The IMF second review staff review of the Extended Fund Facility has been completed and a press statement issued. There is need to appreciate efforts of the government in meeting all the six performance criteria again as was the case in the first programme review.
This should have led automatically to agreement between the authorities and the IMF mission on the review and a commitment to submit the review to the Executive Board of the IMF for release of the third tranche of the loan to Pakistan.
However, there appears to be no such agreement. Instead, the press statement says:‘Steadfast progress on programme implementation will pave the way for the IMF Executive Board’s consideration of the review.’
This represents a major departure from the process followed in previous IMF programmes with Pakistan and a new source of uncertainty. The IMF staff mission has been unusually tough in dealing with Pakistan. Given successful fulfilment of all the performance criteria, the tranche release should have been automatic. In fact, in the last IMF programme from 2013 to 2016 funds were released even when some of the performance criteria were not met by the granting of waivers. Over a dozen such waivers were granted during the tenure of that programme.
The fundamental contradiction is that the IMF is full of praise for the efforts and achievements thereof in the first six months of the programme by the authorities and yet there is a reluctance to arrive at an agreement. Numerous successes have been highlighted in the press statement.
First, there is recognition of the faster build-up of foreign exchange reserves due particularly to the big reduction in the current account deficit and the inflow of funds from the IMF and ‘hot money’. Second, fiscal performance in the first half of the fiscal year has remained strong, with the government registering a primary surplus of 0.7 percent of the GDP. Third, development and social spending have been accelerated. Overall, according to the IMF, economic activity has stabilized and remains on the path of gradual recovery.
Why then is there uncertainty about the steps that are required to qualify for the release of the third tranche? Precisely, what type of ‘steadfast progress on programme implementation’ is required? What will be the time gap between the return of the Mission to Washington and the convening of the Executive Board for review of Pakistan’s EFF?
The press statement should have been more explicit about the kind of progress that is required. There has been speculation in the media that there is apprehension on the part of the IMF that the budgetary position is likely to worsen in the second half of the year and the performance criterion on the size of the primary deficit will be difficult to meet in future reviews. This is based on the fact that there has been a growing shortfall in FBR revenues which cannot continue to be largely compensated by higher non-tax revenues.
Therefore, is the IMF expecting a mini budget in the near future with taxation proposals for generating additional tax revenues by the FBR? Unfortunately, this is the wrong time for contemplating any additional indirect taxation of consumer goods. The economy is floundering and the people are facing severe ‘stagflation’. The inflation rate has risen to almost 15 percent, with food prices jumping up by almost 25 percent. Given the fall in production in different sectors of the economy, unemployment is rising exponentially. Over 1.8 million people have lost jobs since June 2018.
What are then the options for the Government? Given the success in tackling the current account deficit and the improvement in the level of foreign exchange reserves, one option is to ask for a renegotiation of the IMF programme from a somewhat stronger position. However, this is a high-risk option and the Government will need to carefully evaluate if this is feasible, especially since the $3 billion of ‘hot money’ may rapidly exit from Pakistan during the hiatus.
The alternative is to change the budget strategy and attempt to meet the fiscal performance criteria in the third and fourth reviews. The thrust of the new strategy should be, first, curtailment of expenditure wherever possible and, second, resort only to progressive taxation proposals which can yield revenues in the short run. This is essential if a strong reaction from the people is to be avoided.
The types of direct taxation proposals that could be introduced are as follows:
- A ‘super tax’ on non-financial companies earning a net pre-tax return on equity of above 15 percent at the rate of 10 percent on additional profits.
- A 5 percent cess on all withholding taxes.
- Levy of a 3 percent duty and sales tax at 10 percent on the import of services with payment by the importer.
- Increase in the corporate tax rate of banks to 40 percent in view of the higher profitability due to larger lending to the Government and higher interest rates. There was a time when the corporate income tax rate on banks was as high as 58 percent.
- Immediate revaluation of properties and levy of a minimum tax on rental income.
- Levy of a shares transaction tax.
These proposals could yield up to Rs 200 billion on an annualized basis. At no stage should the coverage be broadened or the rate of indirect taxes on consumer goods enhanced since any impact on prices has to be strictly avoided at this time.
Further, there should be a strong attempt to reduce non-salary operating costs which are estimated at Rs 930 billion in 2019-20. A 10 percent reduction is feasible in the short run. On top of all this, the combined PSDP of the Federal and Provincial Governments may be cut by 15 percent. This will improve the budgetary position by almost Rs 240 billion. Privatization receipts are a financing and not a revenue item. However, fast movement on selling loss-making SOEs will reduce current liabilities.
Overall, a budget rationalization plan can be put together and implemented. This will not only ensure that there is less sustained pressure on the current account of the balance of payments but preserve Pakistan’s credibility and standing not only with the IMF but also with international credit agencies. Following the approval of the third tranche release, Sukuk/ Eurobonds of up to $3 billion should be floated rather than increasing further the reliance on ‘hot money’.
Unfortunately, the IMF has put Pakistan in a difficult position despite the strong efforts at stabilization of the economy which have already been undertaken. There is now a new source of uncertainty which could affect the flow of funds into Pakistan in the interim period.
Dr Hafiz A Pasha