Pakistan has clinched a fresh nine-month Stand-By Agreement (SBA) with the International Monetary Fund (IMF) worth $3 billion in a last-ditch bid to avoid sovereign default. The agreement at the staff level is subject to IMF Executive Board approval, which is expected by mid-July. This would undoubtedly assist to alleviate the country’s dire balance of payment issue. However, this raises fundamental concerns: would this arrangement make people’s lives better and the economy more stable? Do we have adequate policies or procedures in place to avert recurrent financial crises?
As a prerequisite for reaching a deal, Pakistan’s central bank raised interest rates by 100 basis points to 22% on June 26th. Economists believe that raising the policy rate is ineffective at controlling inflation expectations in Pakistan, owing to the supply-side rise in prices. Renowned economist Hafiz Pasha also highlighted in his book “Leading Issues in the Economy of Pakistan,” released in June 2023, that the rupee’s depreciation and increasing import costs accounted for 53% of the inflation spike in FY 2022-23. Flood-related supply disruptions and import restrictions contributed a further 27% to inflation. He also emphasized that rising petrol, electricity, and gas prices contributed to 11% of the inflation rate, while monetary expansion accounted for only 9%. This indicates that the price hike is primarily attributable to supply-side factors and is unaffected by policy rate changes.
In accordance with IMF conditions, the current government hiked interest rates from 13.75% to 22% for the fiscal year 2022-23, significantly increasing debt service obligations. Interest payments for the preceding fiscal year were initially predicted at Rs. 3950 billion, yet by the end of the year, it had soared to Rs. 5500 billion. For the forthcoming fiscal year 2023-24, a sum of Rs. 7303 billion has been set aside for interest payments, which account for 50% of federal government expenses. On the other hand, federal government income is insufficient even to pay interest.
To secure the IMF accord, the government levied new taxes of Rs. 215 billion, primarily on the middle-income salaried class. While the government’s expenditure has been reduced by just Rs. 85 billion, or 0.6% of the total expenditure to be committed during the current fiscal year. The government has also decided to raise the petroleum development levy (PDL) from Rs. 50/- to Rs. 60/- per liter. Furthermore, the IMF specifically requested a “timely” rebasing of prices for Pakistan’s electricity sector to ensure that losses are recouped. These policies will aggravate inflation and place more strain on already oppressed populations.
In a cash-strapped economy, the government’s aim and willingness to implement prudent policy measures are severely inadequate. The tax net/base is confined to certain segments of society. Both the wholesale/retail and agriculture sectors account for 40% of GDP but contribute just 2% of government tax revenue. Furthermore, while progressive taxation is a viable way of collecting tax money, it has never been prioritized for implementation.
The government has allocated Rs. 1.074 trillion for subsidies in several sectors. The circular debt of the power sector stood at Rs. 2.5 trillion at the end of the previous fiscal year, with a whopping Rs. 300 to 400 billion added to the debt stock each year. Similarly, the circular debt in the gas sector has reached Rs. 1.5 trillion. In terms of far-reaching reforms, there has been a cautious approach to privatization decision-making and the adoption of a state-owned enterprise management plan, which has resulted in large income leakages once again. The existing administration has allotted just Rs. 15 billion for privatization earnings, indicating a lack of decision-making on the part of the federal government.
The expenditures of administering civil government have also risen over time, with Rs. 714 billion set aside for this purpose in the fiscal year 2023-24. The management of majority ministries was transferred to provinces after the 18th Amendment, however, divisions/departments continue to operate in duplicate. The government must seek ways to decrease costs in the form of protocols, assignment of housing, fuels, and so on. It is believed that the federal government operates 90,000 cars, which consume around Rs. 220 billion in gasoline. To set an example for the entire nation, the government should implement austerity measures by slashing such expenditures.
The failure of policy rates in attaining economic stability has substantial implications for the government of Pakistan, which is a major borrower of commercial banks. The vast majority of interest payments are made at a floating rate. Thus, an increase in policy rate entails greater payments for debt servicing. It is predicted that lowering the policy rate by 1% can save around Rs. 200 billion in interest payments. Hence, to curtail inflation effect, improved governance, and market regulation by limiting hoarding, artificial supply shocks, and cross-border smuggling might potentially reduce volatility in goods markets and hence give some relief to desperate masses.
Aside from the aforementioned policy considerations, the government lacks direction in attracting remittances and promoting exports. Remittances through banking channels fell to $29.87 billion in 2022-23, down from $32 billion the previous year. Similarly, exports fell to $27.5 billion in 2022-23, compared to $31 billion in 2021-22. The gap between the Interbank and open market rates should be narrowed in order to attract remittances through formal banking channels. Incentives should also be granted to the export sector. The imposition of a windfall levy, a super tax, and a withholding tax does not appear to improve exporter confidence. Similarly, no plan is presented in the budget statement to encourage foreign direct investment, which may be a lifeline for the languishing economy.
Pakistan has been in a state of economic turmoil since its creation due to a lack of structural, institutional, and development planning. Famous economists Daron Acemoglu and James A Robinson write in their book ‘Why Nations Fail’ that no amount of donations, aid, or other financial assistance can sustain, let alone reform, a country. Unless and until major institutional and structural reforms are implemented, the dependency syndrome in the form of IMF programs and other multilateral and bilateral assistance cannot be avoided.