In the 1970s, 1980s and the early part of 1990s developed and the developing countries of the world were on opposing sides in terms of their perception of the efficacy of standard normal International Monetary Fund (IMF) prescriptions: the developing countries mostly governed by dictators lamented the reforms as not being people-friendly, actually making the poor poorer with obviously disastrous political repercussions.
The developed world/creditors sanctimoniously talked of the need to take the bitter pill with the objective of reversing past profligacy, mismanagement and corruption and argued that democracy, (of the people, by the people and for the people) was the preferred system of government as transparency and accountability are its watchwords.
This distinction has been papered over with the emergence of the debt crisis in several Eurozone countries. The reforms proposed by the IMF supported by Germany, the largest contributor to the bailout package, focus on drastically reducing the budget deficit by those countries experiencing debt as a percentage of Gross Domestic Product well above 85. Included in the list are Greece, Italy, Portugal, Ireland and France. Reducing the deficit, the standard normal conditions specify, entails a dramatic reduction in expenditure not excluding public sector programmes that target the disadvantaged, freezing salaries of government servants (which implies an erosion of their purchasing power) as well as laying-off surplus staff to further reduce the salary bill. At the same time revenue has to be raised which implies higher taxes that once again impact negatively on domestic purchasing power. Economic theory argues that if a contractionary fiscal policy is followed, (together with a contractionary monetary policy that accounts for historically low interest rates in Europe today) a dramatic fall in expenditure (as well as money supply as demand for borrowing deescalates) and a rise in taxes - then the economy's growth rate (i.e. Gross Domestic Product) would necessarily be compromised. In short the economy would no longer be resilient enough to provide the necessary fuel for growth with the capability to take the ailing economy out of a deep recession or stagflation.
The range and the precise extent of the reforms are still being hotly debated between those actually extending bailout packages, including multilaterals like the IMF and the European countries that are putting large sums into such a package, and the highly indebted nations themselves. However, the need for specific reforms is not in question. Thus the critical issue is how much austerity and revenue rise must a country support to ensure that growth is not compromised - growth that can oil the wheels of industry thereby increasing employment opportunities, as well government revenue.
The outcome of the Eurozone debt crisis in political terms has been violent street protests that have led to the fall of two democratically elected governments - in Greece and Italy. Carefully selected technocrats have replaced governments in these two countries but, quite unlike in the case of Pakistan in the past, with the consent of all major political parties that are focused on one objective: to stay within the Eurozone. The technocrats' terms of reference are unambiguous: to put their economies on the road to reforms without being unduly pressured by the political fallout of these reforms.
What are the causes of the Eurozone debt crisis? Past profligacy or the ongoing toxic debt crisis fuelling recession? The IMF transcripts of a press briefing on 24 January 2012 on its website attribute the following statement to Olivier Blanchard, IMF Economic Councillor and Director of Research Department: "the levels of debt that we have are due in large part to the crisis, and in part to not-the-best-behaviour before the crisis...looking forward you should look at how the debt was decreased after World War II. It was a combination of primary surpluses, high growth and low interest rates. I think the ingredient that is potentially missing in this case and that will make it harder is the high growth. That is why we have insisted on the need for structural reforms, ...anything that can increase the potential growth rate of Europe is really of the essence not only for itself but to get debt under control and to decrease it over time."
Vinals IMF Financial Councillor and Director of the Monetary and Capital Market Department identified one major prescription: "the important thing is to increase the solidity of banks and to do so through a number of actions. One very important one is to increase capital levels. You increase the ratio, but you increase the capital level so that you have the ability to provide more credit. So that's why it is fundamental to increase capital ratios...what we don't want is that credit drops or that increasing the capital ratio goes through decreases in credit, and that is why we think it is very important to follow the guidelines provided by the European Banking Authority... I will talk of the three 'Rs': recapitalize, but recapitalize well, restructure; and restore."
Blanchard talked specifically of Greece and stated that Greece is facing two problems, "The first one is a public debt problem and the second is a competitiveness problem...the current discussion about private sector involvement (PSI) is about trying to resolve the debt problem and reduce debt to an acceptable level, a level that Greece can actually sustain...the goal here is to achieve a PSI, a level of debt-to-GDP of 120 percent, which is already very high in 2012... competitiveness (requires) structural reforms as well as moderate or limited wage growth. And realistically this is going to take a long time..."
Blanchard also referred to Italy and Spain as "countries where fiscal sustainability was in doubt" and urged them to "take measures such that doubts are largely eliminated... after this making sure that they can borrow at an interest rate which allows them to achieve sustainability."
And now a look at what Pakistan is doing wrong. The government doubled salaries of civil servants and military personnel, it has not desisted from using public sector entities as recruitment centres and is compelling private banks to support the 160 billion rupee debt swap, an amount that is not expected to retire the inter-circular debt of over 500 billion rupees. This debt would simply resurface with the government paying the hefty interest rate on the swap from the budget. Thus interest payable from the budget would rise to even more than the 34 percent of the current expenditure envisaged in the budget for the current year. Additionally, the government is borrowing heavily from domestic banks thereby crowding out private sector credit with obvious negative implications on PSI and employment levels. Revenue remains an issue, with the IMF once again urging the government in its Article IV consultation report to support a broad-based RGST without any exemptions. There is a lot wrong in terms of economic strategies, annual policies and their implementation with the state of Denmark indeed, no offense to the Danes!