“THE best is the enemy of the good” — a saying Pakistan’s pre-eminent economist, Dr Mahbubul Haq, often repeated. As Pakistan and the International Monetary Fund (IMF) move closer to signing an agreement for a three-year programme, both would do well to heed this practical advice.
Currently, the remaining points of contention are more regarding the pace and sequencing of short-term stabilisation measures, and not the fundamental reforms that need to be undertaken, on which there is broad agreement.
The government has been rather slow to fully comprehend the precarious macroeconomic situation it has inherited. The continuing rapid decline in foreign exchange reserves, at almost $1 billion a month, even after considerable replenishment, is stark proof that our current account situation still remains of considerable concern. With large debt repayments due over the next few months, the situation could turn alarming.
The government’s recent mini-budget, though well crafted, lacked the strong thrust needed to indicate that it was serious about raising revenues or cutting expenditures. Unsurprisingly, the IMF, the rating agencies and our macro-economy experts viewed it as falling far short of what the critical economic situation demands.
An agreement, based on realistic terms, should be struck soon.
The IMF therefore may be right in demanding a sharper contraction in aggregate demand to reduce the pressure on the current account deficit. It has reportedly suggested reducing the fiscal deficit sharply by almost two per cent this year and 1pc in the subsequent two years. This demand contraction will have a strong deflationary impact on the economy and GDP growth could fall to 3pc this year and recover to just over 4pc next year. This would be a painful pill to swallow.
Instead, what the government should argue for is a less severe contraction on the grounds that, if undertaken at the level proposed, this would smother the growth potential it is trying to build. The government should also insist on a safety net to cushion the impact of this contraction by asserting that a significant part of this proposed decline in the fiscal deficit be transferred as a fund to finance income support measures for poor households, including financing for housing projects. Since these expenditures cater to the poor, the import impact of these measures would be almost negligible.
What may remain an obstacle in coming to an agreement would be the energy price adjustments the IMF will likely insist on together with the removal of all subsidies, which are constantly adding to Pakistan’s mounting circular debt.
Here, the IMF must realise that removing the entire, or almost all, subsidy on fuel prices in one stroke would be a well near impossible task to ask of any elected government — especially a newly elected democratic government in its first few months in office.
At best, the government could agree to an initial price increase in the range of 12–15pc (while exempting the poorest consumers), with the rest staggered over the next 12 to 14 months. These subsidy reductions, the government should insist, would form part of an integrated plan supported by the World Bank and Asian Development Bank (ADB) to upgrade infrastructure for reducing line losses and measures to reduce theft and other losses.
That said, some of the measures the IMF has reportedly demanded to stabilise foreign exchange reserves, including not using foreign borrowings to support the exchange rate, will cause considerable uncertainty if implemented. Most worrying, it will give rise to wide short-term fluctuations as well as the constant threat of depreciation. For the present, it would be much more sensible to leave the decision as to when (and when not) to defend the exchange rate to the State Bank, to which the current government has allowed a strong degree of autonomy.
An agreement with the IMF, which the government is now moving towards reaching, should be struck sooner rather than later. Such an outcome will help focus the government’s attention on implementing its plans and promises rather than worrying constantly about finding ways to plug the foreign exchange gap.
The government must realise that it still enjoys enough good will among the populace, who broadly recognise that the current economic predicament is not of this government’s making. Six to nine months on, this good will may have shrunk, making the government’s ability to implement such measures more tenuous.
An IMF agreement will also go a long way in attracting greater response and on better terms and conditions in global financial markets and from the World Bank and ADB to finance structural reforms.
As to the IMF, it too must move towards a less rigid position — even if, in the crunch, this needs a slight nudge from some old re-emerging friends.
The writer is professor at the Lahore School of Economics and former vice chancellor of the Pakistan Institute of Development Economics.
Published in Dawn, February 13th, 2019