Pakistan will soon be entering into 22nd program of International Monetary Fund (IMF). Expected date of implementation is 1st July of this year. As IMF is a lender financial institution therefore negotiation with financial managers of Pakistan took several rounds to satisfy the fund for repayments and use of this extended fund facility amounting to $ 6 Billion Dollars. In this regard some tough conditions are supposedly imposed which includes market determination of exchange rate, aiming primary deficit to 0.6% of GDP excluding debt repayments, strict compliance to the findings of Financial Action Task Force, increase in discount rate, cost recovery in energy sector, rebalancing the fiscal management between provinces and the federal government. Adherence to these conditions will bring more inflation, economic slowdown and political uncertainty if counter measures may not be properly planned during this three year IMF program. If IMF program is bringing with it some tough conditions, it will also make our economy documented and disciplined.
As we discuss counter measures to IMF implanted conditions it is important to highlight these conditions and there consequences in detail, side by side, for better understanding. Market determination of exchange rate is one of the major impediments which will result in economic slowdown. Industries having appetite of imported raw material will bear most of the hit. From already increasing gap between Dollar and Pak Rupee, Pakistan is witnessing economic slowdown. In recent past business activities are shifted towards import based economy that soared Trade Account Deficit to worst of the history. Consumer behavior in Pakistan is now dominated by import based purchases due to lack of quality of locally manufactured products. Therefore, either imported raw material is being used to make finished products for local consumption or final products are directly being imported. It doesn’t mean that imports were not used to build infrastructural capacity or as a raw material for export purposes but the ratio went down substantially. This pattern is actually outcome of artificially control of Dollar by injecting huge external loans which resulted in Trade Deficit due to increase of imports against declining exports owing to value of Pak Rupee. Now, immediately shifting towards market determination of exchange rate will disturb this consumption behavior which further inflicts pain to already downturn of economy. To deal with this emergency like situation government of Pakistan need to focus on promoting made in Pakistan products either to regulate local consumption behavior or for export purposes. Imports are to be used for Export purposes so that a value addition may bring margins which may result Trade Deficit to down.
Inflation is a definite phenomenon as a result of IMF conditions therefore discount rate is expected to increase by some 150 BPS further. It will increase cost of funds and businesses dependent on Bank borrowing will suffer with a huge finance cost bringing down profit margins
Other condition is to check primary deficit which is to be budgeted at 0.6% of Gross Domestic Product (GDP) excluding debt repayments that may be around 5% of GDP or Rs.2 Trillion this year. If said condition may not be considered, total deficit to GDP may be around 7.3% for Fiscal Year 2020.Containing of fiscal deficit will result in lowering the speed of getting public debt, which is also an objective of IMF. The above fiscal deficit target for FY20 would imply that the government will be aiming for tax revenues to increase by Rs600-800bn next year, which is around 2% of GDP. This seems to be huge target in given circumstances where GDP growth expectation is around 3% for FY20. This means more indirect taxation which can become a cause of further inflation. To tackle this situation in short term, Government has announced Tax Amnesty scheme which will serve two purposes. One is tax collections from those who otherwise would not have paid it and secondly further documentation of economy which will not only broaden the tax net but will help tackling IMF condition to abide by FATF findings. But there is a little hope that this scheme will bring fruits due to its timing and allowed for a shorter period which is affectively till 30th June this year 2019. It is because IMF bailout will be commencing from 1st of July and it discourages such schemes for instant relief to national exchequer due to the fact that the same is unjustful for honest taxpayer. When all other options may be exhausted then fingers will be on cutting defence budget which is not advisable when regional conflicts are surging and an optimum deterrence is essential. A cut on Public Sector Development Program (PSDP) is also not advisable in this economic slowdown scenario. Government spending is must in this situation on revenue based developmental projects for boosting economic activity and to check unemployment. Broadening Tax net and Tax Amnesty Scheme will work side by side on no choice basis together with increasing indirect taxes which should be avoided at most.
This tax amnesty or Asset declaration scheme alone cannot serve the purpose for incremental collection of revenue and inflow of Dollars. A strong business case is needed that would compelled people to send money to Pakistan. Alongwith Tax Amnesty, active investment prospects with better returns can achieve this target. A stock market fund for USD repatriated money can provide an investment opportunity for the declared cash from foreign sources with a very good return as the market has huge potential after witnessing a slowdown. However, the capital investment should have a lock in period so that outflow of Dollars may have been avoided. Similarly Private Equity Management Companies may be established for such inflow of repatriated dollars with same lock in period so that Small and Medium Enterprises who have better prospect may become large scale manufacturing or services units and to be listed on Pakistan Stock Exchange, giving better returns to its foreign investors and become a lucrative investment portfolio for local investors of PSX. The government can also structure the funds from amnesty scheme towards identified sectors which can bring back business activities such as housing and tourism that will further strengthen the related industries.
Inflation is a definite phenomenon as a result of IMF conditions therefore discount rate is expected to increase by some 150 BPS further. It will increase cost of funds and businesses dependent on Bank borrowing will suffer with a huge finance cost bringing down profit margins. A margin shrink can compel businessmen to inject owner’s equity which is a good sign but on the hand this shrinkage of profit margins can shut down many small and medium enterprises. Therefore preferential interest rates should be available to indirect exporters and for those who can bring back consumer behaviour from imported products to make in Pakistan products which can save foreign exchange. As it is stated earlier that some special funds to be created so that foreign investors may participate in a venture which will not only secure returns for them but may generate less costly liquidity for going concerns specially for these SMEs.
IMF is stressing on cost recovery in the energy sector and State Owned Enterprises. In this scenario energy tariff will increase and efforts to reduce circular debt may be observed. Therefore a 25% increase in power tariff is expected whereas gas prices to increase upto50% over a period of next few years. Renewable Energy sources and Dams are the only way to avoid expensive electricity which can help bringing down the tariff in near future whereas water for agriculture will be guaranteed that will help in growth of GDP as well. Speeding up privatization will also be key facet of the upcoming IMF program. In this regard government should identify those stated owned enterprises which are sick units and in losses rather than selling healthy ones. With these funds construction of Dams should be our priority so that particular target of economy may be achieved by injecting cheaper electricity and development of agriculture sector helping economy to grow. IMF has also hinted towards rebalancing the fiscal management between provinces and the federal
Governments. The National Finance Commission (NFC) award under which provinces get their share from Federal resources is the most discussed 18th Constitutional Amendment. Any change will require a constitutional amendment which requires ruling party to have two-third majority that obviously PTI doesn’t have. Therefore Prime Minister should declare present situation of Economy as National Emergency where political parties to be called for consensus over distribution of funds under this amendment. This is possible if PM may give a clear vision and timeline as to how and when the situation will be under control. Without giving timeline a frustration is spreading out in general public which is not only dangerous for Imran Khan but for motivation factor among the people to work hard for better Pakistan.
The writer is an Economist, Corporate Finance Specialist and a Chartered Banker UK