Pakistan and the IMF: The ties that bind

We love to hate the IMF, but how much do we know about its genesis, its global operation and its history with Pakistan?
Published January 11, 2015

By Khurram Husain

Every time I tell someone that I am working on the history of Pakistan’s relationship with the IMF, there is one question that always comes up: “Is the IMF evil?”

There are many iterations of this question, but it always boils down to this: “They say once a country borrows from them,” said one particularly keen questioner, “that country can never repay the debt and remains in their clutches forever, is it true?”

I’m always struck by the level of fear and awe that the Fund commands in our popular imagination. It is run by the Jews, some say. It operates like a medieval money lender, it has usurious terms on its loans, nobody who falls in their clutches ever gets out. The better off try and connect it with some imperialist ambitions: it is a tool of US foreign policy, used to reward those who serve the imperial masters and punish those who disagree. It engineers the overthrow of governments and works in cahoots with the CIA, another told me rather insistently, brushing aside my questions that would cast doubt on the assertion.

 Protesters condemned conditions of the IMF on Pakistan and urged international financial institutions to write off Pakistan’s loans.— File Photo
Protesters condemned conditions of the IMF on Pakistan and urged international financial institutions to write off Pakistan’s loans.— File Photo

My answer to the question is always the same: no, the IMF is not evil, but it’s also not as innocent as it would like us all to believe. Does this mean that it is only slightly better than what popular imagination would say? No, the fact of the matter is actually far more humdrum than what popular imagination would like to believe. The Fund is actually just another bureaucratic body, trying to pursue an increasingly difficult mission, in an increasingly divided world.

The popular imagination in Pakistan is used to perceiving this country as permeated by foreign interests, a mindset that is in part a legacy of the many frontline roles the country has played in superpower campaigns. It’s also used to perceiving all government bodies with extreme distrust and an equally extreme disdain. International institutions that interact regularly with the government, therefore, find themselves sucked into the perceptions that arise from this distrust and disdain. 

And few international bodies have had a longer and more intrusive role to play in Pakistan than the IMF.

So what exactly has this long role been that the Fund has played in our economy?

Let’s start with the obvious. The IMF is an international institution created in the aftermath of World War II along with a whole number of other international institutions that were designed to help operate the post-war order that emerged from the ruins of the British Empire. Those institutions include the United Nations, the World Bank and the International Postal Union to give a couple of examples.

The IMF had a specific mandate. It was designed to help countries tide over temporary balance of payments difficulties. If the price of cotton collapsed in one year, for example, due to a bumper harvest in some other cotton producing country, small countries that relied on cotton exports to earn their foreign exchange would find their reserves of dollars deplete very rapidly. The depleting reserves would curtail their ability to pay for their imports which could end up crippling large sections of their economy if, let’s say, they couldn’t afford to make payments on oil imports any longer.

A small and temporary payments difficulty of this sort could cascade through the economy and create a much larger crisis, maybe even lead to default on external debt obligations. There needed to be, the architects of this new order agreed, some way for countries vulnerable to periodic balance of payments difficulties, to be able to borrow quickly to tide over short term problems without falling into a full blown crisis that could have international ramifications.

 Total exports per capita (in real terms)
Total exports per capita (in real terms)

Those were the good old days when the world was a simpler place. Pakistan borrowed three times from the IMF during the Ayub Khan regime, and each of those facilities was a short-term Standby Arrangement of exactly the sort envisioned in the original Articles of Agreement under which the Fund was created.

The more interesting borrowing history began in the 1980s. Those were the years the world economy was emerging from a debilitating decade of stagnant growth and high inflation that the 1970s became famous for. But the renewed global growth came at a cost. Many parts of the Third World, as it was known at the time, fell into a massive debt crisis, as the levels of their borrowing fast exceeded their ability to repay. Latin America was at the epicentre of that crisis, and by mid decade a massive effort had to be launched to ensure that the region did not default on its external loans, in part by urging those banks that had extended loans to them to soften the terms on which repayment would be made.

