It's that time yet again! The Pakistan economic team is in Dubai discussing and negotiating with the International Monetary Fund (IMF) team. Initially the Ministry of Finance claimed that the scheduled meeting may be transformed into a review mission that would reactivate the stalled Stand-By Arrangement (SBA) thereby paving the way for the release of the penultimate tranche.
But there was a big if; if the government succeeded in satisfying the IMF that it was complying with its critical conditions.
The IMF squashed these speculative reports by placing a program note on its website on April 7, a week prior to the Spring Meeting of the IMF/World Bank attended by all member countries, including Pakistan: "Structural reforms (in Pakistan) had moved forward in late 2008 and 2009, but have been retarded or reversed in 2010 and 2011. In 2008 and 2009, steps were taken to strengthen bank supervision, bolster the social safety net, reform petroleum pricing and taxation, and liberalise the foreign exchange market.
Also, some progress has also been made recently in modifying the existing general sales tax by reducing exemptions and strengthening the refund mechanism. However, this reform has been delayed and its scope has been far narrower than earlier envisaged (reference is to the statutory regulatory order dated March 15 though the government withdrew some of the reduction in exemptions subsequent to protests by some sectors/sub-sectors).
Moreover, very little progress has been made in reforms in the electricity sector (subsidies to this sector continue as does the inter-circular debt) and commodity operations (increasing commodity operations is raising the indebtedness of the government), which are urgently needed to eliminate financial losses that impose a burden on public finances and pose a threat to macroeconomic stability. Further, the legislation needed to strengthen bank supervision and central bank autonomy has not yet been enacted, strengthening of the social safety net is still not complete (Benazir Income Support Programme's pilot for 16 districts to come up with a "Poverty Scorecard" based on Proxy Means Testing as proposed by the World Bank is complete but not yet replicated in the rest of the country), and the reform of petroleum pricing has been partially reversed in recent months (due to threats by the MQM as well as the PML (N))." This list of non-compliance cited in the program note ended speculation that the scheduled meeting in Dubai would ever be upgraded to a fifth SBA review though the Finance Ministry officials remained upbeat with the media.
The programme note ends with a list of challenges that include, "Stronger public finances are needed to allow for higher spending on development and poverty reduction, and to increase much-needed social outlays over the medium-term. Economic reforms will also mobilise financial support from external donors and spur greater private capital inflows." In effect, the IMF is emphasising the need to increase tax collections, while also continuing reliance on external support and foreign direct investment. The two major questions as a consequence of the program note are: should Pakistan follow IMF objectives? Are they doable? The answer theoretically is a resounding yes on both counts; however the specific conditions agreed between the Fund and the Pakistan economic team failed to generate the requisite political support or support by the public.
The reason: the government tightened its belt mainly by slashing development projects which clearly benefit the public, while failing to increase tax revenue through bringing in the untaxed sectors into the tax net (failure to tax the income of the rich landlords remains particularly galling for the common man) and instead it relied on the existing taxpayers to increase its revenue as indicated by the March 15 three presidential ordinances. The amendments to the Statutory Regulatory Orders on the same day by the FBR envisaging higher collections through withdrawal of exemptions on some powerful sectors/sub-sectors were compromised as they prevailed, yet again, on the government to do a volte-face. In addition, large-scale manufacturing output has failed to pick up third year running, attributed to massive load shedding, high cost of borrowing and pervasive security concerns.
A valuable lesson remains unlearned by the economic team and the FBR: continued failure to deliver basic infrastructure (physical and social), an inability to reduce budgetary outlay on some sacred cows and failure to compel the rich to pay taxes has reached levels that many consider is untenable and this fact alone compromises the public's motivation to pay taxes honestly. The country remains mired in this vicious cycle.
