quota-based).

Here, as per the suggestion of ‘Bridgetown Initiative’, highly climate change vulnerable countries like Pakistan should be provided with an annual allocation of climate-related SDR allocation. Moreover, the IMF should also cancel its ‘surcharge policy’, thereby relieving countries of this ‘junk fee’.

Hence, both on the policy side, and the financial side, the IMF needs to make adjustment so that countries that approach it, like Pakistan, will most likely do in the coming months for another programme, should be able to pursue pro-growth policies to effectively reduce debt burden, provide needed social safety, and make appropriate investments for reach much-improved climate resilience.

Short of effective structural and institutional reforms through better legislation from the government side, and counter-cyclical programme approach –a balanced emphasis in terms of aggregate demand squeeze-, and greater supply-side enhancing policies, that is lower emphasis on enhancing policy rate (or monetary austerity), and not having primary surplus conditionalities (or fiscal austerity) for instance – and greater SDR financing provided by IMF, countries in IMF programmes will find it particularly difficult to not adopt austerity policies which, in turn, will not allow breaking the vicious cycle of low growth, high debt distress, increasing poverty and inequality, and less climate change and ‘Pandemicene’ resilience.

Copyright Business Recorder, 2024