IMF programme, debt re-profiling, and debt restructuring

Pakistan is facing a huge challenge in terms of debt distress. Secondly, the country is stuck in a low economic growth equilibrium, and requires increase in consumption expenditure, and investment expenditure.

The country has entered into a medium-term natured IMF programme, titled the ‘Extended Fund Facility’ (EFF), spread over a little over three years, and holding a financing envelope of around US$7billion – SDRs 5,320 million to be exact - and the scope of which includes both macroeconomic stability, and economic growth; unlike Standby Arrangement (SBA) programme, which only focuses on macroeconomic stability.

This incoming financing will help support foreign exchange reserves, and in doing so will help cushion against exchange rate depreciation exchange rate, and in supporting debt servicing, yet since the programme is pro-cyclical in nature – increasing taxes, and cutting expenditure during economic downturn, and overall low growth situation – and hence will likely not push the country to break-away from this low growth equilibrium. In turn, the pro-cyclical IMF programme will likely not allow to (a) meaningfully build up capacity to repay debt, due to resulting weak domestic production, and exports, and overall economic growth given the pro-cyclical nature of the programme, (b) effectively control inflation through meaningfully dealing with otherwise significant supply-side concerns, due to low level of investment likely in the wake of high taxes, low expenditure, and over-board austerity policy emphasized in the programme, (c) ease the pressure on aggregate demand due to high level of inflation, and policy rate that are likely to remain given pro-cyclical programme conditionalities, and (d) meaningfully, and sustainably increase foreign exchange reserves, due to low level of exports, and an environment of high cost of capital disincentivizing foreign direct investment (FDI).

In addition, the country is facing very high debt repayment over the medium term. As per ‘Table 3b’ of the May 10, 2024 released ‘IMF Country Report No. 24/105’, the projected gross external financing requirements, facing the country over the medium-term, stand at around US$21.04 billion for fiscal year (FY) 2024/25, US$23.11 billion for FY2025/26, US$ 22.72 billion for FY2026/27, US$29.20 billion for FY2027/28, and US$27.89 billion for FY2089/29. This means that the country will need to have ample foreign exchange reserves’ build-up, and therefore requires an IMF programme that is counter-cyclical in nature and does not follow an over-board monetary-, and fiscal austerity policy.

Sadly, the current programme is instead both pro-cyclical in nature, and wrongly over-employs policy rate, and calls for reaching primary surplus to control inflation. This, in turn, will likely result in lack of consumption, and investment, and in turn, not allow increase in domestic production, and exports, to allow meaningful increase in economic growth, and effective build-up of foreign exchange reserves, both of which are needed to enhance capacity to repay debt, and reduce future borrowing needs.

Hence, the country needs three important things. Firstly, the EFF programme needs to be counter-cyclical in nature, whereby instead of raising taxes, domestic resource mobilization needs to be built on meaningful direct tax broadening, while the revenue gap needs to be bridged through (i) bringing in greater productive, and allocative expenditure efficiency, (ii) reducing the size of subsidy needs, in particular, for energy, and SOE sector through introducing radical institutional, and governance and incentive structural reforms for both involved organizations/departments, and markets, and (iii) instead of pushing the country to adopt pro-cyclical policy, the IMF should provide enhanced allocation of climate change related special drawing rights (SDRs) on an annual basis – given the country being among the list of top-ten most climate change challenged countries – to allow the country to make expenditure for creating economic resilience, and also for making welfare spending for people suffering higher inflation from lack of spending – due to low fiscal space with the country as a developing country – by the government to unclog the supply-side, which is a significant source of inflation in the country.

Secondly, given the huge debt repayment needs of the country, and even after accounting for inflow of finances during the 37-month EFF programme, and positive boost from other multilateral institutions, bilaterals, and from commercial lending as a consequence of earning greater financial credibility from creditors by being in an IMF programme, there remains a strong case of both debt re-profiling, and debt restructuring.

The writer is of the opinion that the country need not be in an IMF programme, which by being pro-cyclical brings a lot of economic hardship, and also does not allow reaching macroeconomic stability in any sustainable way, since the programme is lopsided in terms of over-emphasis on aggregate demand squeeze policies, and does not allow needed focus on aggregate supply side.

Also, credibility with the creditors – multilateral, bilateral, or commercial – could be earned through IMF’s Article-IV consultations report, which provides IMF’s assessment of the strength of the economy, and standing of economic policies.

