The IMF conundrum

Prime Minister Imran Khan met with Christine Lagarde, the Managing Director (MD) of the International Monetary Fund (IMF), on 10 February on the sidelines of the seventh World Government Summit held in Dubai followed by the Federal Foreign Minister Shah Mehmud Qureshi stating that "we have reached a consensus with the IMF on basic points....the meeting remained productive."
Two days later, Federal Finance Minister Asad Umar stated that "no deal was reached between the two sides" and warned that the "IMF does not offer financial assistance on sympathetic grounds". Few would argue against this cautionary note. Be that as it may, the Prime Minister appears optimistic that the IMF conditions may be less politically challenging after his meeting with the MD than evident during the IMF mission to Pakistan in November last year (or from his perspective less negatively impacting on the poor and the vulnerable). This optimism was perhaps based on the MD's agreement with the Prime Minister on the objectives of the package. And in this instance it is relevant to note that even the much riled opposition would agree with the Khan administration on its economic objectives. However, the devil remains in the government and the Fund agreeing on a detailed time bound reform strategy. The response to how likely this requires a look at the last two IMF packages to Pakistan.
IMF Board approved a three-year Extended Fund Facility to Pakistan in September 2013 - a programme completed three years down the line in September 2016 unlike its three-year 2008 Stand-By Arrangement which was never completed as the Zardari government refused to implement the agreed power and tax sector reforms resulting in suspension followed by cancellation of the last two tranches of the programme.
The question is: why does a completed IMF programme (reflecting the fact that the government met most if not all of the structural benchmarks and implemented the agreed reform agenda (inclusive of policy and governance reforms) require another bailout package less than two years down the line? The obvious conclusion, one that the IMF sadly has not made publicly, is that there were some lacunas in the design of the previous bailout package during the implementation stage - lacunas which are typically identified by Fund staff during the mandatory quarterly reviews which may lead to grant of exemptions for a pending tranche release but, at the same time, account for time bound structural benchmarks as conditions for subsequent tranche releases. Examples of these lacunas during the implementation stage included: (i) allowing the then Finance Minister Ishaq Dar to shore up foreign exchange reserves with external borrowing (from commercial banks as well as through increasing debt equity); (ii) insisting on raising revenue instead of reforming the tax structure resulting in higher taxes on existing tax payers with a negative impact on productivity and savings which, in turn, required more borrowing (withholding tax in the sales tax mode is an indirect tax whose incidence on the poor is greater than on the rich - a policy that unfortunately is continuing to this day); (iii) the rupee remained grossly overvalued through market interventions with a negative impact on exports; this was noted in the quarterly reviews but never made a time bound structural benchmark; and (iv) current expenditure rose to historical heights while the government slashed development expenditure to meet the IMF budget targets.
It therefore should be a source of satisfaction to the government that the IMF has changed the mission leader who designed and implemented/reviewed the Extended Fund Facility and also led the team from 8 to 20 November 2018 for consultations on the package that is currently being negotiated. One would hope that the new team leaders, both from the IMF and the Pakistan government, are better able to design a bailout package focused on restructuring and reforming the poorly performing sectors, particularly power and tax sectors, with a minimum cost to be borne by the poor and the vulnerable and that the government stays the course rather than allowing political considerations to outweigh economic considerations like in the past.
The IMF in one of its reports defines macroeconomic instability as follows: "it may be relatively easy to identify a country in a state of macroeconomic instability (e.g., large current account deficits financed by short-term borrowing, high and rising levels of public debt, double-digit inflation rates, and stagnant or declining GDP)." These are elements that are prevalent in Pakistan today though the rate of inflation has not yet reached double digits, but it is fast moving towards it. The solution the report adds is: "macroeconomic stability depends not only on the macroeconomic management of an economy, but also on the structure of key markets and sectors. To enhance macroeconomic stability, countries need to support macroeconomic policy with structural reforms that strengthen and improve the functioning of these markets and sectors."
Given this definition would the IMF have a comfort level with respect to the decisions taken by the PTI administration during the six months it has been in power? Prime Minister Imran Khan and his bevy of ministers have made considerable mention of their focus on poverty alleviation and on Friday in Peshawar the Prime Minister stated that his government will launch a comprehensive poverty alleviation programme across the country with special focus on tribal districts by the end of current month.
This is likely to be fully supported by the Fund and is reflected by the statement issued by Managing Director IMF on the meeting with Prime Minister Imran Khan in Dubai: "as emphasized in the new government's policy agenda, protecting the poor and strengthening governance are key priorities to improve people's living standards in a sustainable manner." The Fund may also be supportive of the government's decision to merge all state institutions involved in social security payments to the poor and vulnerable (though some legal issues may arise as a consequence for example with respect to Baitul Mal). The Fund, however, is likely to argue that the merger would not only enable the government to raise total social security payments to the vulnerable but also allow merger of all social security programmes/payments under one umbrella i.e. the Benazir Income Support Programme (BISP) which has identified the poor and vulnerable to the satisfaction of multilateral institutions. This, the Fund may maintain, should preempt the need for other subsidies to the poor - be they lower utility rates for example those using electricity units less than 300 or to subsidise food (including during Ramadan), sehat card or constructing houses for the poor.
The Fund may also urge the government to end the tariff differential subsidies to distribution companies, including K Electric, and agriculture tube-wells budgeted at over 150 billion rupees and to instead privatize Discos, a stance that was agreed during the EFF but never implemented for political reasons, and ensure Nepra's autonomy specifically with respect to tariff determination.
To conclude, poverty alleviation focus would be approved by the Fund; however, the government needs to amalgamate its social security system, as it has announced it would, and desist from extending tariff subsidies, and special rates for house construction for the poor, and health cards in addition to the monthly social security payments under the Benazir Income Support Programme - a Fund stance that economists would also endorse.
This is the first of a two-part series of articles detailing the measures taken so far by the PTI government that may be endorsed by the Fund. Next week's article will detail those measures taken by the government that in all likelihood, if endorsed by the Fund, would be considered insufficient or simply not be endorsed.