There is no use in avoiding the obvious - it is best that we as a nation reconcile ourselves to the fact that another IMF programme is inevitable. If there are still people who want to deny the obvious I only refer to our precarious balance of payments position. As of approximately one week ago our reserves stood at $11.76 bil, out of this $5.10 bil belongs to the IMF, leaving us with $6.6 bil.
Now out of this we subtract $2.0 bil approximately that has been transacted in SWAPs and Outrights by the SBP to prop up the PKR. This leaves us with a grand total of $4.6 billion far below the three month import bill of $9.0 billion. Thus the BoP position does not look very rosy. Keeping this in mind it would be in best interests that we contemplate the shape and form of this programme, the path proscribed by the IMF, the pain it will entail and the end result.
In my view, keeping the world economy in mind and the fact that most of the developed world is creaking under the load of oppressive tax regimes; it is highly unlikely that the IMF will take a favourable view of Pakistan's gargantuan tax dodging economy. The probable view that they are going to take is that there should be little reason that the tax-paying, hard working people of the world should subsidise and pay for the lavish lifestyles of Pakistan's landed gentry. The Executive Board of the Fund also probably does not have a very soft corner for us due to our propensity to run away mid-programme; in our entire history as a nation we have only completed an IMF programme once. Thus said programme that is going to be prescribed to us is going to be draconian (at least from our view), heavy on structural adjustments and light on rhetoric.
The Pakistan Government has to realise that the longer they avoid discussing the modalities with the IMF the more the direct and indirect costs of the programme will rise. So it is good to see that a ten member team is visiting the IMF in Washington soon. This trip is akin to a naughty school boy visiting the principal for a good scolding. The fact that we are travelling to Washington means that we are about to have the riot act read to us by our erstwhile benefactors, much the same way Ukraine is having it read to themselves right now. So it would be better for us if we started to dwell on the shape of the programme to come.
The programme will broadly be based around three main points:
1. Macroeconomic Policy (Fiscal, Monetary & Exchange Rate)
2. Structural reform
3. Deregulation and privatisation
A. Macroeconomic policies
Fiscal policy
The first thing that the IMF-supported programme will look to do is to adjust Fiscal Policy. Fiscal policy will be formulated in such a way so as to cut the fiscal deficit in half, to 3% of GDP, while monetary policy will be aimed at containing inflation and supporting the exchange rate. Containing inflation at the moment will not be a problem as the next reading is expected at around 5%: due to a combination of the base effect, administrative measures in calculation and an expected bumper crop. Inflation is expected to picking up towards the end of the third quarter of this year - that is when the SBP will react.
The government will be expected to fully commit to maintaining a sound fiscal policy. The budget will therefore be framed to strike an appropriate balance between preventing undue deterioration of the fiscal position and avoiding an excessive fiscal contraction (which in my view might just be unavoidable). Accordingly, the government will be forcefully nudged in a determined way to follow a policy of a balanced budget, which will try and do its best to avoid any recourse to domestic financing.
The Fund will push the government to reduce economic distortions, and strengthen the fiscal position. Consequently the government will have to gradually eliminate subsidies on fertiliser, fuel, gas and electricity. As the price increases necessary to eliminate these subsidies are very large owing to the depreciation and the amount subsidised, it will not be feasible to bring domestic prices to the level of international prices abruptly. The government will therefore aim to eliminate these subsidies gradually over the course of the programme. However, no matter how slow the adjustments overall are, the initial adjustment will be sizable by any standards.
On the revenue side, the government will announce an increase in taxes on some consumables ie tobacco, beetle nuts, alcohol etc of between 25 to 30 percent. The government will remove all exemptions promulgated through SRO's during the previous years. Tax collection will forcefully be improved and the highly unpopular VAT and agriculture taxes will be introduced. In order to improve tax administration the structure of the tax system will probably be adjusted and the gargantuan labyrinth of tax levying authorities will be simplified. The Fiscal Affairs Department will probably play a leading role in the formulation and implementation of Pakistan's tax policy by providing detailed technical assistance. At a minimum the fund will engineer reforms, to increase non-oil tax revenue, that include: (i) raising the annual audit coverage; (ii) developing improved VAT and other audit programmes to target large potential taxpayers; (iii) increasing the recovery of tax arrears; (iv) and a countrywide economic audit.
