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Crisis fears mount as IMF talks tough

December 03, 2012

-Reuters Photo

KARACHI: Going by the language the International Monetary Fund is using these days, it looks like Pakistan might soon be crying uncle all over again. On the day when the top guns of Pakistan’s economic team, led by the Finance Minister, began their strategic dialogue on finance and economy after an 18-month interruption, the IMF released one of its most strongly worded notes on the state of Pakistan’s economy and the steps required to avert the dangers it is facing.

The note contains some of the harshest language the IMF has ever used in describing Pakistan’s economic management, at times even appearing to criticise itself by pointing out that going forward, there is a need for “better analysing the risks to the programme”.

Most people now agree that the growing precariousness of the country’s foreign exchange reserves makes another IMF programme an inevitability, and this is really what the “strategic dialogue” is all about. The IMF has made clear that “strong ownership and securing broad political support” for the required reforms will be critical, a clear indication of the Fund’s reluctance to deal with an interim government as it is unlikely to bring either of these two key ingredients to the table.

As the election calendar unfolds, ownership of economic problems and political support for the tough decisions called for in the policy note are set to weaken. Once an interim government has arrived, the window for a major strategic economic decision will close. The political calendar then sees the conduct of the elections, followed by the start of coalition parleys, followed by the election of a new prime minister. Then comes the formation of the new cabinet, after which the window for a major strategic economic decision will open one more time. By that time we could be well into July.

“I don’t expect an early programme,” says Sakib Sherani, who served as Principal Economic Adviser to the former finance minister and has dealt closely with the IMF in the past. But Mr Sherani adds that should the reserve position see a rapid deterioration, it might force the Fund’s hand.

The fear at the moment is that Pakistan could drift towards a serious economic crisis, driven by critically low foreign exchange reserves, precisely when it is paralysed in the midst of a major historic transfer of power. The best way to avert this is to get onto an IMF programme before the curtain drops on the present dispensation. But the Fund appears to be setting the bar very high for a government famous for its indifference to economic problems. “They will insist on prior actions this time” says Shaukat Tarin, the former finance minister who led the negotiations for the last programme Pakistan signed with the IMF in 2008.

That programme was heavily front-loaded — meaning that a large proportion of the money was released up front, with expectations of policy reform to come later. According to the IMF, implementation of that programme was “initially good, but remained incomplete thereafter”. Translated into plain English, it means that Pakistan took the money and ran.

That memory lies behind the harsh language in the IMF note, and the demand for prior actions before any funds are released.

But what might these prior actions be? The note talks about “short-term revenue and expenditure efforts” like broadening key taxes and ending subsidies.

It also calls for an end to a monetary policy that “has accommodated large fiscal deficits”.

“After the walkout from the last Fund programme, the government has gone ahead with massive tax breaks,” says Dr Hafeez Pasha, a former finance minister. “The IMF is saying ‘please go back to the tax system as it was’.

In addition, the Fund has called for a “more prudent monetary policy”, a “substantial fiscal adjustment” and “more exchange rate flexibility”, meaning devaluation of the rupee.

BANKING ON US: Is this realistic given that the adjustments required as prior actions carry steep political costs? Shaukat Tarin agrees that the political economy is stacked against these “prior actions” and says Pakistan will therefore “lean on the US to ask for lenient treatment”.

“If the IMF wants to move on merit alone, they will ask for prior action, but America has tremendous influence and can change that,” he says. And he should know. Pakistan has reportedly received help twice from its superpower patron in past dealings with the IMF.

Some indications of what the IMF could face in trying to pressure Pakistan came during the outgoing week when the White House said that it “strongly objects to the certification requirements” that Congress sought to place on disbursements from the Coalition Support Funds, saying these requirements come at “a particularly sensitive time” and can put at risk “the success of our campaign in Afghanistan”.

If the White House can tell Congress to back off from pressuring Pakistan, where does that leave the IMF? Perhaps it is with this in mind that the IMF has released a harsh assessment at precisely this time. “This report will make it harder for the IMF executive board to justify lending resources to Pakistan with the status quo,” says Sakib Sherani, who agrees that the demands being laid out are politically unfeasible at the moment.

By tying its own hands early in the negotiations, the IMF may be building a case to tell the US that continued indulgence of Pakistan’s refusal to reform is harmful for everybody’s interests. The IMF may be battling to save its credibility as a financial institution by putting out this note, but the stakes are highest for Pakistan.

A continued erosion of reserves carries severe risks of a spiralling economic crisis in the midst of a political transition. “The lack of a quick resolution on a new programme with the IMF could influence when elections are called in Pakistan,” says Sakib Sherani.