The Fund’s mission underwent an important change during that time. When the dust settled from the Latin American debt crisis, the Fund was no longer confined to lending only to paper over temporary balance of payments problems. From that point onwards, the Fund’s mission grew to include reviving economic growth in stagnant economies.

This was a critical turning point, and it carried the Fund deeper into the borrowing countries economic management than it had ever gone before. Reviving growth, it turned out, was a far more complex affair than simply papering over a temporary balance of payments problem. The Fund staff had to become party to the myriad and complex dysfunctions that afflicted the borrowing country’s economy, and the terms of its loans entered into areas that they had never imagined they would be entering.

From here on, the Fund found itself examining the budgets of every borrowing country and urging structural changes in the economy that they could not have done in the earlier times. Privatisations, trade liberalisation and altering the institutional architecture of the state were all far reaching requirements that the Fund began to insist upon from borrowing countries in this time.

This new and intrusive commitment is what sparked the first big criticisms of the IMF. In Latin America, the Fund was accused by left leaning critics of being a tool of Western capital, seeking to pry open the economies of the region for penetration by American companies seeking profitable terms of investment. In later years, the criticism was echoed from Africa as well.

The next big growth in the Fund’s mission came in the wake of the collapse of the USSR in 1991. As Eastern European countries lined up for bailouts, the Fund threw its weight behind the “shock therapy” programmes dreamed up by champions of free market thinking. The long and painful years of collapsing infrastructure and unemployment that followed were blamed on the Fund, and the kind of thinking it had embraced in its search to kick-start growth in “transition countries” of the former Soviet bloc.

In the late 1990s, the Fund found itself sucked into a new kind of crisis altogether, with the onset of the East Asian financial crisis. This was no ordinary debt crisis, nor a temporary balance of payments issue, and not an issue connected with transitioning from a centrally planned economy to a liberal market economy. The sudden drain of foreign exchange reserves that countries like South Korea, Indonesia and Thailand experienced in this crisis was the popping of a large bubble, and there was little to no guidance available within the economics profession on how to properly manage the aftermath of such an event.

Another critique of the Fund emerged following its bailouts of East Asian economies in this episode. It was championed by some of the biggest names in the economics profession, like Joseph Stiglitz, a Nobel Prize winner, who argued the Fund acted to safeguard the interests of western bond investors rather than the common citizenry of the countries in question.

And most lately, the Fund has again found itself in the middle of a new type of crisis, this time centred on the United States and particularly Europe. For the first time, the Fund departed from its traditional recipe for crisis management, and has advocated moving away from strict fiscal discipline as the main remedy for crisis, arguing that a rapid unravelling of the myriad stimulus schemes put in place in the aftermath of the 2008 financial crisis is undesirable, and that large economies such as Germany should shoulder some of the pain of rescuing smaller European economies like Greece and Portugal.

Pakistan’s story in the Fund

The interesting thing to note through all this is that none of the large critiques developed about the IMF applies to the case of Pakistan. Western investors are not exactly battering down the doors to gain access to our economy or its natural resources. Our financial system is hardly so large or so deeply connected with the global economy to present a risk to the international financial system, like was the case in East Asia in the late 1990s. We are strategically important to the superpower, but nowhere near as important as Russia was in the 1990s, or Eastern European countries were during the decade of their transition, nor has our opening up involved anywhere near the complexities that were involved in transitioning from communist to liberal capitalist systems in the former Soviet Union.

Our region too, has no sustained history of interaction with the Fund. India signed one facility with the IMF in 1991, Bangladesh has had three facilities since 1990, Sri Lanka has had two while Nepal has had three. Pakistan, by contrast, has had 12 IMF programmes since 1988, more than all the other countries of the region combined. Our story with the Fund is uniquely ours, it does not partake of any of the larger critiques developed about the Fund over the decades.