There is a consensus that there is a need for stronger public finances. Is the Reformed General Sales Tax that would end all exemptions to the rich and powerful, the only way? The economic team and the Fund appear to focus on the implementation of this tax. Political parties, notably, MQM is opposed to this tax arguing correctly that the government must first plug exemptions on all those with income above a certain level - income tax being the most equitable tax of all. Amongst other stakeholders support for RGST is limited to Pakistan Business Council that constitutes a group of major industrial players (around 30), who would remain unaffected by the tax.
The others, including Chambers of Commerce and Industry, are opposed to it as it is not in their interest to become part of the documented economy that pays tax. The general public at this stage remains undecided simply because one group, the government, is arguing that the tax would not impact on prices while the traders/retailers/wholesalers argue that the tax would be passed onto the consumers in its entirety. The government needs to begin public debate on this more proactively than it has done to date.
There is also agreement on the need to raise development spending and reduce poverty through a expenditure allocation readjustment. This seems unlikely given the economic indicators as presented in the Budget Strategy Paper 2011-14 approved by the cabinet recently: (i) public debt has increased to more than 60 percent of the Gross Domestic Product (GDP) and the public debt to total revenue has reached 400 percent; and the heavy reliance of this government on foreign assistance would not be supported by disbursements with projections of external assistance down to 95 billion rupees (as opposed to 138 billion rupees in 2009-10), the realisation of which will depend on whether the IMF does release the last two tranches though the government expects assistance under the Kerry-Lugar bill and the Coalition Support Fund, irrespective of strains in relations between the two countries, post-bin Laden killing, as the paper notes 95 billion rupees in grant assistance next year; (ii) foreign reserves stand at 17.5 billion dollars, a positive sign, the paper argues but fails to note that according to its own forecast foreign reserves would decline to 14.7 billion dollars in the next fiscal year (enough for 3.1 months of imports) and further decline to 9.9 billion dollars by 2013-14 (enough for 1.8 months of imports: (iii) fiscal deficit as a percentage of GDP is expected to improve from 5.5 percent to 4.5 percent next year to 4 percent of GDP in 2012-13 and 3.6 percent in 2012-14.
Part of the reason maybe a concerted effort to reduce expenditure and increase tax collections through raising the burden on existing taxpayers (Salman Siddique has already come on record stating that there will be no new taxes). To meet this tax, target growth as per the strategy paper is forecast to rise from this year's 2.8 percent to 4.2 percent next year, however this rise is not premised on any credible change in the ground realities as reflected by an increase in private sector investment (expected to rise by nearly 13.8 percent next year as opposed 9.4 percent this year - a statistic that is not justified on account of continued load shedding, high cost of borrowing and security issues) and gross fixed capital formation again likely to jump from this year's low of 11.6 percent top 16.6 percent.
At present, the government is sharing its budget proposals for fiscal year 2011-12 with the Fund. Its objective: to convince the Fund team that the budget adheres to its prescriptions. Does this imply that home-grown policies have yet again taken a back seat to IMF prescriptions? Or more pertinently does this imply that there are simply no home-grown policies?
The public of this country would no doubt like to know why our economic team is so enamoured of the IMF prescriptions that even though it has failed to comply with them till now, due to domestic political opposition - the reason for the stalled Stand-By Arrangement (SBA) - and public angst that has compromised the government's ability to raise rates as well as oil prices by as much as it first announced; yet it remains steadfast in its resolve to comply with the remaining conditions. Critics of Dr Hafeez Sheikh allege that as he was the IMF's nominee and, as a former employee of a multilateral lending institution, he is genuinely convinced that the way forward is through implementing IMF prescriptions. Even if one holds no brief for these prescriptions, yet Dr Sheikh appears to be genuinely convinced that the way forward is as agreed with the IMF.
However, it then becomes Dr Sheikh's responsibility to seek bipartisan political support for these prescriptions and in case he fails to generate that support, as is evident till now, he must come up with appropriate alternatives that are acceptable to the Fund and the politicians. And Dr Sheikh must take the public into confidence and defend his proposals in public fora instead of leaving it to his political colleagues who remain unconvinced about the prescriptions and threatening his staff not to talk to the media as is being widely alleged.