IMF shadow on Pakistan’s fiscal budget

Pakistan will have to implement a slew of economic reforms as part of the International Monetary Fund’s conditions for a US$ 6 billion bailout. These conditions are likely to be part of the fiscal budget that will be announced on Tuesday by Abdul Hafeez Shaikh, the prime minister’s economic advisor .

This means that the budget needs to reflect measures to stabilize the economy, reduce non-development expenses and bolster exports. This will also be bad news for the Pakistani rupee, which has been in a free fall for over six months. According to top government sources, the IMF wants the value of the Rupee to be “market-determined.”

Shaikh will present the 6.8 trillion rupee [$46.5 billion] budget for the current fiscal year in the National Assembly on Tuesday. The incumbent Pakistan Tehrik-e-Insaf (PTI) government led by Imran Khan maintains that the budget would focus on revenue generation and growth, while at the same time being “people friendly.”

Economic Reforms

The announcement came less than a month after Pakistan agreed on terms with the IMF for a bailout package. The three-year bailout deal worth $6 billion requires an “ambitious reforms agenda” to address Pakistan’s financial woes. Islamabad’s staff-level agreement with the IMF is conditional to the Fund’s proposed reforms being incorporated in the upcoming budget.

Sources in the Pakistani negotiation team say that there are clear instructions that the IMF money will not be used to service any bilateral loans and debts from other countries. This is an indication that the IMF will not permit any part of the bailout to be used to service loans from China for the China-Pakistan Economic Corridor (CPEC) or the Belt and Road Initiative (BRI). This has been a point of considerable friction during the negotiations.

Finance Ministry officials insist that using the IMF money to pay China was never a part of their plan anyway. Nevertheless, the PTI government has been trying to re-negotiate the agreements under CPEC and BRI with China, but Beijing is not keen to do so, sources said.

The condition to make the Pakistani rupee’s value be determined by market forces was regularly reiterated throughout the negotiations with Pakistan over the past year, resulting in the rupee intermittently retracing new lows against the US dollar. In the immediate aftermath of the agreement with IMF last month, the Pakistani rupee plunged to an all-time low of 155 against the US dollar. Uncertainty over the terms agreed with the IMF meant that the market was rife with speculation, resulting in investors queuing up to hoard US dollars.

“There was chaos after the IMF deal announcement since nobody knew the exact terms of the deal,” Dr Ashfaque Hasan Khan, a member of the government’s Economic Advisory Council, told Asia Times. “What everyone knew was that the deal would be ‘market determined,’ so the market decided to take matters into its own hands. Once the final approval comes from the IMF, the exact terms would be revealed. Then we can expect the markets to stabilize,” he added.

After a month of volatility the rupee has settled around 150 against the US dollar, which reflects a 43% plunge in the value of the Pakistani currency since December 2017. In interviews with Asia Times, members of the economic team of the then-finance minister Ishaq Dar had revealed that the rupee was kept artificially afloat around the 100 mark.

Dar decided to inject about $7 billion into the market. This was done through the State Bank of Pakistan (SBP) and it helped prop up the Pakistani rupee for a while. However, the artificial overvaluation of the rupee through this injection ended after Dar left the Finance Ministry following the filing of corruption cases against him. It was Dar who had overseen the completion of the previous three-year IMF bailout package from June 2013 to June 2016, under the Pakistan Muslim League-Nawaz (PML-N) rule.

“After the earlier IMF deal ended (in 2016), the government stopped following its directions and that completely undid all the benefits that Pakistan had gained from the bailout,” said former finance secretary Waqar Masood Khan. The fiscal deficit started rising immediately, the external account deficit rose and [foreign exchange] reserves fell.

“And even if you’re perfectly treated by a doctor, if you start neglecting what the doctor tells you, you will end up getting sick again and go back to the hospital. That is what is happening to the economy,” he added, referring to Pakistan’s return to the IMF.

Deficit improves

However, the current account deficit has seen a slight decrease as compared with the same period a year ago. It declined from $15.86 billion in May last year, to $11.58 billion this year. The reduction in the deficit has been largely achieved through monetary aid from Saudi Arabia, China, the UAE and Malaysia, with a combined $18 billion in aid, loans and deferred payments. Riyadh gave Islamabad a $6 billion bailout package in November in exchange for support following the crisis over the killing of journalist Jamal Khashoggi. Another $6.2 billion package from the UAE followed in January.

The aid from allies meant that until February this year Islamabad was actively considering the prospect of not having to go to the IMF at all. In this regard,  the”Finance Supplementary (Second Amendment) Bill of 2019″ was specifically “designed to avoid the IMF bailout.”

By April, however, with a current deficit still over $11.5 billion, it had become inevitable that Pakistan would need a 13th IMF bailout. The then-finance minister Asad Umar led the Pakistani delegation to Washington to discuss the terms. Days after his return, Umar was sacked.

Multiple sources within the ruling PTI have confirmed that Umar was removed because of the IMF’s recommendation. His replacement, Abdul Hafeez Shaikh, was also appointed as the economic advisor in accordance with the IMF’s demands, given that Shaikh had successfully negotiated an agreement with the Fund as the finance minister under Pakistan People’s Party (PPP) rule.

“The IMF bailout will only be able to regulate the payments that we have to make to the IMF and other donor agencies,” said former finance minister Rana Afzal Khan. “But that will provide some relief to the government and they would be able to focus on the internal dynamics. They need to focus on reducing current expenses,” – which Khan described as “a tragedy.”

Hard times ahead

“They have increased the expenses by at least Rupees 1,000 billion rupees [$6.6 billion] in the first ten months, and there’s a 500 billion rupee [$3.3 billion] reduction in tax collection targets. While we’re looking for money from the outside, we’re losing money on the inside owing to mismanagement over the past 10 months, which resulted in loss of US$10 billion, and the borrowing of another $10 billion, resulting in a cumulative impact of $20 billion,” he added.

Given that a lot of the government’s borrowing is local, the central bank’s interest rate hike has increased its fiscal burden. Last month, the State Bank of Pakistan increased the rate to an almost eight-year high of 12.25%, signifying an increase of 150 basis points. Asad Umar mentioned in a recent panel discussion that IMF had asked for a 600 basis points hike, which would’ve taken the interest rate to 22%.

The value of the government’s loans owing to the fall in rupee’s value and the interest rate hike denotes that the economy needs significant increase in domestic revenue generation. This has prompted the government to launch an Asset Declaration Scheme to increase the tax net. Similarly, the defense budget, which takes up a significant chunk of the finances, is not being increased this year.

Tuesday’s budget is likely to see major reforms overseen by a team that has been handpicked by the IMF. Whether this will be adequate to rescue a failing economy remains to be seen.