To initiate discussions on the second review of the Extended Fund Facility (EFF) programme, a mission of International Monetary Fund (IMF) visited Pakistan during February 3-13, 2020. The mission released a press release at the conclusion of the visit, whereby as per the press release, the mission pointed out that ‘Considerable progress has been made in the last few months in advancing reforms and continuing with sound economic policies. All end-December performance criteria were met, and structural benchmarks have been completed… In implementing the program, development and social spending have been accelerated.’
Although the government will be most probably be happy to receive this assessment from the IMF, it is highly unlikely that the consumers and investors will share the same euphoria, given they are suffering from low and that too diminishing growth in the agriculture and manufacturing sectors – major absorbers of employment in the country – double-digit inflation, high policy rate, and difficult exchange rate, ballooning fiscal deficit, slow pace of reform, including in two important sectors of energy and state-owned enterprises, and a low level of development spending especially in the social sectors.
No wonder then that this has been a big reason for the slowdown in growth of both these sectors, which has not only kept the expected overall growth projections for FY2018/19 to just around 3 percent, unemployment has increased
Strangely, the press release makes no mention of the issues of the sort indicated above. Instead what is mentioned is a rosy economic affair, whereby ‘The macroeconomic outlook remains broadly as expected at the time of the first review. Economic activity has stabilized and remains on the path of gradual recovery. The current account deficit has declined, helped by the real exchange rate that is now broadly in line with fundamentals, while international reserves continue to rebuild at a pace considerably faster than anticipated.
Inflation should start to see a declining trend as the pass-through of exchange rate depreciation has been absorbed and supply-side constraints appear to be temporary. Fiscal performance in the first half of the fiscal year remained strong, with the general government registering a primary surplus of 0.7 percent of GDP on the back of strong domestic tax revenue growth. Development and social spending have been accelerated.’ Let’s analyze.
Keeping interest rate high, and leaving the exchange rate mostly market-determined, Pakistan indeed has been able to narrow down current account deficit mainly on the back of huge decrease in imports. That reduction in imports did not just account for less consumption but also in decreased imports of machinery and materials for the two major sectors of the country in the shape of agriculture and manufacturing.
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No wonder then that this has been a big reason for the slowdown in growth of both these sectors, which has not only kept the expected overall growth projections for FY2019/20 to just around 3 percent, unemployment has increased, and with it any gains reached through increased social spending will be heavily dented with slowdown in the economic activity, and in turn will add to poverty level and income inequality overall.
And to what end, inflation has remained stubborn, and it would because it is at least equally a fiscal phenomenon in developing countries like Pakistan. Hence, greater intervention of fiscal/governance-related policy was need instead of persisting with tight monetary policy. That did not come, even when the signals to this end were clear for many months now that high-interest rate will not be of much help, especially in dealing with food prices.
On top of that to make matters worse for economic activity, real interest rate was taken relative to headline inflation and not core inflation as generally is the case for developing countries where food and energy prices (the latter case being Pakistan being a net importer of oil) have little correlation with interest rates.
IMF’s and government’s celebratory tone then on achieving primary surplus is highly misplaced
It was hoped that the IMF mission would take note of these anomalies in programme design, but the mission concluding statement has no reference to all this. Moreover, keeping interest rate high to induce portfolio investment, and to build foreign exchange reserves on the back of ‘hot money’ is a risky policy and the huge sacrifice ratio in terms of large economic activity forgone and overall getting all the more trapped in the stagflationary situation, to obtain this highly fluid portion of reserves of not much magnitude anyways is a policy choice of the like of walking on this ice. If this situation leaves IMF and in turn the economic team of Pakistan satisfied then there is not much else left to be said anyways.
On top of that given government is under a huge amount of domestic debt, mainly at the back of bailing out the state-owned enterprises (SOEs), and the energy sector, where circular debt has amassed to Rs. 1.7 trillion, along with government being the major borrower of loanable funds, higher interest rate has meant high level of domestic debt repayments that the government is having to make.
Imagine the funds available with the government to make all the more development expenditure and social spending, if these repayments were less. Also, how can the reforms be making any significant headway, as is being indicated by the IMF, given the two main areas in the shape of SOEs and circular debt still sucking in so much of bailout money.
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On the other hand, revenue shortfall on account of reduced imports and diminishing economic activity, and increased expenditures, for the reasons mainly responsible for these highlighted earlier, the fiscal deficit has also ballooned. In that sense primary surplus does not make much sense because debt repayments are huge and likely to rise because the pace of reform is very slow. IMF’s and government’s celebratory tone then on achieving primary surplus is highly misplaced.
Overall, institutional quality has not improved much, and that is a real worry sign because research has shown that without it any macroeconomic stability and positivity in growth are mostly short-lived and do not have any sustained basis. That is perhaps one of the reasons historically speaking that immediately after an IMF programme generally, any macroeconomic adjustment reached by the recipient country gets even worse than before the programme situation. Hence, both the IMF and the government should see the ground realities more clearly.
Dr. Omer Javed is an institutional political economist, who previously worked at International Monetary Fund, and holds Ph.D. in Economics from the University of Barcelona. He tweets at @omerjaved7. This article originally appeared at Pakistan Today and has been republished with the author’s permission. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.