“PTI will not leave behind an economic crisis on external front”
Asad Umar may recently be most known for his impressive leadership as chairman National Command and Operation Center during Covid-19 pandemic, but the man has worn many hats since Pakistan Tehreek-e-Insaf (PTI) came into power. As PTI’s maiden finance minister, he led the negotiations with the IMF during 2018-19, which have had a lasting impact both for his political legacy, and his party’s performance on the economic front.
Last week, Umar set down with BR Research to finally take on all the theories head on: was the PTI government reluctant to go to IMF? What part, if any, did Umar play in delaying the agreement with IMF, and what the delay has meant for Pakistan’s economy. Below are the edited excerpts:
BR Research: Your stint at the finance ministry was very eventful. Is it correct that you were hesitant to agree to IMF’s conditions, while your successor was quickly able to reach an agreement with the Fund soon after his appointment?
Asad Umar: IMF programme cannot be finalized in a week’s time. The agreement with the Fund was already reached during our meetings held in Washington DC during mid-April 2019. I also made a public announcement confirming the same in a press conference at Pakistan embassy in the US capital. By the time Pakistani delegation was on its way back, the Fund had announced schedule for its staff visit to Islamabad, which would have allowed us to put the agreed terms in writing.
BRR: The dominant theory suggests that had Pakistan entered the programme early on, it could have benefited from a lot less stringent conditionalities than that followed eventually due to the delay?
AU: Pakistan concluded FY18 with a negative primary balance of 2.2 percent of GDP. During our initial consultations in October 2018, the Fund demanded an immediate adjustment of 1.7 percentage points, followed by improvement of primary balance to positive 1.5 percent of GDP in three years. In contrast, Pakistan eventually agreed to a substantially lower adjustment of cumulative 2.8 percentage points in primary balance, spread over four years.
Moreover, the negotiating team persuaded IMF to space out monetary and fiscal adjustments over two years. While Pakistan made significant monetary adjustments during the first year of the programme, fiscal adjustments did not follow until the second year. That saved the economy from simultaneous twin-adjustment shocks.
With respect to exchange rate management, the Fund demanded that Pakistan switch to free-float on immediate basis. Because current account deficit stood at $2 billion in June 2018, an overnight shift to free-float would have taken exchange rate to Rs184 per dollar. Similarly, IMF demanded that energy tariffs be revised upwards, which would have dealt a double-whammy as the underlying payments for both electricity (IPPs) and gas (FO, LNG) are also priced in dollar.
Together, this would have led to average CPI during the programme climbing to 17.4 percent, along with further inflationary adjustment of 12.9 percent during the following year. In order to mitigate the impact of pure float exchange rate and to maintain positive real interest rates, the Fund recommended that the policy rate be increased by 600bps overnight, with eventual increase of policy rate to 21-22 percent.
I am proud to claim that our initial resistance enabled Pakistan to agree to materially less stringent conditions eventually, which both allowed the GoP to fund welfare support and poverty reduction programs, while also protecting the majority of the lower- and middle-income segments of the population from the effects of a prolonged and painful cycle of macroeconomic adjustment.
BRR: Why then did negotiation broke down circa December 2018? Was the ruling party opposed to an IMF programme due to its electoral commitments against the same?
AU: Even before the 2018 elections, PTI was very clear that Pakistan’s economy needed a bail out, the only question was whether the bail out would come from IMF or elsewhere. Within eight days of my swearing in, Pakistan invoked the consultancy clause as member IMF. By October 2018, the GoP had announced that it was going to IMF.
During the negotiations, the Finance team was guided by the macroeconomic models from SBP, which disagreed with IMF’s forecast of Pakistan’s macroeconomic indicators. Historically, the forecast models coming out of SBP have been far more accurate than others. The Pakistani side insisted that it was already undertaking several macroeconomic adjustments which would improve the fundamentals before we entered the programme. IMF was persuaded to observe the response of economic indicators during the interim period, and agreed to mellow the programme conditions if Pakistan could demonstrate that the adjustments undertaken were bearing fruit.
BRR: Which policy measures specifically do you believe persuaded the Fund to soften its preconditions?
AU: These measures included exchange rate adjustment of 30 percent, which brought REER down to 103 from 127 under PML-N era. Similarly, income tax slabs were restored, with highest slab going up to 30 percent through a supplementary finance bill. Federal excise duty was increased on import of luxury items, while custom duties on over 5,000 non-essential items were also increased. Similarly, regulatory duty was also imposed on over 900 items. Gas prices were increased by an average of 25 percent, while electricity prices were increased by an average of 11 percent. Meanwhile, policy rate had also been revised upwards by 450 bps. As a result, current account deficit had been brought down from $2 billion under PML-N to $666 million by February 2019. Never in Pakistan’s history have such difficult monetary and fiscal adjustments have been taken prior to entering an IMF programme.
