The International Monetary Fund has implicitly blamed two political governments of the Pakistan Muslim League-Nawaz and Pakistan Tehreek-i-Insaf for misaligned policies and inadequate policy action, respectively, for the critical economic challenges the country is facing.
In its staff report on $6 billion bailout to Pakistan approved by its executive board earlier this week, the IMF has given a background of how the economic difficulties emerged and how corrective measures were delayed.
Without directly naming the two governments, the IMF held the PML-N government responsible for unbalanced policies and unfinished reforms. “Misaligned economic policies, including large fiscal deficits, loose monetary policy, and defence of an overvalued exchange rate, fuelled consumption and short-term growth in recent years, but steadily eroded macroeconomic buffers, increased external and public debt, and depleted international reserves,” it said.
While economic growth has been relatively fast — averaging close to five per cent over the past five years — macroeconomic vulnerabilities have rapidly increased on the back of weak policies supporting a consumption- and import-driven growth model. In particular, procyclical fiscal policies led to a surge in the FY2018 fiscal deficit to 6.5pc of GDP, 2.5pc higher than budgeted, pushing public debt to 75pc of GDP.
Fund’s staff report on $6bn bailout highlights risks to reform programme higher than usual
The IMF said the lacklustre progress in structural reforms continued to hamper investment and allowed inefficient state-owned entities (SOEs) to linger and a large informal economy to expand. While the macroeconomic deterioration, which eroded the stability gains achieved during 2013-16, had been largely due to homemade factors, the increase in oil prices and more limited capital flows added to this difficult picture.
Likewise, the IMF also blamed the current PTI government for delayed and yet unsatisfactory policy action for correction. Hence despite some exchange rate depreciation and significant monetary policy tightening, sizeable foreign exchange interventions continued through April 2019. “Similarly, fiscal slippages in the first half of the fiscal year have been significant despite the adoption of two budget amendments. Finally, increases in power and gas tariffs have not been sufficient to stem the accumulation of quasi-fiscal losses,” the Fund noted.
It also pointed out that sizable short-term financing from bilateral creditors provided critical financing relief, but “also deferred the urgency to tackle the underlying problems while increasing the maturing debt obligations due in coming years”.
Therefore, on the back of weakening confidence, economic activity has slowed considerably and inflation accelerated. High-frequency indicators, including the large-scale manufacturing index, domestic cement dispatches and motor vehicle sales, have continued to deteriorate, confirming a marked slowdown in economic activity.
Also, fiscal imbalances have continued to build. Despite the adoption of two supplementary budgets, the overall fiscal deficit (excluding grants) widened to over 7pc of GDP against the budgeted target of 5.1pc. “This deterioration is largely driven by a significant revenue shortfall, equivalent to 1.4 per cent of GDP relative to the budget target,” the Fund noted.
It said the authorities were committed to carrying out the new programme, but the outlook was subject to considerable risks. The risks relate mainly to domestic policy implementation as well as external events. It said Pakistan’s capacity to repay its Fund obligations in a timely manner was adequate but was subject to “higher than usual risks”.
Risks to Pakistan’s repayment capacity have increased on account of the continued decline in reserves and a delay in the adoption of adjustment policies. Adequate capacity to repay and debt sustainability will depend on strong policy implementation and adequate execution of the existing financing commitments.
The Fund also highlighted that despite the safeguards included in the design and financing of the programme, the risks to the programme were “particularly high”.
Managing successfully the transition to a market-determined exchange rate will be crucial to ensure popular support for the programme. In this respect, failure to maintain an adequately tight monetary policy could lead to exchange rate overshooting and second-round effects on inflation.
Fiscal slippages and resistance to some of the fiscal measures could undermine the programme’s fiscal consolidation strategy, thus putting debt sustainability at risk. Progress in governance and institutional building may be opposed by vested interests, weakening structural reforms and medium-term growth prospects.
Moreover, the absence of the ruling party’s majority in the upper house of parliament may hinder the adoption of legislation needed to achieve programme objectives. Also, there is a risk that provinces may underdeliver on their commitments to budget parameters.
Finally, a potential blacklisting by the Financial Action Task Force could result in a freeze of capital inflows to Pakistan, jeopardizing the financing assurances under the programme. Other risks, including those related to domestic security conditions, global trade, growth in major trading partners, oil prices and tighter global financial conditions, could exacerbate these challenges.