Pakistan and the IMF must avoid bailout déjà vu

The current EFF program is Pakistan’s 22nd bailout facility provided by the IMF. During its execution, the country has had six finance ministers, three central bank governors, and two governments. Neither continuity of key personnel executing the program nor policy consistency has been its hallmark. Rather, it has seen a series of fits and starts where initially ambitious quarterly fiscal and monetary targets, along with comprehensive policy and institutional reforms to correct underlying economic imbalances, were adjusted over the course of the program due to external shocks and government commitments falling off track.

The economic and financial conditions over the last year have taken a sharp turn for the worse. Inflation has accelerated from under 13 percent year-on-year in April of 2022 to over 38 percent in the same month a year later. Meanwhile, economic activity has shrunk from a GDP growth rate of 6 percent in the fiscal year 2022 to an estimated 0.5 percent in the current fiscal year. The narrow path for avoiding external default got narrower with all the key macroeconomic measures having deteriorated since the start of the EFF program. The chronic balance of payments (BOP) crisis has deepened.

Pakistan dollar-denominated bonds with maturity of one to three-year trade at less than 50 cents per dollar and those of more than three years tenor lower than 40 cents. Similarly, credit default swap (CDS) premium increases from around 40 percent for one-year dollar borrowing by Pakistan to nearly 60 percent for a 5 years term. The credit market is implying a rising risk of default over time. This ties in with the likelihood of Pakistan returning to the Fund for another present once the present one runs its course in June.

Pakistan’s informed and aspiring youth would like to see society re-organized based on greater equity and the IMF must be mindful of this in any future program

- Javed Hassan

The underlying reasons for the downward spiral are poor governance and the lack of political will to implement sustained economic reforms. A history of fractured governance where the development of democratic institutions has been interrupted by military intervention has meant insufficient contestation of policies in the public domain. Unfortunately, even during purportedly democratic dispensations, the parliament and elected leaders have failed to develop the state’s institutional capacity to regulate and direct economic and social interactions for promoting the democratic participation of citizens in governance. There has also been only limited advancement in an open and competitive business environment.

Rentiers have misused the institutions to extract resources from society without reinvesting in productive activities, leading to stagnant productivity and declining economic growth. They have also directly contributed to weak governance, corruption, and limited access to credit for all those who are not insiders. Wealth and power are concentrated in this small section of society that does well through its privileges but has done little to encourage policymakers toward investment in human capital and infrastructure. The lack of democratic institutions and accountability has contributed to a culture of impunity for policymaking that promotes rent-seeking if not outright corruption.

Persistent high inflation undermines macroeconomic stability and erodes public confidence in the government. The lack of political will to control fiscal deficits and the State Bank of Pakistan’s (SBP) monetary policy actions have further dented credibility and raised questions about the efficacy of autonomy. The deteriorating macroeconomic conditions have reduced state resources to invest in key reforms like improving competitiveness and lowering trade tariffs to bring about global integration. Policymakers have relied excessively on remittances and donor and multilateral funding, perpetuating the cycle of poor fiscal performance and increasing indebtedness.

The mood among many middle-class Pakistanis as the country stands on the verge of bankruptcy is increasingly dissatisfied with the extractive political institutions that support privileged groups by cementing their power to benefit from the extraction. The informed and aspiring youth is getting impatient as they would like to see society reorganized based on greater equity. The IMF must be mindful of this and in any future program seek reforms that are in line with the 1996 Madrid Sustainable Global Growth declaration of “promoting good governance in all its aspects, including by ensuring the rule of law, improving the efficiency and accountability of the public sector, and tackling corruption, as essential elements of a framework within which economies can prosper.”

The Fund’s facility must not be used only to tide over a BOP crisis while avoiding reforms that address underlying structural weaknesses. It must seek a firm commitment from the government of the day to broaden the tax base, the progressivity of the tax system, and the deep rationalization of expenditures. A future program must also aim at a near-term primary fiscal surplus to navigate Pakistan out of the debt trap. Although it cannot be expected to do everything everywhere all at once, the performance targets must be ambitious and enthusiastically owned by the government. Failure to do so runs the risk of a bailout déjà vu.

– Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.

Twitter: @javedhassan