Nothing is certain on how the negotiations with the IMF culminate, as there is a complete change of economic team. Those at the helm are coming out of the shoes of IMF and WB. This could be good or bad at the same time. All what is required to learn from our own mistakes on how we did not comply to the numerous IMF conditions. And the Fund also needs not to see Pakistan from Egyptian lens.
In a prolonged run prior to the IMF programme, in the past eighteen months (Dec17 to-date), the authorities at home took some stiff decisions of exchange rate adjustment and interest rates hike to curtail imported demand and to not let inflation go too high. That yielded results in the form of improvement in lowering the current account deficit.
The big problem is how to resolve the fiscal mess which is becoming worse despite steep cut in development spending. Within fiscal, energy subsidies - mainly hidden, are reaching alarming levels. The Fund's stance is to go for fiscal tightening - massive tax efforts combined with expenditure cuts, especially subsidies. The IMF may ask for further monetary tightening. With a flexible exchange rate regime, devaluation in currency amid rise in taxes and energy prices may inch up inflation, and to counter, the prescription is to raise interest rates.
There are no two ways on to controlling fiscal deficit. Reforms at FBR, and stopping leakages of PSEs through privatization should be the focus. And the other element is lowering energy subsidies without too much burden the consumers.
Some new taxes may be introduced along with increase in GST or removal of exemptions or a combination of both. The talks are of having 1.4 percent of GDP in the form of additional taxes - but the way changes are made in the economic team, a fresh set of target could be announced. The IMF wants firm commitment in case of privatization of PSEs. The government may soon have one or two PSEs up for privatization in the conditions as well.
The politically tough decision would be increasing energy prices - gas and electricity, to the tune of 25-30 percent across the board. That would be a tough sell for PM Imran who is already facing bashing from the opposition benches. Nonetheless, energy related circular debt and other subsidies, without any change, can bring the fiscal house down in next 5 years.
The new taxes, inflation, currency depreciation, cut down in development spending, and higher energy prices will further slow down the economic growth momentum and may result in further job losses. That is opposite to PM’s promise of creating 10 million jobs in 5 years. But we have to live with these adjustments, as without doing so, the economic leakages would reach a level to implode. If we do not take action today, tomorrow (in a few years), the country may hit hyper inflation and a complete collapse.
But these are to be done with care, and the decision makers have to have complete understanding of ground realities and the functioning of Pakistan economy. One element, that the Fund may pursue, but the newly formed economic team should resist is increasing the interest rates.
There are two arguments for high interest rates - one is to curb domestic demand and to target inflation. The other is to lure global funds in home country. In case of managing domestic demand to curtail inflation, the model works when core inflation is growing - demand pull factors are in play. That is not the case in Pakistan where supply push inflation is moving up headline inflation.
The inflation may not come down due to excessive monetary tightening, after a certain point in countries like Pakistan, but that surely would have fiscal implication - around two third of banking credit is to government, and any increase in interest rates, balloons the debt servicing cost.
The IMF looks at primary balance - revenue minus expenditure (adjusted for debt servicing). The argument Fund presents is to have foreign flows in the country to jack up NFA and improve the external balance position. This happened in Egypt, as when treasury bill rates were around 20 percent, the portfolio inflows ran in tens of billions of dollars, but now the trend is reversing. How can long term strategy be based on short term flows?
The monetary tightening would not only have negative impact on growth, but would severely hit fiscal side too as around 70 percent of government domestic borrowing is short term. And in the absence of a robust cash management system and a relatively inefficient market dominated by commercial banks, prohibition of government borrowing from central bank can do more harm than good.
The IMF needs to be convinced on not imposing simultaneous tightening of both fiscal and monetary policies. Even, the IMF’s own literature argues against simultaneous tightening of fiscal and monetary policies, especially when economic growth is fragile.
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