IMF and the economy

It seems the government is finally reaching an understanding with the IMF to provide a three-year facility to support a programme of economic adjustment.

The likely timing for an agreement at the staff level would be just before the announcement of the next budget in late May or early June. The first tranche could then be released after the passage of the Finance Act towards end-June.

The new programme would take the current year as the benchmark for projecting a three-year path of economic stabilization and growth. There would be a performance criteria (fiscal deficit, domestic credit, foreign reserves and government borrowing from the SBP) and a set of structural policies (energy pricing, privatization, public-sector enterprises (PSEs) reforms, banking and finance and central bank autonomy, especially in exchange rate determination) to underpin the programme. Growth, inflation, interest rate and exchange rate would be the key variables that would determine how successful the programme is.

What the programme would ask for in terms of adjustment depends on the projection of economy at the end of the current fiscal year. Let us see where the key variables are headed after nine months into the fiscal year. The balance of payments has shown some signs of improvements during Jul-Feb but reserves and exchange rate continue to face pressure. Clearly, further compression in import demand would be a key target of the programme.

The most formidable challenge is the fiscal deficit, contributed by low tax collections and rising expenditures. The nine-month revenue collection has already seen a shortfall of Rs318 billion, quite unprecedented in the recent past. At this rate, it could cross Rs400 billion or more than one percent of GDP. The non-tax revenue was hardly 25 percent of its annual target in the first half of the year, further weakening the overall revenue collections. On the expenditures side, things are equally precarious primarily because of debt servicing and defence. Perhaps, it was in this backdrop that the finance minister announced that the deficit would reach Rs2900 billion, a staggering 7.6 percent.

The first condition of the Fund programme would be to cut the budget deficit to no more than 5 percent of GDP in the first year of the programme. This is a tall order, requiring a fiscal adjustment of 2.6 percent, which, under the next year projected GDP of Rs42.5 trillion, would translate to Rs1105 billion. At least half of this amount would have to come from revenue effort, particularly from tax measures. Significant tax has been lost this year on account of (i) tax breaks given by the Abbasi government; (ii) the Supreme Court order against telecom taxes; and (iii) less than full recovery of taxes from petroleum prices. Eliminating these leakages would be low-hanging fruits to plug the hole in the tax system.

The work on the expenditures’ side would be no less challenging. It is hoped that the PM’s Committee on Austerity would finalize its recommendations to guide this process. Some brutal surgery on the expenditure side would be required to achieve meaningful results. On the other hand, any further increase in interest rate would have adverse implications for expenditures.

The government borrowings from the SBP at the end of March were recorded at Rs6 trillion, which would require a major correction as it is indicative of near breakdown of money and bond markets in the country. There has been a sustained deleveraging from commercial banks in their holdings of government paper. With the exception of some recent moves to auction government bonds, government debt is confined to shortest maturities in treasury bills. The Fund programme would require significant reduction in SBP financing, and that too steeply. This would have implications for interest cost to the budget. To minimize this, as soon as the Fund programme is in place, government should look for issuing bonds internationally as this would reduce SBP debt without disrupting the domestic debt market.

The most serious issue requiring resolution with the Fund would be the adjustment in administrative prices of gas and electricity. The Fund would require that the government should get out of the business of interfering in setting the prices after the regulator has done so, through a statutory process. This would be painful, undoubtedly, but would set the fiscal house in order.

Settlement of circular debt (CD) would be a must under the programme. Since the time the Fund saw it last in September 2016, circular debt has more than doubled. At the time, the Fund was given a settlement plan that depended on: (i) no further accumulation through appropriate tariff adjustments; and (ii) privatization of Discos and Gencos. Evidently, apart from falling significantly short in tariff adjustments, this government has shown a general aversion to privatization.

More significantly, the government has resorted to issuing domestic sukuks based on securitization of the assets of the DISCOs and GENCOs, which may pose a new challenge for future privatization efforts so long as these sukuks are outstanding, which would be the case going by the history of debts parked in power holding companies, which are routinely rescheduled.

The subject of privatization would also feature as a key point of negotiations in the context of reforms in PSEs. The Fund would insist on bringing the costs of running PSEs into the budget so that a true picture of the government’s footprint in the economy is transparently accounted for. A privatization programme is the most desirable solution against the continuing losses in the PSEs.

The Fund programme would be painful, both for government and public. In the immediate aftermath, growth would come down while inflation would accelerate. There may be further need for exchange rate and interest rate adjustments. However, as soon as the Fund programme is signed, there would be order in the markets, particularly the forex market, the bleeding of reserves would stop, investors’ confidence would be restored and the process of investment would resume.

Ease of doing business should be a major focus of government policy. In the second year, growth may begin to pick up as well. But continuing surge in international oil prices could lengthen the period of stabilization.

The writer is a former finance secretary.

Email: waqarmkn@gmail.com