Moreover, the financing gap could be made up without going an IMF programme – with otherwise deep negative consequences in terms of economic growth, and overall economic hardship – and rather approaching creditors independently, although hard, but possible if efficient technical negotiation skills are brought to the table for debt re-profiling/restructuring.

Given the reality that the country is in an IMF programme, it should nonetheless take IMF on board, and start the process of debt re-profiling/restructuring on the external front.

On the internal front, lack of outflows in terms of lessening of burden of debt repayment – and hopefully through provision of enhanced allocation of climate change related annual allocation of SDRs over the next decade or so, given the importance of next decade or so in terms of meeting the global warming targets needed to rein in climate change crisis meaningfully, and for which the remaining room is just a decade or so as per most scientific calculations – will help build greater foreign exchange reserves, which in turn will strengthen domestic currency, with positive consequences in terms of weakening of imported inflationary channel. Lesser inflation would mean lower policy rate, and in turn, decrease in domestic repayment needs. This, in turn, will also mean greater fiscal space with the government, holding positive consequences for resilience-, and welfare spending, and for overall economic growth.

In terms of understanding about debt re-profiling, an April 2015, ‘Center for international governance and innovation’ (CIGI) published paper ‘Debt re-profiling, debt restructuring and the current situation in Ukraine’ pointed out: ‘This paper discusses “debt re-profiling” — a relatively light form of sovereign debt restructuring in which the tenor of a government’s liabilities are extended in maturity, but coupons and principal are not cut.’

Moreover, with regard to understanding debt restructuring, an April 2015, CIGI published issue paper ‘Sovereign debt restructuring’ pointed out: ’Sovereign debt restructuring is an exchange of outstanding government debt, such as bonds or loans, for new debt products or cash through a legal process… To constitute a debt restructuring, one or both of the two following types of exchange must take place: debt rescheduling, which involves extending contractual payments into the future and, possibly, lowering interest rates on those payments; and debt reduction, which involves reducing the nominal value of outstanding debt.

Restructurings often occur after a default, but it is also possible to conduct an early debt restructuring that pre-empts default. In addition to economic variables, the type, timing and terms of a debt exchange are largely determined by negotiations between the sovereign debtor and its creditors.’

Also, the same paper indicates that it is not as if it is very rarely that debt restructurings have taken place, and pointed out in turn ‘Sovereign defaults and debt restructurings have been fairly commonplace since the early nineteenth century. New data show that since 1950 alone there have been over 600 individual cases of sovereign debt restructuring worldwide…’

Re-profiling/restructuring is also important given the fast-unfolding nature of climate change crisis, creating a lot of unforeseen vulnerabilities for countries – especially highly climate change challenged, and developing countries like Pakistan – in the shape of climate change induced disasters, in turn, producing higher borrowing needs. For instance, the devastating floods caused by climate change inundated one-third of the country in 2022, and in addition to causing damage to life, created billions of dollars of spending needs for rehabilitation, reconstruction; not to mention loss to economic growth as a consequence.

Moreover, the world is facing polycrisis – from existential threats like climate change, and related likelihood of ‘Pandemicene’ phenomenon, to geo-political conflict, for instance, in the Middle East, and Ukraine – which like in the case of Covid pandemic, could produce another global aggregate supply shock.

In addition, there is likelihood of rising oil prices at least in the short-term, since the OPEC reportedly indicated it will not increase oil supplies this year, producing balance of payments pressures for net oil importing, developing countries like Pakistan.

Supply shock is likely to remain severe even in the medium-term, given years of neoliberal assault producing a weak regulatory environment, and perpetuation of market fundamentalism producing lack of supply of otherwise important commodities, for instance vaccines.

Hence, it is all the more important, that in a very uncertain world, keeping high probability of quick, and deep borrowing needs for developing countries in particular, it is important for countries under already high debt distress, like Pakistan, to go for debt re-profiling, and restructuring, while on the other, for developed countries, and multilateral institutions to bring on board much better debt restructuring framework.

One of the important reasons that so many countries, including Pakistan, are under high debt distress was because of seriously lagging multilateral spirit during the pandemic in terms of greater allocation of SDRs through IMF – and one based on much better allocation formula than the usual quota-sharing – and also lack of better provision of debt relief/moratorium, and debt restructuring framework, and one involving in better way private sector creditors, and China, which have assumed a lot of importance in terms of creditors for developing countries over the last decade or so.

Copyright Business Recorder, 2024