BRR: Do you agree that macroeconomic indicators had worsened by the time Pakistan entered the programme in May 2019?
AU: No. The financial markets responded well to the positive shift in fundamentals. The spread between open and inter-bank exchange rate fell from the peak of 3 percent to 0.2 percent. SBP forex reserves started to rebuild after a long break. Stock market returned to its pre-election levels. Pakistani Eurobonds rallied by 20 percent in January 2019, making them the best performing in Asian emerging markets. Credit default swaps (CDS) on Pakistani Eurobonds improved by one-third. Similarly, commercial banks’ participation in PIB auction also staged a comeback. Foreign portfolios also returned to equity market.
BRR: Why then did IMF not acknowledge the shift in macroeconomic indicators?
AU: When negotiations resumed in March 2019, IMF representatives conceded that Pakistan had delivered on its promise. Unfortunately, exchange rate worsened again after the Balakot airstrike and resultant escalation. Nevertheless, Pakistan was able to close its deal with the Fund by April 2019.
BRR: It is believed that the Fund demanded a pure float exchange rate regime, which became a sticking point eventually?
AU: Our negotiators agreed with the IMF that exchange rate should not be held artificially, but instead act as a shock absorber that reflect any worsening of economic fundamentals. However, we insisted that because the currency market is very thin, it should not be left at the mercy of the market completely. Doing so would create vulnerabilities by exposing exchange rate to speculation, especially when the country had such low levels of forex reserves. Thus, Pakistan insisted on a market-based flexible exchange rate, where the central bank would only intervene in cases where depreciation occurred due to speculative activity, and not when it would be fundamental-driven.
Not only was Pakistan successfully able to convince IMF of its position, the central bank governor – who was previously associated with IMF during the negotiations – later commended our position as well.
BRR: Independent analysts fear that the economy appears to be entering another cycle of growth on steroids since the latest change in leadership at finance ministry. What is your assessment?
AU: The incumbent finance minister seeks to build on the ongoing expansionary phase by creating both purchasing power and a safety net for the most vulnerable segments of the economy.
My assessment is that Pakistan has entered a similar phase as it had in November 2018, where it hopes to demonstrate to the IMF that robust growth can be powered without worsening of macroeconomic indicators. Just like last time if we succeed in proving that the indicators are inclined in the same directions as our projections – for example, if revenue collection grows as has been projected in the budget - Pakistan shall succeed in persuading the IMF for continued engagement.
BRR: But the way energy tariffs have been frozen recently indicates that the government is inclined to let energy circular debt fester to fuel growth. While it may be difficult to increase electricity tariffs, what is the delay in changing gas pricing to weighted average cost basis?
AU: I am the foremost advocate of gas pricing based on weighted average cost of gas (WACOG). I advocated the same back when I was working in private sector as part of Engro Corp. However, a short-termist, view won at that time, as the political parties in power at the time did not want to face the public reaction.
The PTI government has finalized plans to switch to weighted average cost of gas. We have even worked on various scenarios to soften the blow as some sectors such as CNG and power are already paying full price. The switch shall increase gas prices by 20 percent, but it is not too high to have a highly adverse fall out for the economy. In fact, gas shortage has a far more negative impact on the economy than any increase in gas prices can have.
BRR: The case of fuel prices is no different, where petroleum levy and GST have been reduced. If the government continues on this expansionary trajectory, it will be near-impossible to increase PL as election season draws close?
AU: Unfortunately, the global markets are witnessing a commodity price boom, which has increased prices of both food and energy commodities. Thus, Petroleum Levy has been lowered temporarily to provide a cushion to vulnerable segments of economy from an inflationary cycle. However, the reduction in Petroleum Levy is in no way permanent. If global prices of petroleum products do not decline, either local fuel prices will increase, or the government will be forced to cut back on its expenditure. Both cannot sustain.
BRR: Independent analysts insist that sustainable economic growth can only be achieved if energy markets are deregulated. What is your view?
AU: Gas and electricity may be the lifeline for Pakistan’s economic growth, but they are not more important than food security (wheat) for any nation. DAP fertilizer is the most crucial input for wheat productivity, yet DAP prices are completely deregulated in Pakistan. Has the country ever faced DAP shortage?
Sooner or later, Pakistan will need to deregulate its energy markets, both for electricity and gas. Once a competitive markets framework is in place, the role of government shall be restricted to that of a regulator. Of course, that cannot happen overnight. But that’s the direction in which we must move in, both through policy and implementation.
BRR: Will PTI conclude its term with another economic crisis brewing on the external front?
AU: Both the prime minister and the party are very clear that the country must not be allowed to return to a deficit fuelled growth phase. Economic growth is only welcome if it comes with macroeconomic indicators held intact and healthy. Thus, PTI will only succeed in creating a legacy for itself if it manages to put the country on a road to sustainable growth. This will not only be beneficial for the economy, but also for PTI as a political party.