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WHAT WENT WRONG?

Our economy witnessed notable economic growth and overall economic development with relatively greater price stability, lower incidence of un-employment, and level of poverty in 2003-04. However, due to a number of factors, the situation began to deteriorate. The economy started facing serious macro-economic imbalances, particularly a sharp decline in foreign currency reserves during the mid 2008.

By the end of 2008 the country was going to default in its commitments of external payments. The government was left with no option but to approach the IMF for financial assistance to manage its economic problems.

In response to Pakistan’s request, a package of financial assistance under the IMF’s Stand-By Arrangement, worth of US $7.236 billion was approved. To ensure success, the programme, which was designed to restore economic stability in Pakistan, was conditioned to follow some structural performance criteria and conditionalities.

Key elements of the programme comprised seeking reduction in fiscal deficit, tightening of monetary policy, amendment in the banking legislation to enhance the effectiveness of the State Bank of Pakistan, to harmonise the General Sales Tax (VAT) and income tax regimes. Conditions also provided for achieving SBP’ Net Foreign Assets (NFA) monthly targets, finalisation and implementation of electricity tariff adjustments in consultation with the World Bank and ADB with a view to eliminating tariff subsidies, removal of inter-corporal debt in energy sector, and implementation of action plan to strengthen social safety net for the marginalized.

More than two and a half years have passed since the implementation of the programme supported by the release of five tranches amounting to about $8.7 billion, (the last two to be released by December 2010 were withheld due to non-implementation of structural reforms). It will be worthwhile to examine the performance of the economy in achieving objectives attached to the programme.

Initial response to the programme had been generally positive as policy implementation through end-April 2009 (period of first IMF quarterly review) had been good and programme remained on track. The fiscal deficit target appeared challenging but was achieved. Despite pressure owing to downward tax revenue collection, the government was successful in maintaining a tight fiscal policy regime through a combination of non-tax revenue generation and control on expenditure.

The exchange rate by and large remained stable through capitalisation by SBP to mitigate the pressure on rupee. Although inflation during the period had fallen and current account deficit narrowed but the level of economic activity slowed down. As regards the overall achievement of the programme, it was observed that all quantitative performance criteria was met during the period but structural reforms had been slower than envisaged.

During the period of second review (April-July 2009) by IMF, the analysis reveals that the ceiling targets for net foreign assets of SBP, its net domestic assets and the government borrowings from the banks had been successfully observed. The SBP adopted greater exchange rate flexibility during the period, which resulted in an increase of gross official reserves from $ 3.5 billion at end-October 2008 to $ 9.1 billion by end-June 2009.

Inflation continued to decline during the period but core inflation remained high and persistent. However, despite a decline in exports, it was experienced that a significant decrease in imports along with higher volume of overseas workers remittances, reimbursement under coalition support programme and releases of loan installments; the external current account position improved substantially. But in case of fiscal deficit, it was noted that it exceeded by a large margin (0.9 percent of GDP) from the agreed quantitative performance ceiling. The elimination of electricity tariff subsidies, originally scheduled for end-June, 2009, could not be achieved.

During the third quarterly review (August- December, 2009), it was observed that despite measures taken to strengthen budgetary management, fiscal deficit ceiling on the overall budget for end-September was again missed and this time by about 0.3 percent of GDP due to some compelling circumstances. However, all structural benchmarks meant for the period were met, of course most of them with delays. In order to sustain the feeble economic recovery, the discount rate was revised downwards from 14 percent to 13 percent in August and 12.5 percent in November 2009.

The government, thus, implemented the most critical structural reforms, although with some significant delays such as in tax administration and designing of VAT law during the period. Although the implementation of the programme was not entirely successful, some politically difficult reforms were carried out by the government, despite facing constraints.

In the next quarter, programme implementation has been mixed with delays in achieving some structural benchmarks and accumulation of quasi-fiscal liabilities. On the other hand, some improvement in the level of economic activity took place but, still, growth rate remained only 4.1 percent. Inflation rose higher than expected due to large food and energy price increases. SBP’s international reserves were found stable since October 2009. The current account deficit came down during the period, which was mainly on account of import contraction (due to lower commodity prices and drop in the demand of other imports) and stronger inflow of workers’ remittances.

The economic slowdown and erosion of purchasing power caused by inflation seemed to have reversed gains in poverty reduction, which had significantly declined during the pre-crisis period. Due to some administrative capacity constraints the roll out for the BISP has been found taking longer time, which certainly aggravated the problems of vulnerable groups. As regards the SBP’s NFA and domestic assets, these were met with wide margins but the ceilings on the overall budget deficit (excluding grants) and net government borrowing from the SBP were missed, which exceeded by 0.2 percent of GDP while the budget deficit target exceeded by 0.7 percent of GDP.

It may be concluded that the government failed on many counts in the implementation of some very significant structural benchmark conditionalities which were planned to be achieved by end-December, 2010. There was a continuous breach of fiscal deficit limits, postponement of the implementation of Value Added Tax (VAT) regime, non-finalisation of amendment in the legislative framework for the financial sector, absence of energy sector reforms, etc.

The failure of the government to meet these key conditionalities became a source of irritant to the IMF and, consequently, the fifth review scheduled for June, 2010 was postponed first for August, then for September 2010 and subsequently for indefinite period.

The government approached the IMF with the request for a nine-month extension. In response to that, the IMF approved a nine-month extension “on a lapse-of-time basis”. The objective was to give time to the authorities to complete the reform agenda. Meetings between the two sides have taken place since early March on the programme’s fifth review. A request has been made for waiver of performance criteria.

The available data indicates that the country is again found slipping into heavy debt. Total debt (in domestic currency) amounted to Rs4310 billion (56.5 percent of GDP) at the end of financial year 2005/06, which rose to Rs4750 billion (54.8 percent of GDP) at the end of June 2007 to Rs5980 billion (58.4 percent of GDP) by the close of financial year 2007-08. The same trend was found afterwards as the amount further rose to Rs7277 billion (57.1 percent of GDP) in June 2009 to Rs8160 billion (55.6 percent of GDP) at end June 2010 and to Rs.9470 billion (55.3 percent of GDP) by the end of December 2010.

Debt in foreign currency rose from $37.229 billion in 2005/06 to $40.322 billion by the end of financial year 2006-07, while it went up to $46.161 billion in June 2008 and to $52.333 billion as at end of financial year 2008-09 and $ 55.901 billion at the close of financial year 2009/10. Latest figure about external debt is available for December 2010, which is $58.393 billion.

According to SBP, the country paid an amount of $2.517 billion in foreign debt servicing in second quarter of the current financial year as compared to $1.7 billion during the first quarter, showing an increase of 48 percent in such a short period of time. The principal amount paid against the total amount of foreign debt, stood at $ 2.21 billion during October-December as against $1.46 billion in the first quarter of the financial year 2010-11. And the interest that was paid against the total external debt rose to $306 million in the second quarter of the financial year 2010-11 while it was $236 million during the previous quarter.

The financial assistance provided by the IMF solved the immediate problem of correcting the extremely adverse balance of payment position of the country along with some positive impact on the economy but rising public debt does not bode well for macro-economic growth in the medium and long term.

 

The writer is Senior Economic Advisor, Sustainable Development Policy Institute

hyder@sdpi.org

This article was originally published at: The News

The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.