Incomplete IMF review

The IMF Mission for Second Review under the three-year Fund programme, concluded its work last week without reaching a staff level agreement.

The Mission and authorities have not given details regarding the reasons that resulted in inconclusive talks. It is not clear whether this review will be completed within the stipulated time or pushed to a combined second and third in May before the budget. Before we discuss the prospects of the programme, let us briefly review recent developments.

There was good news in the large-scale manufacturing (LSM) sector which showed a handsome growth of 16.4 percent in Dec ’19 over Nov ‘19 and 10 percent over Dec ‘18. However, Jul-Dec 2019 production was down by 3.4 percent compared to a year earlier.

The significant growth over last month and year-on-year owes to two major developments. Sugar production, which came on stream earlier than last year, has shown an increase of 97 percent, from half a million tons to more than one million tons. This will be significantly corrected when the January 2020 production compares with a much higher production level registered in January 2019. The other notable growth was seen in petrol and diesel production which grew by 21 percent and 10 percent, respectively. Apparently, there is no seasonality involved here and therefore this could mean a turnaround in petroleum production.

Furthermore, paper & board (33 percent) and cement (8 percent) also registered high growth over the last month. But with continuing fall in imports in general, the slow-down remains the defining characteristic of the economy.

In agriculture, cotton arrivals at the end of January were down 20 percent compared to last year. Growth in the sugarcane production was also negative and its adverse impact on prices of sugar is already visible. The overall production scenario therefore remains dormant.

There is also an adverse development on the exports front. Seven-months exports grew by a meagre 2 percent. More concerning is the fact that exports growth has been declining since October 2019. It is a harsh reality that, despite massive devaluation, exports have increased by only $49 million in the last 18 months whereas imports have declined by $11 billion. This reduction in imports has halted domestic production and weakened economic life.

In these pages, we have been highlighting the suffering inflicted on people because of adjustment policies – sans any ray of hope that it would end soon. Even when we concede that the new government inherited a challenging economy which was in need of correction, 18 months is more than a long period to keep hearing about stabilization without a promised relief. The very structure of the Fund programme envisages no growth in the next three years. Accordingly, we have been urging the need for relief, loosening so that people’s sufferings can be lessened.

The painful reality is that there has never been a Fund programme that preceded a period of considerable fiscal and monetary adjustment which the government had done at its own before entering a programme. For nearly a year, the present government didn’t enter a programme but voluntarily chose to do what the Fund would have required under a programme. After the Fund programme was signed, yet another round of adjustment took place. Cumulatively, the rupee has lost more than 40 percent of its value, the interest rate has more than doubled, all-time high taxes were imposed in the budget and administered prices were significantly increased. The result is explosive inflation, loss of production and jobs and rise in poverty.

It was unrealistic for both the managers and the IMF to envisage 45 percent growth in taxes when it transpired in August 2019, after the fiscal accounts were finalized, that the tax revenues in the base year, estimated at Rs4,153 billion, were actually Rs3828 billion, nearly Rs325 billion short. If one were to begin with the lower base and apply the autonomous growth of nominal GDP of 15.4 percent, collections would come to Rs4417 billion. The realistic level of maximum discretionary tax effort would be Rs250 billion, taking the total to Rs4,667 billion or at best Rs4,700 billion. This level gives a nominal growth of 23 percent from the base, which is still higher than the 21 percent recorded in a single year.

Another concern is the use of primary deficit, which is fraught with dangers in an environment of high interest rate. If we contrast the target of overall fiscal deficit in earlier programmes, it would be unthinkable for the IMF to target it beyond 5 percent in the first year. This would have meant an adjustment of 2.2 percent, relative to the revised budget estimate and 3.9 percent from the actual. By focusing on primary deficit, the programme has allowed an overall deficit of 7.2 percent, thus opening a floodgate of interest payments. These payments are being capitalized and will lead to much higher debt accumulation than if the overall fiscal deficit was targeted.

In the last six months, interest payments have amounted to Rs1281 billion, 46 percent higher than the Rs877 billion last year. Last year, final interest payment was Rs2091 billion, which was 238 percent of the interest incurred in six months. If we assume the same growth, the final interest payments would be Rs3048 billion, significantly higher than the Rs2900 billion in the budget. But it would be much higher as last year interest rates were rising, whereas the rate has peaked since July. Accordingly, there would be significant over-runs in the interest payments relative to the budget estimate – pushing the overall deficit closer to or higher than last year. It would be hard to find another example of a Fund programme that would allow so much deficit, only guised in the garb of primary deficit.

The prime minister’s refusal to increase utility prices is also understandable. He has given more than an elected government should give for economic adjustment. We hope that the government is able to convince the Fund that it would be unreasonable to load people with even more burden. Lower oil prices on the horizon would lessen the need for adjustment. The spirit of adjustment and reforms would be preserved and in some cases, like privatization, would be accelerated.

Undoubtedly, there will be implications of suspending the Fund programme but those have to be compared with the fall-out that is imminent from continuing on the IMF’s prescribed path. It is indeed a choice between a rock and a hard place.

The writer is a former finance secretary.

Email: waqarmkn@gmail.com