After months of speculation, Pakistan has finally signed yet another loan agreement with the IMF — its 16th, and the biggest ($6.7 billion) one after the 2008 loan of $11.2 billion.

Earlier agreements were plagued by controversial loan conditions and premature exits, as Pakistan was unable to meet important requirements. Will this loan be different? Early signs suggest not.

The agreement contains several sensible conditions, such as those relating to strengthening tax administration system. However, there are also many undesirable conditions that reflect commendable underlying principles (e.g. fiscal discipline), but which contain overly prescriptive and inappropriate details.

The conditions included five prior actions that Islamabad took before the loan approval, and a dozen-plus structural benchmarks that Pakistan must attain within 12 months under its fiscal, monetary, financial and structural policies.

One prior action dictated the net purchase of $125 million by the SBP from the local foreign exchange spot market. This contributed partially to the rupee recently declining to around 110 to a dollar, which fanned fears about the economy’s dollarisation and cost-push inflation, as the value of imports increased significantly.

Unsurprisingly, the SBP had to reverse gears to steady the rupee. Ostensibly, the depreciation could boost exports. However, this is highly uncertain, given the severe supply-side constraints faced by exporters like power shortages and insecurity. Furthermore, other loan conditions mentioned below increase production costs and reduce the benefits from the rupee’s depreciation.

The goal to enhance the SBP’s reserves was sensible, since foreign exchange reserves had fallen well below the prudent benchmark of covering three months of imports. But the specific tool recommended — i.e. local dollar purchases — risked a sudden rupee depreciation and cost-push inflation.

It would have been better to increase reserves by front-loading the IMF’s loan distribution beyond the modest first installment of around $550 million. This was something the IMF was loathe to do, given Pakistan’s track record in implementing loan conditions when disbursements had been front-loaded.

However, in trying to ensure Pakistan’s compliance by limiting disbursements and demanding excessive local dollar purchases by the SBP, the agreement ran the risk of inflicting more damage than would have emerged from possible non-compliance after receiving a large initial disbursement.

Another prior step and a structural benchmark related to increasing sales taxes and power prices to reduce the large fiscal gap. Again, the government, under court pressures, had to recently reverse some of these increases. This loan condition was again based on laudable underlying principles, but erred in its details.

Pakistan must certainly reduce its yawning fiscal deficit, despite the current economic stagnation where fiscal consolidation is often avoided. However, the indirect tax increases and subsidy withdrawal measures included in the loan agreement will increase inflation and the cost of production, thus perpetuating economic stagnation.

On the other hand, there are several other avenues available for Pakistan to plug its fiscal gap that will better protect economic growth. They include increasing direct taxes, eliminating public sector enterprise losses and reducing tax leakages, which together could easily deliver the 5-6 per cent decrease in the fiscal deficit required by the IMF in three years.

Another structural measure relates to tightening the monetary policy and increasing interest rates in order to dampen inflation. This, again, is a debatable measure. On the one hand, the loan conditions are fanning cost-push inflation by increasing indirect taxes, eliminating subsidies and depreciating the rupee. Then, as if to make amends for these follies, the agreement attempts to dampen inflation through interest rate increases.

However, inflation is increasing due to cost-push factors. Thus, attempts to dampen cost-push inflation through demand-dampening measures, which are effective against demand-pull inflation, may not succeed. They are more likely to perpetuate stagflation, as inflation increases due to cost-push factors while demand, and thus economic growth, is reduced due to tighter monetary policy.

One structural measure aims to “give the SBP autonomy in its pursuit of price stability as its primary objective, while strengthening its governance and internal control framework, in line with the Fund staff’s advice”.

Again, the benefits of a laudable underlying aim — SBP autonomy — are lost by inappropriate details. If the goal is to enhance the SBP’s independence, why is the SBP being constrained to adopt price stability as its primary objective by the loan conditions and that too “in line with the Fund staff’s advice”? This condition seems even more bizarre in this period of economic stagnation and milder inflation in Pakistan.

Central banks the world over, including highly conservatives ones like the European Central Bank, are trying to pursue economic growth while putting price stability on the back-burner, given weak national economic growth.

It seems that the IMF’s real intention is not to make the SBP independent, but to transform it from being subservient to the Pakistani government to being subservient to the IMF and its underlying macroeconomic outlook, which has been discredited increasingly around the globe in recent years.

The IMF staff also often strays way beyond its narrow area of expertise, i.e. macroeconomics. Loan documents contain several negative IMF comments related to the policies of the judiciary, the recent devolution package, and relations with India. It is difficult to see how the IMF staff feels emboldened to dispense advice on all these political issues when their advice even in their core macroeconomic area of expertise is so much under criticism around the world.

It is becoming increasingly clear that the attempts by donors to use IMF loans as a way of forcing developing countries to adopt appropriate economic policies does not work. IMF loans are taken when these countries are already in bad economic shape. Thus, the adoption of austerity measures by such countries under Fund loans further undermines their economic performance when they can least afford it.

It is time for donors to come up with approaches that encourage required adjustments when developing countries are doing well economically and abandon the use of the IMF as a disciplining institution during downturns.

The writer is a political economist at the University of California, Berkeley.

murtazaniaz@yahoo.com