Tuesday, December 16, 2008

Pakistan to Swallow IMF's Bitter Medicine

The International Monetary Fund (IMF) has approved a 23-month, US $7.6 billion loan to Pakistan in November to avert a severe current accounts deficit and Pakistan's debt default. On November 27, the IMF released to Islamabad a first installment of $3.1 billion, in it first "bailout" of an Asian country during the current world financial crisis.

Prior to this news, Pakistan's President Asif Ali Zardari knocked on many doors and begged unsuccessfully for billions of dollars in assistance for months from "Friends of Pakistan" (FOP), a group of countries including China, Saudi Arabia and the United States. This was part of an effort by Pakistan's new president to avoid going to the International Monetary Fund (IMF).

Why did the FOP decline to help? Why was Mr. Zardari trying to avoid an IMF bailout? Let's try and examine the answers to these two important questions being asked.

Friends of Pakistan:

Being friends, the FOP know a lot about Pakistan and Mr. Zardari. They have been watching Pakistani economy's return to the bad old days. While each of the friends genuinely wants to help in stabilizing Pakistan's economy, they have major concerns about the need for transparency and fiscal discipline before committing their money to help their friend. Given Mr. Zardari's reputation as Mr. Ten Percent, they are reluctant to write checks with no strings attached. In other words, they want to trust but verify, an objective that seems achievable if the IMF is involved in closely supervising Pakistan's budget, spending and economy.

Avoiding IMF:

Mr. Zardari has tried to avoid borrowing from the IMF for several reasons. For example, he does not want any one watching over his shoulders as he transacts business as usual. Another reason is that the IMF imposes tough conditions and budgetary restrictions that are usually unpopular and hurt the democratic government's chances of staying in power. The IMF makes the system of political patronage in a feudal society more difficult, if not impossible. Pakistanis have bitter memories of the IMF austerity programs implemented by the PPP and Pakistan Muslim League (Nawaz) governments in the late 1980s and 1990s. Fearing a hostile public reaction and not wanting to accept a further loss of Pakistani "sovereignty" under conditions where the US is routinely carrying out military operations within Pakistan, the PPP-led government long hesitated in seeking a loan from the IMF. Earlier, President Musharraf's government had ended Pakistan's dependence on IMF by economic reforms that created confidence in Pakistan's economy and brought significant foreign investments to Pakistan. That confidence has disappeared after Musharraf's departure from the scene.

IMF's Tough Conditions:

1. Pakistan's central bank must tighten money supply. In order to pave the way for the IMF loan, Pakistan's central bank raised its bank lending rate in early November by 2 percentage points to 15 percent and the state bank has let it be known that a further 1.5 percentage point hike will be implemented in January. The justification for such high interest rates is the high inflation rate in excess of 20% in Pakistan, mainly due to high food and energy prices. Removal of subsidies is making it worse, in spite of declining world oil prices. Tighter money supply will almost certainly hurt businesses, consumers and overall employment, forcing a major recession. According to an Asia Times Online report, Anjum Nisar, the president of the Karachi Chamber of Commerce and Industry, has said, "Pakistan's industrial landscape may soon be marked with dead and sick units and there will be massive unemployment because of the devastating impact on businesses of the higher cost of bank loans arising from the interest rate increase." The liquidity crunch resulting from IMF's tough conditions will turn the already precarious situation of Pakistan's poor daily wage earners into a disaster. Increase in hunger and poverty will hurt Pakistani government's ability to fight Islamist insurgency and maintain peace and stability.

2. Pakistan government must cut spending and raise taxes. The IMF economic stabilization package calls for the government's annual budget deficit to "be reduced from 7.4 percent of GDP in 2007/2008 (July-June) to 4.2 percent in 2008/2009 and 3.3 percent in 2009/2010." The IMF added, "This fiscal adjustment will be achieved primarily by phasing out energy subsidies, better prioritizing development spending, and implementing strong tax policy and administration measures." This condition will also lead to a deep and prolonged recession in Pakistan.