The IMF will ask Pakistan to pay special attention to tax reform and plugging fiscal leakages. Services such as transport, professions such as lawyers, doctors and so on will have to buy into the tax net and policies that contribute to tax evasion and smuggling, such as the Afghan Transit Trade will have to be revisited.
In recognition of the serious financial crisis facing Pakistan, the PSDP is sure to become a casualty. The government will probably decide to discontinue immediately any special tax, customs, or credit privileges granted to projects ie such as tax holidays to refineries setting-up on the coastline, any budgetary and extra-budgetary support for development such as discretionary funds and credit privileges to projects will have to be stopped. The restructuring of Public Sector Enterprises (PSEs) will be inevitable in order to help plug a gapping hole of approximately PKR 300 billion that they create. In any event, the government will have to implement ahead of schedule reforms that they would rather ease in monetary and exchange rate policy.
Monetary strategy will be formulated in a way so as to support the PKR exchange rate, leading to a 5 to 10 percent controlled devaluation. It is my view that this time around SWAPs or Forward sales will not be made available as a tool to the SBP and its use of such instruments will be severely curtailed. The present cap for SWAPs/Forward sale as defined by the IMF was $2.7 billion; there is a high probability that this will be slashed to below $2.0 billion. Any increase in inflation will be combated by maintaining a firm monetary stance.
The overall policy package that will be adopted and set out in the IMF Memorandum, will envisage the speedy restoration of confidence in the economic direction of the country. And as this occurs, the exchange rate of the PKR will finally stabilise. However, during the transitional period, in which confidence is taking hold, lingering concerns about exchange rate depreciation are likely to keep market interest rates at high levels. The SBP will be forced to recognise the ground realities, in these circumstances; it will need to keep its own interest rates high. Accordingly, the SBP will start raising interest rates across the entire spectrum of maturities, from overnight to one year, thereby bringing them in line with conditions prevailing in the money market - and sending a clear message to financial markets that it will maintain a firm monetary stance for as long as proves necessary. The OMO outstanding of PKR 400 billion will also be fully unwound slowly and as part of this process the rates are slowly being pushed up already. At the same time, the IMF will insist on providing full and further autonomy to SBP to adjust rates policy as it pleases, so that it can take important and hard economic decisions independent of governmental pressure.
This tight monetary stance will inevitably mean that, at least for during that time, the amount of credit available for lending to the corporate sector will remain constrained and the cost of credit will remain very high. Such a situation will place a particular burden on smaller enterprises, which rely on bank credit for their sole source of financing. To alleviate this burden, the government will probably be allowed to introduce a temporary programme under which credit will be provided to small-scale enterprises through the state banks at subsidised interest rates. The cost of the subsidy will probably be borne not by the SBP, but rather by the central government budget. The Export Refinance Rate (ERF) will also be tweaked, probably downward to help support our already fragile export sector. Eventually, though the mandate will stipulate that, these arrangements will be wound down. The Fund's logic for this will be that, since once confidence is fully restored and the exchange rate stability is regained, then funds should flow back into the banking system and the overall policy stance should be relaxed gradually, thereby providing greater room for banks to expand credit and lower their interest rates - for all firms.
The IMF will formulate the financial programme in tandem with the SBP in the context of extremely uncertain financial conditions, where demand for monetary aggregates will be monitored very closely. Over the course of the programme, the growth of broader monetary aggregates will have to be slowed considerably, with M2 being the prime target (at the moment M2 growth is expected at approximately 11 in FY12). As the programme progresses the money multiplier will fall sharply, partly because there will be a marked increase in the demand for currency, as concerns grow over the scale of economic difficulties, but also because financial intermediation will decline, as banks become more reluctant to lend.
The IMF will probably require the SBP to operate monetary policy within a well-defined framework, with a clear inflation objective, ie explicit inflation targeting. The programme will probably aim to contain inflation to single digits, while tweaking policy to ensure that there is only a limited pass through of the very substantial depreciation onto the prices of imports, and only a muted impact on food prices. To achieve this ambitious objective, the SBP will have to limit the growth of broad money. Broad money growth targets will be attained by controlling base money, rather than by relying on direct quantitative lending targets.
