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Economy in political transition

October 07, 2012

After over a weeklong consultative process on post-programme monitoring, the IMF, while disagreeing with Pakistan’s economic and fiscal projections, has focused on challenges facing the economy ahead of elections and political transition.

Among its most crucial concerns is the low economic growth cycle amidst growing population, crowding out of the private sector credit by government’s excessive borrowing, resultant inflationary pressures, sluggish revenue expansion and bleeding power sector.

This evaluation could have consequences for other multilaterals, bilateral lenders and private international investors who have been sitting on the fringes.

In discussions with the authorities, the IMF mission led by Mr Jaffrey Franks estimated, based on official data, that real economic growth would be around 3.2 per cent, far short of official target of 4.2 per cent.

In its public announcement, however, the Fund talked about a growth band instead of quoting a specific number. “Pakistan faced a challenging economic outlook.

GDP growth in 2012-13 is projected to be in the 3-3.5 per cent range, which needs to accelerate in order to absorb the growing labour force”.

Both the IMF and the Asian Development Bank have confirmed that official growth target of 4.2 per cent was simply unachievable even though the two institutions have come up with different GDP growth numbers. While the IMF dialogue with authorities was in progress, the ADB lowered growth forecast to 3.7 per cent.

While both the IMF and the ADB called for strengthening of reform process, there is almost consensus among independent economists that the PPP government could not be expected to deliver on reforms just ahead of elections. It is argued  that any meaningful reform process could take roots only when it is based on long -term political ownership starting in the first year of the next government.

The Fund has disagreed with major fiscal estimates for the current year that included power sector subsidies, provincial expenditures and revenue targets.

“Decisive and far-sighted action is needed to address this challenging outlook”, said the IMF. The two sides agreed on the need to contain the budget deficit to help lower inflation, reduce crowding out of private sector credit, and ensure debt sustainability.

“In our view, this requires significant corrective measures; the fiscal deficit is otherwise likely to exceed the budget target by a significant margin”, the IMF noted while putting .  the estimated fiscal deficit in excess of six per cent of GDP.

Insiders said the IMF questioned authorities’ ability to achieve revenue collection target of Rs2.381 trillion and noted that at best it would be Rs2.150 trillion at the end of the fiscal year, leaving a gap of over Rs230 billion or over one per cent of GDP.

The authorities, however, informed that a usual revenue growth would take Federal Board of Revenue’s taxes to Rs2.2 trillion while another Rs200 billion worth of additional measures would be introduced soon. That would also include a couple of tax amnesty schemes. The mission, however, did not take tax amnesty schemes in good taste.

The overarching view of the IMF mission was that whitening schemes in fact encouraged tax evasion in the long- term. To reduce fiscal deficit, both revenue  and expenditure measures will be required. On the revenue side, while appreciating some improvement in tax collection, it called for raising tax revenue through sustained policy measures and strengthened administration both at the federal and provincial level, including a significant step-up in the Federal Board of Revenue’s enforcement activities.

Likewise, the IMF team believed that given the election sentiment running the public finance, it was unlikely to restrict provincial expenditures within a Rs1.118 trillion limit.

On top of that, the IMF mission was very critical of the lack of power sector reforms resulting in continuous pressure on the federal budget.

In this context, the authorities informed the mission that while the government had estimated about Rs120 billion for power tariff differential subsidy in the budget, the target had been revised to Rs185 billion.

Based on feedback from the World Bank, the IMF mission said the power sector subsidy could not be contained below Rs250 billion and may go beyond Rs325 billion or another half a percentage of GDP in excess of budgeted target. It also noted with concern that power sector reforms – more importantly – strengthening of national electric power regulatory authority, central power purchase agency and power companies of Wapda – had shown negligible progress and hence the most critical challenge to federal budget remained unaddressed.

In its public statement, the IMF noted that untargeted subsidies should be reduced, while fully protecting the most vulnerable members of society through targeted assistance schemes. The Fund appreciated the resolve of the economic managers to prudently manage public spending, despite pressures associated with the electoral cycle and noted that same approach of fiscal restraint was equally important for the provincial governments, which now have increased spending responsibilities.

The mission appreciated the fact that inflation had fallen recently but feared its bouncing back in double digits by the middle of next year if corrective measures were not taken to reverse monetary financing of the fiscal deficit. At the same time, the IMF noted with concern that an underlying inflation remained high representing a regressive tax that disproportionately hurts the poor.

The ultimate goal of the State Bank of Pakistan (SBP) should be to bring inflation down significantly by using its policy tools.

On the back of stronger international oil prices and almost declining exports, the IMF noted weakening of the country’s external position. It said that while the current account deficit was not large by international standards, financial flows have weakened and central bank reserves have fallen.

The IMF concluded its assessment by saying that addressing macroeconomic imbalances will help supporting higher growth. It was in this context that the mission advocated once again for a comprehensive approach to reform to tackle power sector problems,  including full cost recovery, lower subsidies, improved governance, higher investments  and better regulatory performance.