3. The IMF wants Pakistan to raise tax revenue from the present 10 percent of gross domestic product (GDP) to 15 percent by 2013. Neighboring India's total tax revenue, including levies on income, imports and sales, also amounts to less than 10 percent of GDP now. In China, the figure is 20 percent, and among the members of the Organization for Economic Cooperation and Development it averaged 37 percent in 2001. As part of a plan to increase tax revenue, the IMF is pressing Pakistan for the introduction of a tax on agricultural income. Pakistan's large landowners have tenaciously resisted such proposals in the past. Should Islamabad ultimately impose a tax on agricultural income, it will only be after a bitter struggle within the Pakistani feudal ruling class over how to design it to be regressive to make small producers bear a disproportionate share of the tax burden.

4. IMF does not require defense spending cuts, further exacerbating the economic impact on ordinary citizens. The IMF, which is controlled by the US and other western powers, made no demands for cuts to Pakistan's massive military budget. Juan Carlos Di Tata, IMF senior special adviser for the Middle East and Central Asia, expressed concern about the rise in Pakistan's defense spending, but then added that the question of Pakistan's military expenditure had been excluded from the bank's negotiations with the country's Pakistan People's Party-led coalition government. "The issue of defense spending was not discussed during the program negotiations," said Di Tata. "Defense spending is basically an item that was determined by the government and included in the budget projections for this fiscal year. There was no discussion of this topic."

What's Next:

According to the IMF, even after last month's IMF loan, Pakistan will need another $20 billion "to get control over its imbalances." The FOP are scheduled to meet January 13-16 to decide on additional non-IMF assistance to Pakistan. Most likely, they will want IMF to continue supervising Pakistan's economy as a condition for their assistance.

While the US economic revival is planned with multiple stimulus packages, near-zero interest rates and tax cuts to increase liquidity for government, business and consumer spending, it seems the IMF prescription for Pakistan is quite the reverse. It is a basic economic fact that raising taxes does not increase revenue during a slowdown. Rather than close the budget gap, attempts to raise revenue cause a downward economic spiral. Instead of softening the impact on businesses and consumers, the austerity measures will clearly hurt the average and poor Pakistanis disproportionately and cause a great deal of suffering leading to greater political instability in the country. An unstable Pakistan is in no one's interest. But,what is good for the goose is apparently not good for the gander, according to the IMF's perverse logic.


Diganta said...

All of IMF's conditions are in its own interest, i.e., to get the money back. So, no surprise on that front.

Riaz Haq said...

Unfortunately, the IMF's unreasonable conditions will make it more difficult to revive Pak economy. IMF's recipes usually make recipient nations deadbeat and dependent on more handouts from IMF and World Bank.

Diganta said...

It's an illusion that IMF does "good" to an economy. IMF, like all other lender institutions, serves only its purpose and does no charity. Whether Pakistan can align itself to the causes of IMF, is what needs to be seen.

Anonymous said...

I agree, IMF does no good to any economy. From an Indian point of view, I feel that Pakistan's first priority should be to revive its economy & attract foreign investors. Open your economy towards free markets. And you need to work towards being a 'safer' country. That will bring in more investors. Yor second challenge should be Taliban. India & Kashmir should take a low priority as we do not threaten your existense. but your faltering economy & Taliban do.

Riaz Haq said...

Here's a Dawn story about the duplicity of Pakistan's "democratic leaders" published Jan 16, 2009:

ISLAMABAD: While publicly it criticizes former President Musharraf for the present economic mess, the government in its official documents has appreciated the economic policies of the previous regime that became a strong base for seeking loans from multilateral donors and friends of Pakistan.

The PPP-led coalition partners have been blaming Musharraf regime in public speeches for fudging economic figures to paint a rosy picture, while its overall policies pushed the country into economic crisis.