Even in the case of other South Asian countries, it is hard to employ any of the critiques of the Fund that have grown out of the experience of other regions in other times. The role the Fund has played in South Asia is fundamentally different from the role it has played in Latin America, Africa, East Asia, Eastern Europe or the European Union today. The nature of the crises in which it has had to intervene in South Asia is also fundamentally different from the debt crisis of the 1980s, or the foreign currency crisis of East Asia in the late 1990s, or overseeing the transition of post communist societies in the early 1990s, or the restarting of growth in the EU today. In short, the story of the IMF and Pakistan has been told very sparsely, and is not widely understood.

What exactly is this story?

One place where the story has been told is in a paper written in 2013 by two former Fund staffers of Pakistani origin that was circulated amongst a select group and is now available online from the website of the Asia Research Center at the London School of Economics. The authors are Dr Ehtisham Ahmad and Azizali Mohammad, both of whom have held senior positions in the Fund and have a reputation that is global in scope.

The paper’s title gives away the biggest clue: Pakistan, the United States and the IMF, great game or a curious case of Dutch Disease without the oil?

Right at the outset, we can see that they are casting the role of Pakistan IMF relations within the matrix of larger Pakistan-America relations. The subheading tells us more; Dutch Disease is a technical term used by economists to describe a situation where a country is used to easy money from a particular source — let’s say oil exports. The country in question is therefore unable to develop any other sectors of its economy or break its dependence on the stream of easy money flowing in through a single source. That, of course, is a gross simplification but in a nutshell describes the problem at hand.

Consider how Dutch disease works in a typical case. Take a country that exports oil, and the resultant inflows of foreign exchange are so large that its currency is very strong in comparison to that of its trading partners. People in that country will not be able to invest in manufacturing because whatever they produce will be so much more expensive that what they can simply import from abroad, rendering the country unable to develop an export base beyond oil and oil based products. 

Look at how the Gulf countries, for instance, have been utterly unable to build any economic sector beyond oil that is competitive globally, and you’ll understand how the phenomenon works.

Consider the impact this has on the host economy. With a narrow base for the economy, the country’s exports will remain stuck in one product, and the revenue base of the state will not grow either. So long as oil prices are high, in the example of the oil producing country we’ve taken, the government will be happy to accumulate plenty of reserves, generate ample revenue from the oil economy, and pay for imports to help sustain its consumption. High levels of consumptions will come easy to this sort of country, but only while international factors like high oil prices help pay for it.

In the case of Pakistan, the authors of the paper argue, the Fund’s role appears to have produced an effect similar to Dutch disease, except there is no oil or any other resource in the picture. The resource that has produced continuous inflows of easy money that prevent a broadening of the revenue base as well as hinder the accumulation of reserves through broadening of the export base, is what they call a “locational rent”.

In a nutshell, what this means is that Pakistan was too important to fail. During the 1980s, the country was too important a player in American foreign policy, and was kept afloat through generous aid programmes. When the aid dried up, the IMF stepped in and disbursements continued. Once the aid resumed following 9/11, the Fund became less important as a source of foreign exchange for Pakistan. 

Following 2008, a complex system was instituted to channel civilian aid with very high accountability mechanisms through the Kerry-Lugar bill. Military aid continued in the form of CSF “reimbursements”, and the IMF was engaged to provide balance of payments support to shore up the reserves. But at no point was Pakistan cut off from its continuous injections of external assistance, except perhaps for a brief period following the nuclear detonations in 1998, and even then the Fund came to the rescue with a small facility in 2000 that prevented the country from slipping into a balance of payments crisis.

This history of continuous injections from abroad inculcated a warped sense of priorities in successive governments. Rather than focusing on reforms to “mobilise domestic resources”, that is, to encourage tax reforms and encourage productivity to promote exports in a rapidly globalising world, the emphasis for successive governments came to be on ensuring the release of the next tranche of dollars from the Fund. And the Fund itself, under instructions from its patrons in the US government, readily obliged each tranche by going easy on the reviews and giving Pakistan a continuous series of waivers.

All of the 12 facilities that Pakistan has signed with the IMF since 1988 have had two objectives: one, to close the gap between revenues and expenditures in order to prevent the deficit from getting out of control and; two, to raise the level of the foreign exchange reserves. For almost a quarter century now, these are the two core priorities that Pakistan has been grappling with.