This monetary strategy will be complemented by well thought-out foreign exchange intervention to stabilize and support the exchange rate. The scale of this intervention will be determined by the IMF staff, and will also be subject to SBP maintaining net international reserves above the monthly and quarterly floors as specified in the programme. A new addendum to the intervention that the fund will probably insist on will be the sterilisation of FX interventions; this is when the SBP will withdraw as much PKR liquidity as FX liquidity pumped in.
B. Structural reforms
The IMF will set out in its Memorandum an ambitious strategy of structural reform, aimed at bringing the economy back to a path of rapid growth, by transforming the high-cost economy into one which would be more open, competitive, and efficient. To achieve this transformation, the strategy will call for foreign trade and investment to be further liberalised, domestic activities to be further deregulated, and the privatisation programme accelerated.
To ensure the full implementation of free market economics across the spectrum including in the agricultural sector, and so that final consumers obtain the maximum benefits from reform, I believe that we will be asked to wind down monopolies like the Trading Corporation of Pakistan (TCP), National Fertiliser Company (NFC), coupled with a full deregulation in the agricultural sector. Importers and exporters will be allowed marketing of all these products domestically and internationally, except maybe for the international export of wheat. Similarly, as part of the adjustment, costs tariffs will probably be introduced on all of agricultural products, but these rates will be limited. In tandem with the above the government will have to take a long hard look into the agricultural support price mechanisms and it's resultant outstanding debt. As of April the amount outstanding against Government agricultural operations stood at approximately PKR 315 billion. All these reforms will be implemented not only to open up the sector and make it more competitive but also to tackle the huge problem of agricultural sector circular debt.
C. Deregulation and privatisation
The third major thrust of the structural reform strategy will be to deregulate and privatise the economy, in order to promote domestic competition and expand the scope of the private sector. As a bold first step the Competition Commission will probably be further strengthened and given more judicial power through requisite legislation. Like in the past, their decisions will now probably be only challengeable in the Supreme Court if the Fund has its way.
Similarly, trade in agricultural products will also be deregulated. Traders will have the freedom to buy, sell, and transfer all commodities across district and provincial boundaries. In particular, traders will be able to buy and sell basic soft commodities at unrestricted prices to all any agents of their choosing, effective immediately. Provincial governments will probably be prohibited from restricting inter-provincial or intra-provincial trade.
In parallel with these efforts the government will look to increase public sector productivity; the government will have to promise to undertake a public sector expenditure and investment review in order to promote the more efficient use of government resources. This review, which will be carried out in collaboration with the IMF or World Bank, when completed, will result in a comprehensive programme to improve fiscal efficiency, restructuring and privatisation of state-owned enterprises and strategic industries ie PIA, Pakistan Railways, Pakistan Steel, State Life Insurance Corp, Utility Stores Corporation, various Gencos and so on. Additionally, adjustments/rationalisations in government departments and ministries will be inevitable.
The Funds review will also be the basis for an accelerated programme of privatisation. Already, oversight of public enterprises will probably be moved to the Ministry of Finance or the Privatisation Board from line ministries. A clear framework will be established for the management and privatisation (either through share flotation or negotiated enterprise sales) of government assets which will probably include: (i) criteria for determining whether enterprises should be closed, restructured or fully privatised; and (ii) a transparent sales process that maximises the return to government and treats all bidders equally.
Within this framework, the government will aim to accelerate privatisation and to take decisive action to restructure or close poorly performing enterprises. In addition, further tranches of government-controlled shares in public enterprises which are already listed or privatised will be offered for sale, so that these enterprises, too, can be fully privatised. As for any enterprises that will remaining within the public portfolio such a Railways, clear profit and performance targets will be established, which will be made public and reported annually.
The above adjustments are what I feel - at a minimum - the IMF will ask for if we enter a new programme. While these structural adjustments will be difficult the combination of fiscal consolidation, structural reform and financial backstops will help Pakistan in the long run. These reforms will give Pakistan policy space and a way to escape the bad dynamics despite some output loss in the short run. In particular, reducing economic distortions, monopolies and capital inefficiencies will bread stronger economic growth and result in sustained optimal GDP. The importance of structural reform cannot be emphasised enough; it will help Pakistan escape from the bad dynamics it finds itself in. Last but not least, we must realise that financial backstops such as the IMF are helpful, but only to "buy time". This additional time must be used productively, for fiscal consolidation, institutional reform and structural reforms to bear fruit and move towards sustained progress.