The letter of intent (LoI), on the basis of which, Pakistan sought the much-needed $7.6 billion bailout package from the International Monitory Fund (IMF), has bit by bit appreciated the Musharraf policies since 2000.

During the past one decade (1999-2007), the LoI says Pakistan’s economy witnessed a major economic transformation from substantial increase in the volume of gross domestic product (GDP) to greater international trade.

Talking to Dawn on Thursday former Finance Minister Ishaq Dar said whatever he said about the health of economy was based on the balance sheet existed on March 31, 2008. He said the balance sheet was dully approved by the then cabinet headed by Prime Minister Syed Yousuf Raza Gilani.

He said no body denied the contents of the balance sheet. The focus of the previous economic policy was on promotion of consumerism without supporting the industrial base.

Apparently not willing to agree with the LoI contents, he said though he has a different view of the past economic growth but quickly added the same was destroyed in the last 15 months of the military led dictator.

An official source requesting not to be named said the economic wizards in the finance ministry are not politicians to make only speeches but they have to look into ground realities. ‘We reported to IMF whatever is factual and based on evidence,’ the official added.

The LoI said the country’s real GDP increased from $60 billion in 2000-01 to $170 billion in 2007-08 with per capital income rising from under $500 to over $1000. During the same period, the volume of international trade increased to nearly $60 billion from $20 billion.

For most of this period, real GDP grew at more than 7 per cent a year with relative price stability. The improved macroeconomic performance enabled Pakistan to re-enter the international capital markets in the mid-2000s. Buoyant output growth, low inflation, and the government’s social policies contributed to a reduction in poverty and an improvement in many social indicators.

Former Finance Minister Dr Salman Shah told this scribe the government has made the 170 million people fool while telling them pack of lies in the past nine months about the economic policies of the Mushrraf regime.

He said that as the present government acknowledged in black and white, the impressive past growth made their way easier to make access to the new facility of the IMF for emerging markets hit by the crisis to support the balance of payment problems.

Had growth not been achieved, Pakistan would have to apply for other long term IMF financing facilities like poverty reduction, structural adjustments etc, Shah said adding government should tell truth to the nation if they have confidence.

‘The recruitment made so far for running the finances of this country is very depressing. This shows this government has neither commitment nor capabilities to take the country out of the current crisis,’ Dr Salman said.

Riaz Haq said...

In rural Pakistan where about 70% of Pakistanis live, people spend 55% of their income on food, according to a World Resources Institute (WRI) report.

The bottom two BOP (Bottom of Income Pyramid) groups alone account for more than 50% of national food spending in Pakistan. Average annual food spending per household in the BOP in Pakistan is $2,643. While BOP3000 households have 6 times as much income on average, they outspend BOP500 households in the food market by a ratio of only 2:1 in Cameroon, 2.3:1 in South Africa and Pakistan, 2.4:1 in Kazakhstan, 1.9:1 in Uzbekistan, and 3:1 in Peru.

Currently, food inflation in Pakistan is running at 15.49 percent, hitting the poor the hardest.

According to a recent Daily Times report, Non-perishable food item prices increased 14.76 percent whereas perishable food items recorded 21.30 percent increase in their prices.

Fuel & lighting index rose 20.19 percent during January this over the last year whereas house rent index posted 13.38 increase this month.

Transport & communication index rose 9.43 percent, education expenses increased 13.68 percent and medical expenses increased 5.88 percent.

The detailed analysis of the SPI prices for Jan-10 reveals that few items, within the food category, were observed to post over 100bps MoM increase in prices. Sugar (1.92 percent weight in the CPI) remained exceptional with 19 percent MoM increase and food prices (40.3 percent weight in the CPI) contributed passively this time around to the CPI in Jan-10 due to being relatively stable.

Hopewins said...

Here is the "all over the place" news that is typical of our GOP's dealings with the IMF:

(1) IMF Praises Pakistan for Prompt Repayment

(2) GOP wants IMF to defer Repayments

(3) GOP not thinking of asking for more IMF help.

