What next?

February 28, 2020

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The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.
The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

IT is said that if you leave Argentina and come back 20 days later, everything has changed; but if you come back after 20 years, everything is the same! This tragically apt joke can easily be as true for Pakistan. The lack of progress for decades on a wide range of policy as well as institutional and structural issues has been the hallmark of the country’s anaemic efforts at reform.

In our latest tryst with an IMF programme, our 23rd since 1950, despite near-fatal programme design weaknesses, there appeared to be hope that Pakistan would finally move the needle on wide-ranging reform. The prime minister was personally invested in the decision to go to the Fund for a bailout, and has been as, if not more, committed than any other leader of the country in seeing a tough, conditionality-laden programme through. But barely into the second review, the prime minister appears to have pulled out a white flag and put the brakes on remedial measures and prior actions needed for the Fund staff to take Pakistan’s case to the executive board.

The remedial measures are in the form of new taxation measures designed to staunch the ever-growing shortfall in FBR’s tax collection versus target under the programme. The prior actions appear to include resuming the ‘automatic’ quarterly adjustments in electricity tariffs and notifying the pending gas tariff increase.

How did we get here so quickly? Persistently high inflation, especially food inflation, coupled with a sharp slowdown in the economy has exerted pressure on the government. The massive taxation measures undertaken so far under the Fund programme, and the prevailing high nominal interest rates have had the business community up in arms. Commentators in the mainstream media have added their shrill voice to the growing chorus of criticism of economic policy — easily (and unscrupulously) switching from their earlier censure of the PTI government for not going to the IMF quickly enough to denunciation for following the Fund’s ‘disastrous’ dictates.

The IMF programme appears to have been paused, not derailed.

All this has understandably generated pressure on the government and, by extension, on its behind-the-scenes patrons. Nonetheless, the epicentre of the stress on the prime minister is not just the economy. As a consequence of the post-crisis stabilisation path that an economy under an IMF programme takes, with the pain of adjustment compounded by a long, rough road to recovery, the economic pain is inevitably transmitted to the political sphere. As the government has begun to experience an erosion of political capital and its perceived ‘legitimacy’ to govern, it is facing heat not just from its constituents and supporters, but also from fickle allies.

In short, the under-stress economy has put further strain on a wobbly political coalition. With a thin majority, the PTI government’s travails are showing in the loss of confidence exhibited in the body language as well as tone and tenor of the prime minister’s speech.

What can the government do to salvage the situation? Not continuing with the Fund programme is hardly an option — not because it is our best hope for reform, but because it is holding together the entire edifice of external financing from multilateral, bilateral, commercial and market sources that Pakistan so desperately needs over the next three years to make good on its maturing obligations. In addition, any unravelling of the Fund programme will bring a quick end to the hard-won stability of the external account. The resulting pressure on the rupee will unleash a second episode of inflation — precisely of the kind the government is so desperately trying to avoid. However, continuing with the programme will mean more political downside for the government.

The via media that appears to have been adopted by the prime minister is a clever one. On current trends, it is likely that headline inflation will begin to unwind from April onwards. By waiting for a noticeable reduction in inflation, to be followed by a cut in the policy rate by the State Bank by June, the government can buy itself time and some political space before resuming the adjustments under the IMF programme. If this is indeed the case, the government needs to improve its strategic communication to the markets, and signal this as a pause rather than a complete break with the IMF.

As a related aside, the notion that the IMF programme offers the best hope for reform is a thoroughly misplaced one. As I indicated in my critique of the IMF programme design at the State Bank two weeks ago, the structure of a typical Fund programme is meant to act more as a triage for a crisis-beleaguered economy than a roadmap for meaningful structural reform. One large part of the problem is that the standard programme is dominated by policy and price adjustment action, which rarely attack the underlying structural and institutional fault lines in the economy.

If price adjustments alone could substitute for structural and institutional reforms, Pakistan would have been a star reformer since 2008. With dozens of electricity tariff adjustments since then, cumulatively amounting to 172 per cent for the B1 industrial slab, the circular debt in the power sector has increased from Rs150 billion to Rs1,900bn. Pakistan has ended up with the worst of both the worlds.

Additionally, in our case, the two near back-to-back recent Fund programmes, 2013-16 and the current one, have established a negative feedback loop in at least one important area. In the case of tax reform, by anchoring the programme in an impossible upfront tax collection target, the programme has precluded serious reform of FBR and incentivised short-term collection measures, which have almost always tended to be sub-optimal.

The unintended consequence of this design flaw has been to burden formal, already-documented firms and widen the ‘tax arbitrage’ between the formal and informal sector, thus incentivising informalisation and narrowing the tax base even further. If there is indeed a pause, one hopes the IMF can tweak the programme to include greater structural conditionality — while Pakistan gets its act together viz its own reform plan.

The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, February 28th, 2020