The IMF mission has reached a staff level agreement with Pakistani authorities for a $5.3 billion bailout package. The duration of the programme is three years, and the resources will be provided to Pakistan under the Extended Fund Facility (EFF). The staff-level agreement will be reviewed by the IMF management and once it is cleared, it will be presented to the Board during the first week of September 2013 subject to the timely completion of prior actions by the Pakistani authorities.
The new programme is good for Pakistan for the following reasons. In the first instance, it will remove uncertainty surrounding Pakistan’s economy. It will also help prevent a crisis of confidence and the resulting capital outflow, further depletion of foreign exchange reserves and pressures on exchange rate. Additionally, the agreement will save Pakistan from defaulting on its external debt payment obligations and protect the poor and the middle class from severe pain and sufferings on account of this default.
I have been advising the Pakistani authorities to seek IMF support since September 2011 as the writing on the wall was absolutely clear. It was simply a matter of time. I commend the efforts of the Finance Minister Ishaq Dar and his team in finally reaching an agreement with the IMF for a new programme.
The critical elements of the programme include: i) broadening of tax bases and phasing out of the SROs, ii) strengthening tax administration, iii) addressing issues pertaining to fiscal decentralisation, iv) reforming the energy sector by focusing on resolution of circular debt, prevention of electricity theft, recovery of electricity bills and support of investment in the power sector.
Other elements of the programme include restructuring and privatisation of the rotten PSEs including the DISCOs and tightening of monetary policy to control inflation and prevent capital outflows. Budget deficit target has been reduced to 6.0% of GDP instead of 6.3% for 2013-14. It will further be reduced to 3.0-4.0% of GDP by the end of the programme period. Improving investment climate and protecting the poor segment of society from the cost of adjustment through strengthening of social safety nets are also critical elements of the programme.
In short, resource mobilisation through tax base broadening, addressing issues of fiscal decentralisation, energy sector reform, investment climate improvement, fiscal deficit reduction and reducing public debt burden are some of the major objectives of the programme. Other major objectives are aimed at strengthening the financial sector, strengthening corporate governance, building foreign exchange reserves to provide stability to exchange rate and bolstering social safety net programs.
If these reforms are successfully implemented, Pakistan may see its economic growth approaching 7.0-8.0% per annum with relative macroeconomic stability in the next five years. But there are serious challenges for the implementation as well as achieving all the performance targets of the programme.
As a result of the NFC Award, the success of the programme depends crucially on provinces. The initiatives of maintaining fiscal discipline and reducing budget deficit have been shifted to provinces as they receive 60-65% resources collected by the Federal Board of Revenue (FBR). This is what I have been stating all along since the finalisation of the new NFC Award in 2010, but the country’s financial managers have not paid any attention and as such fiscal indiscipline has been allowed to reign galore with all its adverse consequences.
Realising its importance for the success of the programme, both the IMF and the Pakistani authorities have agreed to address the issue as a prior action for the programme. In other words, some binding constraints on the part of the provinces to generate targeted surplus will have to be instituted and approved by the Council of Common Interest (CCI) by early September 2013. In my view, this will be the most challenging task of the finance minister to bring all the four provinces to agree on the binding constraints and get the approval of the CCI. I hope the provinces agree to these binding constraints in the larger interest of the economy. Failure to this agreement is not an option. The other prior actions may include tightening of the monetary policy by raising the discount rate in the range of 100-150 bps and raising the power tariff to prevent the re-emergence of circular debt.
The success of the programme will also depend on the ability of the FBR to collect targeted revenues, which has been made even more challenging in the IMF programme. It is well known that the FBR is in a bad shape. Infighting among different tax groups has reached to an unprecedented level. The quality of staff including the senior staff members has deteriorated significantly over the recent years. Economic experts seriously doubt the ability of the FBR to collect targeted revenues.
The power sector has the ability to derail the programme by creating slippages on the expenditure side, if not handled properly. Rs 150 billion allocated for inter-DISCO tariff differential in the budget 2013-14 is most likely to be breached, thus creating slippages on the fiscal deficit target.
Slippages on non-tax revenue side are high as well. The government has targeted receiving Rs120 billion through the sale of 3G licenses. This revenue is not likely to be realised for two reasons. Firstly, the existing telecom operators do not see this as a viable investment at the back of heavy increase in the tax burden of the users of the cell phone in the Budget 2013-14, and further tightening of regulatory requirements. I will urge the finance minister to discuss these issues with the CEOs of the existing telecom companies, particularly after the damaging interview of the CEO of Telenor Pakistan, published in The News and other English daily. Secondly, increase in taxation on telecom has reduced their revenues and hence purchase of 3G licenses is no longer a profitable venture.
To monitor implementation and progress towards the programme, I would recommend the Finance Minister to appoint a senior level officer in the Ministry of Finance to coordinate with concerned ministries and monitor the progress.
Finally, I would also recommend the separation of tax collection and tax policy. Currently, the FBR is performing both the responsibilities and, given its deteriorating state, none of the tasks is likely to be performed to satisfaction. The government may consider appointing a secretary level officer to take care of the tax policy. This Division will serve as a thinktank for tax policy, work on broadening of tax bases and analyse their economic implications, prepare tax-forecasting model to forecast revenues, and also work as a thinktank for the National Finance Commission.
Reaching an agreement at the staff level is the first step towards an IMF programme. Meeting prior action will be the second step. Successful implementations and achieving the programme targets will depend crucially upon the provinces, the FBR and, most importantly, upon the law and order situation in the country in general and Karachi in particular. q (This article was previously published in The News International.)