An onerous programme?

It is curious to observe different responses from economists regarding the efficacy of the IMF programme in retrieving the dwindling fortune of the country’s economy. While some have welcomed the news of a staff-level agreement, others have expressed deep scepticism. To be sure, with few exceptions, all had been advocating that the country should enter the programme as there was no other way to stem the haemorrhaging being suffered.

Even though few details are available about the contents of the programme, assumptions have been made to assess its implications. Some facts about IMF programming are well known such as its essential approach to contain aggregate demand manifested in high fiscal and external account deficits as well as the tools (exchange rate, interest rate, taxation and expenditure cuts) at the disposal of policymakers to accomplish this goal. Given this framework, the choices made in negotiating a programme revolve around the speed of adjustment. While the host country would vie for a moderate pace, the Fund would typically urge a faster pace.

The sceptics – while not opposing the programme – apprehend that the agreed speed of adjustment is too steep and as such would impose significant burden on people in terms of reduced income per capita, reduced disposable income, higher inflation, rise in unemployment and consequent increase in poverty. Some have even demanded a re-negotiation of the programme as it would lead to massive slow-down in the economy.

There is no barometer that can determine the optimal speed of adjustment. As much as the host country would seek slower speed, the Fund would be conscious of setting it at a level that in some sense would be feasible in terms of containing its adverse effect since the Fund would also like to see the success of the programme. The response of economic variables is not cast in stone nor are they known a priori with certainty. How the programme implications would unfold only time would tell. However, if there are surprises, there would be flexibility of adjustment in programme targets and policy prescriptions at the time of periodic reviews. At the beginning, only best estimates are available to guide the Mission and government negotiators.

The prior actions that would secure the programme relate to exchange rate, interest rate, announcement of budget with a primary deficit target of 0.6 percent of GDP and some adjustment in prices of electricity and gas. Since the staff-level agreement, so far we have seen adjustments in exchange rate (five percent depreciation) and interest rate (150 bps). Many analysts have opposed these moves and some have declared them perilous. However, despite some initial disruptions, the market has welcomed these adjustments or has not reacted violently against them. This has been so despite a muted defence and weak ownership of the programme and near absence of communication with public by government authorities.

To ascertain whether the programme is more onerous than in the past, we would seek answers to two questions: (1) How do the initial conditions of the economy compare with the past programme?, and (2) Are the prior actions more difficult?

Pakistan has entered the programme under perhaps the weakest initial conditions. The fiscal and current account deficits were among the highest in the country’s economic history. The debt burden is more elevated in the last two decades, including the foreign debt. Non-budget obligations (electricity and gas unpaid bills) are unprecedented. There are fever big-ticket items whose privatization can bring significant returns. The stock market, investment environment, growth and inflation outlooks are depressing. What’s worse, these conditions have been obtained in the backdrop of a successful IMF programme during 2013-16, mainly as a result of policy failures in the presence of a political turmoil. Under the circumstances, setting the economy right is a herculean task. The required adjustments would be more painful; the IMF cannot be faulted for seeking more durable policy actions to signal a deeper commitment to reforms.

Despite the above, has the Fund really imposed unbearable prior-actions to warrant a renegotiation of the programme? We would answer that in the negative, based on the limited information so far available. We have already noted the impact of exchange rate and interest rates; given that these have been substantially completed; their impact was contained as the market response has been positive throughout last week. Let us now discuss the other condition relating to primary deficit.

We would argue that this prior action is significantly more palatable than the most onerous condition imposed in the 2013 programme, which required an increase of 60 percent in electricity tariff. Let us explain it in some detail. The primary deficit is fiscal deficit excluding interest payments. The nine-month fiscal data shows we have incurred highest deficit in more than a decade at 5 percent.

The final number is estimated at 7.6 percent. A customary approach would have targeted reduction of at least 2.6 percent in the first year of the programme. Instead, it is the primary deficit which is targeted. In nine months, primary deficit is just 1.2 percent. But assume it will be at the same level of 2.2 percent as last year (implying interest payments of 5.4 percent). Requiring to bring it to 0.6 percent means an adjustment of 1.6 percent. With an estimated GDP of Rs45 trillion, 1.6 percent reduction in primary deficit would amount to Rs720 billion, which can be achieved through a combination of tax increases and expenditure cuts.

The programme has sensed that interest payments are high and targeting overall fiscal deficit would impose more hardship in the presence of an inflexible and rising expenditure (interest payment). Accordingly, if the interest payments remain as high as this year of 5.4 percent, the overall deficit is likely to be 6 percent, which is unprecedented. The focus on primary deficit ensures elimination of explosive path of debt accumulation which it signifies and hence, down the road, debt-to-GDP ratio would begin to come down.

The required tax effort is moderate if viewed in the context of revenue lost through uncalled for concessions, court intervention and reduced taxation on petroleum products. This tax is already there but lost because of imprudent policy actions. We, therefore, conclude that prior actions are not too onerous to correct an economy which for nearly two years was virtually unmanaged.

The writer is a former finance secretary. Email: waqarmkn@gmail.com