As Pakistan moves into the second year of the IMF programme, following three successful reviews, foreign exchange reserves have risen above $9 billion, which is equivalent to over two months of import cover. The currency has remained stable since its sharp appreciation in March. In this changed environment, the relationship with the IMF may now change fundamentally.
We are beginning to see sharp deviations in actions in relation to those envisaged in the original programme design. The ministry of finance has begun to adopt a more ‘homegrown’ approach to policies rather than follow the dictates of the IMF blindly.
The first major area of difference is that the government has opted for a larger national PSDP of 4.1 per cent of GDP compared with 3.6 per cent agreed with the IMF in the third review. This is clearly the appropriate strategy. A larger development outlay will not only provide a short-run fiscal stimulus but also increase the productive capacity of the economy in the medium run.
The second major divergence is in the exchange rate policy. The principal instrument built into the programme for improving the balance of payments was depreciation of the rupee by about eight per cent in real terms in 2013-14. Instead, following the receipt of the ‘gift’ of $1.5 billion, the State Bank of Pakistan (SBP) opted for a sharp appreciation of the rupee. By April 2014, the real effective exchange rate has increased by over 11 per cent in relation to the level at the end of 2013. In this case, there appears to be too large a deviation from the exchange rate policy agreed originally with the IMF. The impact has been negative. Exports increased by six per cent from July 2013 to March 2014. They have since fallen by six per cent in the months of April and May 2014. The rupee has become overvalued and this is exerting a negative impact on exports.
In the budget of 2014-15, the government has signalled that the goal is to maintain a stable, nominal exchange rate. Any problem of overvaluation is to be addressed by reducing the mark-up on export finance and in the long-term financing facility. In addition, higher duty drawbacks will be given to exporters who achieve over 10 per cent growth in exports. These actions may provoke the same reaction from an otherwise passive IMF. A more appropriate policy is to keep the real effective exchange rate, rather than the nominal exchange rate, constant, in the face of higher inflation in Pakistan. It remains to be seen if the ‘homegrown’ policy adopted to promote exports will work in raising them in 2014-15.
On the tax reforms front, the government has implemented a structural benchmark in the programme by withdrawing some of the SROs in customs duty and sales tax. This will lead to recovery of about one-fourth of the tax expenditure in 2014-15. Perhaps, a stronger move was expected, but powerful lobbies have come in the way.
The government also originally implemented a big increase in the rates of the Gas Infrastructure Development Cess (GIDC) in the 2014-15 budget. The objective was to generate additional revenues of 0.4 per cent of GDP as agreed with the IMF. But in the face of a strong reaction from the Sindh government and by the industry, the finance minister has announced a reduction in the GIDC by one-third to two-thirds for different types of gas consumers. However, no measures have been adopted to compensate for the revenue loss.
Another route that is being adopted by the government is engagement in larger quasi-fiscal operations. Some of the circular debt of the power sector is being retired through direct borrowing by public-sector enterprises, like the Pakistan State Oil, with government guarantee. Also, the Pakistan Development Fund (PDF) Company is being set up to directly finance infrastructure projects, possibly in the form of public-private partnerships, initially with the ‘gift’ money. The danger is a loss of transparency and accountability. It will be interesting to see if the Fund reacts to these quasi-fiscal operations.
Another important deviation from reforms proposed in the original programme relates to the expansion of the income tax net. It was expected that notices would be sent to the large number of NTN-holders, who have not filed returns. But initial attempts by the FBR have been an abysmal failure. Now the government has proposed the ‘homegrown’ measure of raising advance/withholding taxes on non-compliant taxpayers. This appears to be a more pragmatic approach.
A potentially serious issue relates to the sharp reduction in power sector subsidies, as required by the IMF. The government has complied by bringing down the tariff differential subsidy to Rs185 billion in the 2014-15 budget from the actual amount of Rs309 million in 2013-14. The problem is of implementation of the implied tariff increase at a time when the political and security situation has worsened. In the presence of high levels of power loadshedding, a tariff increase could lead to widespread riots. As such, the government may be compelled to defer this move.
Overall, the government has increasingly shown the tendency to adopt ‘homegrown’ reforms, following some stabilisation of the economy. Many of these moves are pragmatic in nature and show a better understanding of the local context. Others, like the policy on export promotion, may need to be reviewed subsequently. Hitherto, the IMF has demonstrated a flexible and supportive approach in the three reviews that have taken place. It is hoped that it will maintain the same attitude in subsequent reviews as well.
Published in The Express Tribune, July 27th, 2014.
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