FeaturedNationalVOLUME 18 ISSUE # 34

Another IMF package imminent?

Pakistan is currently facing significant economic challenges characterized by a contracting economic expansion and contraction cycle, rising fiscal imbalances, and a mounting debt burden. The recent staff-level agreement on a Stand-By Arrangement with the IMF offers temporary relief, but long-term stability requires comprehensive structural reforms.

After striking a $3 billion Stand-By Arrangement (SBA), economists agree that it will be followed by a longer-term Extended Fund Facility (EFF) due to the country’s sustained fiscal imbalance. In Pakistan, the goal of achieving full-cost recovery has never been met, regardless of whether the country is under an IMF programme. Structural reforms aimed at improving the performance of key sectors, particularly power and taxation, have been lacking. Instead, the burden has been shifted to consumers through increased base tariffs and charges.

The power sector remains a major concern, with a current circular debt of over 2.5 trillion rupees, despite 23 previous IMF programmes. Unfortunately, the suspended EFF, with $2.6 billion remaining undisbursed, and the SBA, both involve raising utility rates through rebasing exercises, quarterly tariff adjustments, and passing on increased fuel costs to consumers.

Additionally, economically unviable decisions made by previous administrations, such as approving projects reliant on expensive fuel and agreeing to contracts overwhelmingly favoring independent power producers, have further hindered the power sector. Pakistan’s tax structure heavily relies on indirect taxes, with over 70 percent of direct tax collections coming from withholding taxes on services/goods or sales tax. Instead of broadening the tax base to include traders, the current budget focuses on increasing taxes on existing taxpayers for political reasons. Moreover, relying on the petroleum levy, another indirect tax, to generate revenue of 869 billion rupees in the current year, despite a significant decline in consumption due to high inflation, reflects misplaced optimism. It is concerning that petroleum levy is not part of the divisible pool of taxes and is not shared with provinces.

Governments in Pakistan have consistently increased current expenditures to maintain political support from key stakeholders. The fiscal year 2023-24 budget anticipates a 26.5 percent rise in current expenditure from revised estimates of the previous year and a 53 percent rise from the previous year’s budget. This increase in non-development expenditure is a major contributor to inflation.

To bridge the growing gap between revenue and expenditure, the government relies on borrowing from external sources, including bilateral and multilateral support, issuing debt equity (Eurobonds/sukuk), borrowing from commercial banks abroad at reasonable rates, and domestic commercial banks. However, this borrowing crowds out private sector borrowing and constraints economic growth. The high discount rate of 22 percent has also inflated the budgeted debt servicing component of current expenditure. Additionally, the government taps into savings deposited in National Savings Centers.

The staff-level agreement on the SBA has temporarily boosted the stock market and stabilized the exchange rate between the rupee and the dollar, alleviating fears of imminent default. However, these indicators do not imply an increase in output, as the private sector continues to grapple with rising input costs. The poverty levels persist, and the poor and low-income earners remain trapped in a struggle to make ends meet.

It is crucial to acknowledge that while the staff-level agreement with the IMF has helped avert default and buy some time, Pakistan is still ensnared in a debt trap. To prevent default, the government must significantly reduce expenditure, implement tax reforms, make decisive decisions regarding state enterprises that burden the budget, and streamline ministries dealing with provincial matters.

However, with the caretaker government scheduled to take over in August, without the mandate to amend the budget or undertake structural reforms, it is vital that they avoid overspending beyond the allocated budget. Such actions could disrupt the plans of the incoming elected government and undermine the IMF SBA.

It is imperative for Pakistan to address its economic challenges by implementing necessary reforms to achieve long-term stability and sustainable growth. Pakistan’s economic challenges necessitate urgent action to address the root causes and implement structural reforms. The incoming elected government must take bold steps to tackle these issues effectively.

First and foremost, a substantial reduction in government expenditure is essential to curb the growing fiscal deficit. Frivolous spending and unnecessary allocations must be cut back to ensure fiscal discipline and allocate resources more efficiently. This will require tough decisions and a commitment to prioritize the country’s long-term economic stability over short-term political gains.

Furthermore, comprehensive reforms in the tax structure are crucial to broaden the tax base and reduce reliance on indirect taxes. By introducing measures to encourage tax compliance and expanding the tax net to include traders and other sectors, the government can enhance revenue generation in a fair and equitable manner. A progressive tax system that places a greater burden on the wealthy can help redistribute wealth and alleviate the burden on the poor.

Another pressing issue is the state-owned enterprises (SOEs) that continue to drain the budget. A thorough evaluation of these entities should be undertaken to identify those that are financially unsustainable and burdened with inefficiencies. The government must make tough decisions regarding the restructuring, privatization, or closure of such SOEs to relieve the fiscal burden.

Additionally, the government should focus on devolving power to the provinces and eliminating unnecessary divisions and ministries that duplicate responsibilities and drain resources. By empowering provincial governments to manage their respective domains efficiently, resources can be better allocated and decision-making can be streamlined.

It is also vital to prioritize investments in human capital development and infrastructure projects that foster long-term economic growth. By investing in education, healthcare, and skills development, Pakistan can unlock its human potential and build a more productive workforce. Simultaneously, infrastructure development projects, particularly in energy and transportation sectors, can create employment opportunities and attract private investment.

Lastly, there is a need for greater transparency and accountability in the management of public finances. Strengthening governance mechanisms, improving budgetary controls, and enhancing oversight can help mitigate corruption and ensure that resources are utilized efficiently and for the benefit of the people.

While the caretaker government may not have the mandate to undertake significant reforms, it is crucial that they adhere to the budgeted allocation and avoid any actions that could disrupt the incoming elected government’s plans or jeopardize the IMF Stand-By Arrangement.

In conclusion, Pakistan’s economic challenges require a comprehensive approach that includes reducing government expenditure, implementing tax reforms, addressing state-owned enterprise issues, devolving power to the provinces, investing in human capital and infrastructure, and improving governance and transparency. Only through concerted efforts and long-term structural reforms can Pakistan break free from the debt trap and achieve sustainable economic growth for the betterment of its people.

To overcome Pakistan’s economic challenges and achieve sustainable growth, bold and decisive actions are needed. The incoming elected government must prioritize reducing government expenditure, implementing progressive tax reforms, addressing state-owned enterprise inefficiencies, devolving power to provinces, and investing in human capital and infrastructure. Additionally, improving governance and transparency will be crucial to ensuring the effective utilization of resources. By undertaking these structural reforms, Pakistan can pave the way for long-term economic stability and prosperity for its people.