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Adjustment and its discontents

Updated October 18, 2018


The writer is a member of staff.
The writer is a member of staff.

NOW that the negotiations with the IMF are set to begin in earnest, some things are worth bearing in mind as the process moves along. Every government that has walked the path of adjustment that the PTI government is about to embark upon has paid a heavy political price for it.

The reason is simple: adjustment requires the government to sharply increase revenues, curtail spending and bring the fiscal deficit down to a stipulated target. At the moment, the government is telling us that the deficit is running at almost seven per cent of GDP and the target for this year was to bring it down to 5.1pc, which means an adjustment equal to 1.9pc of GDP.

Take a look: Why Pakistan will go to the IMF again, and again and again

This is huge, and it is entirely likely that the IMF will need this to be raised further, meaning the scale of the adjustment could require the government to bring the deficit down to less than 5pc of GDP before the end of the year. In past programmes the Fund has followed a rule of thumb that the fiscal deficit cannot be larger than the growth rate, which is projected to fall to 4.8pc this year as per an Asian Development Bank projection.

Bridging the deficit means more taxes and expenditure cuts. The Fund has already pointed at power and gas tariffs, and once the programme gets going in earnest, regulatory duties on imports will also be frowned upon.

Every government faces a steep political price for undertaking economic adjustment, but each responds differently to it.

The FBR’s idea of serving notices to non-compliant individuals, who are visibly leading a high-consumption lifestyle, is a welcome development only as a routing enforcement action, not as a revenue earner. So if the government thinks that these notices being sent out by the field formations are a way to raise revenues, they have another sharp learning curve ahead of them.

The only elastic revenue lines, those that can yield revenues quickly, are taxes on utilities, rise in income tax and the sales tax rate, as well as the penalty tax on banking transactions of non-filers. Some combination of these is going to have to be used to raise hundreds of billions of rupees in the weeks to come. It doesn’t help that the fund negotiations will end midway through the fiscal year, so the time in which to meet the first year’s target will be limited, meaning the adjustment required will be sharper still.

The fiscal side is not the only one where and adjustment is going to be required. Some action has already been seen on the exchange rate, and there should be little doubt that more is to come. At the moment, from what bankers tell us, the State Bank has let the rupee find its own value. This is a healthy development, but in days to come as the reserves further decline before stabilising, there is likely to be further downward pressure before a stable level is reached.

The consequences of both these developments always lands up in the price level, or inflation. The PPP government had the misfortune of having to implement a very sharp adjustment at the outset, and inherit the highest inflation level in the country’s history (the CPI hit 25pc in those days).

Growth dropped to below 2pc. Businessmen were so weighed under the costs of evaporating demand (domestic and international since that was the aftermath of the global financial crisis of 2008), coupled with the highest interest rates in well over a decade, that there were almost daily reports of ‘factory fires’ that those of us reporting on knew were deliberately set to activate force majeure clauses in bank loans and get an insurance refund on the investment.

Back then the government made matters worse by avoiding an approach to the IMF until the crisis broke in earnest. The financial markets nearly shut down, capital flight of foreign exchange was at a peak and a near run on rupee accounts was beginning. Some companies were actually withdrawing their working capital to hold as cash out of fear that rupee withdrawals might be frozen. It was probably the closest we’ve ever come to a banking crisis, at least since 1970.

This government wisened up faster, and asked for a bailout before matters escalated to crisis levels. Some people have expressed surprise at my claim that there is, at the moment, no crisis in Pakistan. Let me clarify that the operative words in that claim are ‘at the moment’, because things are certainly moving in that direction.

What happened on the stock market last Monday, followed by the currency markets the day after, was a trailer of what a crisis actually looks like. For the full movie, feel free to preview day-to-day developments back in November 2008, when the State Bank was forced to adjust statutory liquidity rations in a desperate bid to prevent a systemic liquidity crisis in the banking system as overnight lending rates shot up so high that many smaller banks were quite literally at risk of facing a run. The situation was at such a critical point that the bailout money from the IMF arrived first (in November 2008) while the letter of intent was released later (in February 2009).

It might be the only time in Pakistan’s history that this happened. Things could come to that this time too, but timely action seems to have averted it (touch wood that prudent decision-making will continue).

Every government faces a steep political price for undertaking economic adjustment, but each responds differently to it. One temptation is to shoot the messenger who brings bad news, that such and such programme has to be discontinued, that a given request for resources has to be declined, etc. There is a temptation under these circumstances to shoot the messenger. And that is the biggest lesson for Finance Minister Asad Umar to bear in mind as he moves forward with crafting and implementing the adjustment agenda.

The writer is a member of staff.

Twitter: @khurramhusain

Published in Dawn, October 18th, 2018