IMF: be counter-cyclical

Since the IMF’s statement regarding a staff-level loan agreement with Pakistan was released May 12, economic observers have been busy parsing the text, hoping to decipher how tough the going will get. Not to split hairs, but some of the content in the statement merits a closer look.

For instance, the statement attributes Pakistan’s “challenging economic environment” to a number of factors, including “procyclical economic policies”. In good times, a pro-cyclical policy would mean having loose monetary and fiscal policies, to extend a boom. The PML-N government, which didn’t see the warning signs until too late, tried to prolong the expansionary business cycle through higher government spending and a lax tax policy.

During bad times, however, following a pro-cyclical policy would entail reducing government spending, increasing taxes and raising the policy rate. In that sense, IMF, too, leans pro-cyclical when it offers countries facing downturn a recipe-mix of austerity (lower or flat-lined government spending) and demand compression (higher taxes, tariffs and interest rates).

Perhaps a better recipe in a downturn is to be counter-cyclical – that is, stimulate the economy through higher government spending and maybe tax cuts, too. By the above definition, IMF is going pro-cyclical on Pakistan by asking for tax and tariff hikes. Of course, there is a dire need to control inflation and reduce the twin deficits through “adjustment” measures. But going down that path is not exactly counter-cyclical.

Nevertheless, the government still has the precious tool of development and social spending at its disposal as the IMF grants “prudent spending growth aimed at preserving essential development spending, scaling up the Benazir Income Support Program and improve targeted subsidies”. That makes one curious, though. What level of spending is “prudent”? And what does “essential” really mean here?

Perhaps mindful of the challenge of rising poverty in coming years, both the Fund and the government have committed to scale up the social-safety-net (SSN) spending. It remains to be seen whether the finance minister can secure his Rs80 billion raise on that count. Things look more somber for development spending, for which the government is reportedly allocating Rs1.57 trillion for next fiscal – a double-digit decline over current fiscal.

Even if development spending actually came close to that allocation in FY20, it will take back spending level to 2016/2017. Development spending, which offers a higher multiplier effect, is already low. Averaging just 4 percent of GDP in the decade ending FY18, it is about a fifth of total expenditures p.a. In 1HFY19, development spending dropped to a fifth of total expenditures, coming in at 1 percent of GDP. Further reducing development spending in real terms will be the pro-cyclical measure this sick economy doesn’t need.