(4) GOP may seek fresh IMF help.

Well? Which is it? They can't all be true at the same time, can they?

Muddled. Confused.

Hopewins said...

^^RH: "The IMF wants Pakistan to raise tax revenue from the present 10 percent of gross domestic product (GDP) to 15 percent by 2013. Neighboring India's total tax revenue, including levies on income, imports and sales, also amounts to less than 10 percent of GDP now."

I agree that our Tax/GDP ratio is less than 10%.


But I disagree that India's Tax/GDP ratio is also as low as ours.


The reason is that India has very different tax structure.

We have a federal-only tax structure. India has a (60-10):(40+10) federal to state tax structure.

In other words, their central government collects 60% of all taxes and returns 10% to the states, retaining 50% of all taxes for itself. Their individual states collect 40% of all taxes and get the 10% that was transferred from the center.

So if the WB data, which always refer to central government, show India's tax revenue as 10% of GDP, it means that India's total tax revenue is 16.7% of GDP.

In our case, however, the "subahs" do not collect much (if any) taxes and the collection is still along Ayub's "One Unit" system. So when our WB data show that our tax revenue is 9% of GDP, then that is really all our tax revenue approximately is.

The IMF/WB know this. That is why they are always breathing down our neck for reform and do not say much to India.

Please correct yourself in the future.

Riaz Haq said...

Here's an interesting Op Ed by Mazur Ejaz in Friday Times:

The condition of an economy is often confused with the financial health of its government. Pakistan's economy is perceived to be in a deep hole because of its near-bankrupt fiscal conditions. Similarly, America's inability to settle on a national budget is taken to be an indicator of the collapse of the US Empire.

In some ways, the condition of the economy and the financial health of the government are separate matters. Major stock market indexes at Karachi Stock Exchange and the Wall Street are at their highest level, but both governments are facing serious financial problems. Most of the countries around the world are facing similar dichotomous situations. So how does one solve the riddle of the corporate sector making record profits while governments around the world are in serious financial jeopardy?

The phenomenon needs to be analyzed at grass-roots level. A shopkeeper from my village comes to mind. He told me that he sells PTCL internet cards grossing about Rs 9,000 every day. There are several other such shops in the village. That means that just in one village, the total sale of PTCL internet cards is up to 50,000 rupees. This consumer item was not present five years ago, which means hundreds of computers have been bought in the village recently. Furthermore, if such luxury products are making such huge profits for village shops, traders throughout the country must be making much larger profits selling essentials every day. One of the indicators of booming business in our village is that the United Bank branch in the village is doing very well, according to its manager.

There are thousands of such villages in the country, and that gives one an idea of the mammoth growth of rural markets. Such an undocumented economy is not even factored in estimating the economic growth of the country. From these supposedly marginal markets, one can extrapolate the profits of the corporate sector in towns and cities.

It may be astounding for some that Pakistan's banking sector is considered fourth in profitability in the entire world. Producers of other major industrial and agricultural products are also making huge profits. Cement, fertilizer, automobile, construction and telecommunication industries are doing extremely well. Other than the textile industry, which has been hit by power shortages, there is hardly any manufacturer or importer/exporter of any kind of goods who is not making money. The stock markets look at the profits of these industries and price them accordingly. Therefore the claims of Pakistan's economic growth are not a fairy tale. The evidence is out there in the market.

The government is also like a large corporation whose income depends mainly on tax revenue. Most of the goods and services (such as roads, defense, education and health) provided by the government are public goods which are not priced directly. The government has to price its public goods through direct taxes on income and sales, or indirectly. Following a certain brand of capitalism, countries like Pakistan and the US are not collecting enough taxes to cover the cost of public goods. They have failed mainly in collecting direct taxes on income. While Pakistan cannot implement an appropriate tax collection mechanism because of corruption, the US has leaned towards favoring high income groups and ended up in a jam. The net result is the same: the rich are getting richer, appropriating most of the new wealth generated....