And every programme has had fundamentally similar conditionalities to achieve these objectives. Raising revenues has meant instituting new taxes on consumption, called the General Sales Tax, which is designed to help document the economy and broaden the base of the revenue machinery. Raising foreign exchange reserves has meant boosting export competitiveness, and freeing the currency from political influence.

In order to achieve these objectives, it was considered necessary to reform the tax machinery and to grant autonomy to the State Bank to manage the reserves. Each programme that Pakistan has signed has tried to accomplish these objectives, but in every case the authorities have been unable to follow through with their commitments. The authors of the paper mentioned earlier refer to “10 red cover reports on tax policy and administration” that were developed over the decade of the 1990s to little avail. The tax code remained moth eaten, riddled through with exemptions and the tax bureaucracy remained as uninterested in pursuing documentation and implementing a transparent sales tax as it ever was.

Same was the story with State Bank autonomy, except for a brief period in the 1990s again, but which became outmoded in the years following 9/11. To this day, the government remains hesitant on this measure, unsure how to follow through on this commitment without giving away the important controls it exercises over the central bank for purposes of borrowing as well as setting the currency and managing the reserves.

A careful look at the IMF and its role in Pakistan over the decades shows that the Fund is certainly not evil, as the popular imagination would like to believe. But it also is not the purely technocratic “lender of last resort”, coming in with purely economic advice in times of crisis either. In fact, the Fund appears to be responding to political compulsions as much as to its own bureaucratic interests when dealing with Pakistan.

Nobody in the world wants to push an unstable, nuclear armed country too hard on difficult economic choices. Such a course of action was indeed adopted against other countries, most notably Sudan in the mid 1980s, when it was unplugged from the global financial system once the IMF refused a bailout. That country slid into unviability very fast and was engulfed by civil war within a decade. Nobody wants to risk similar consequences with Pakistan. So it’s a lot cheaper to keep the country afloat with a couple of billion dollars a year in subsidised inflows, whether through formal aid channels or through the IMF.

But the very fact of keeping the line open, of keeping the country afloat, ends up underwriting a status quo that is increasingly becoming unsustainable, as the expenditures required for the upkeep of the state increasingly outstrip revenues, and the shortfalls on the foreign exchange inflows increase every year. So Pakistan presents the international community with a difficult choice: how to deal with a country that uses its own instability as a bargaining chip for larger and larger bailouts, that would prefer to keep living on bailouts instead of reform domestically and fundamentally rewrite the rules of engagement between the state and the economic elites?

 Loud and clear.
Loud and clear.

Within Pakistan, there is no constituency for change, the rhetoric of some parties notwithstanding. Given the ferocity with which power struggles are waged domestically, nobody, not even military governments, have had the space to attempt to rewrite the social compact between ruler and ruled, which means first and foremost the economic elites. With no constituency for change, the status quo has found new ways to defeat any attempts at reform. So documentation of the economy has not happened, the base of exports has not broadened, the institutional architecture of the state has not been reformed to close of discretionary spaces of decision making. In short, the rulers have always opted to retain the tools with which to reward allies and punish enemies, rather than move to boost productivity and generate revenues.

What this means is that the IMF’s role has been to underwrite the status quo more than the urge to reform. This is a very different role to what it has played in other regions in other times. Contrary to what the popular imagination has conceived, the Fund has worked to give Pakistan exactly what it wants rather than hoist difficult choices upon the state, and by doing so has stalled any possibility of change. It has not done so because it is evil.

Quite the contrary, it has done so because it is powerless before the larger interests that operate with the country, and the international partners, particularly the superpower, that would prefer to keep the country chugging along rather than risk any semblance of instability. The Fund is, therefore, not some powerful international agency pushing a foreign agenda upon us. Instead, it is a toothless bureaucracy trying to keep its head above water in the stormy seas that Pakistan is drifting upon.

Published in Dawn, Sunday Magazine, January 11th, 2015

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