IMF’s latest EFF program with Pakistan is laden with moral hazard

Pakistan has once again signed an Extended Fund Facility (EFF) agreement with the IMF, along with the usual government assurance that it will be the last. However, for an economy heavily dependent on foreign loans and IMF bailouts, avoiding another return to the Fund in three years hinges both on the implementation of structural reforms and the assumptions that underpin the IMF’s analysis. Without these coming through, Pakistan’s debt sustainability will remain precarious, forcing a reliance on import compression and stifling growth to avoid default.

In its May 2024 country report, the IMF projects a sharp rise in external inflows from private creditors, increasing from nearly USD 7 bln during FY23-24 to USD 13.862 bln and USD 15.317 bln in FY25 and FY26, respectively. These figures indicate a near 100 percent increase from recent years and a 40 percent rise over the past six years. The implication is clear: Pakistan’s access to international credit markets must expand significantly— a goal that remains unmet despite the current IMF program, unlike the experience of other countries.

Although Pakistan’s credit default swap (CDS) rates have fallen from their peak, the latest offering from Standard Chartered Bank, with rates as high as 11 percent for short-term facilities, indicates that access to global credit markets remains constrained. This suggests that markets are signalling doubts about the sufficiency or feasibility of the structural reforms embedded in the IMF program. In essence, markets are not yet convinced by Pakistan’s projections for fiscal balance, the current account and external fund flows.

Pull-quote: The absence of a radical policy shift suggests that Pakistan may sink deeper into a cycle of mounting debt and slow growth. 

- Javed Hassan

Economist Dr. Ahmed Pirzada of Bristol University argues that the IMF has consistently been overly optimistic in its capital inflow projections. Tracking IMF reports, Pirzada notes that since 2022, the Fund’s forecasts have frequently missed the mark. He further points out that ‘this assumption underpins the IMF’s expectation that GDP growth will reach 3.5 percent in FY25 and 5 percent by FY27. Such projections, based on unrealistic assumptions, undermine the IMF’s assessment of Pakistan’s debt sustainability” (Pakistan Institute of Development Economics (PIDE), May 2024, Incentivizing Cooperation Between Creditors).

The IMF also expects Pakistan’s debt-to-GDP ratio to decrease over the next decade. This critically depends on the assumption that the GDP will grow at 5 percent from FY26 onwards while the primary surplus will consistently remain at 0.5 percent of GDP. However, if the expected inflows fail to materialize and fiscal stimulus is avoided, the GDP growth rate will likely remain between 3-4 percent, preventing any meaningful reduction in the debt-to-GDP ratio. In a scenario where a fiscal stimulus is indeed deployed to stimulate growth, we may see a temporary reduction in the debt-to-GDP ratio, but this would be quickly reversed by a subsequent economic downturn.

Sustainable growth can only emerge from increased fiscal space without derailing the current account. Achieving this requires deep structural reforms in public finance that promote the reallocation toward more productive, tradable sectors. Expanding the tax base is essential for maintaining a fiscal balance and promoting more efficient capital and labor allocation— both of which are crucial for sustaining higher growth rates.

The IMF’s latest program sets ambitious targets for increasing tax revenue, which is vital for closing the budget deficit and reducing debt to sustainable levels. However, the tax burden disproportionately falls on compliant taxpayers— corporations, salaried workers, and professional businesses— the most productive sectors of the economy. Meanwhile, non-compliant and often less productive sectors, such as agriculture and real estate, remain largely untaxed. Although provincial tax policies have been aligned with federal personal and corporate taxes in the agriculture sector, no firm targets have been set, and there is little indication of more rigorous enforcement in tax collection compared to the past. Without the political will for comprehensive tax reform and stricter enforcement, a clear roadmap for the necessary structural overhaul remains absent.

Equally concerning is that the EFF program, as reflected in the current federal budget— passed only after IMF review— fails to prioritize government spending efficiency. There is a lack of shift from recurrent expenditure to public investment. Although public sector development spending (PSDP) has increased significantly, much of this allocation merely disguises current expenditures. No mechanisms or firm targets have been established to thoroughly review throw-forward PSDP liabilities and reduce them based on efficiency criteria.

Without fundamental changes in taxation and recurrent expenditure, enhancing public investment to boost productivity will be difficult, if not impossible. Although the government hails the latest EFF as a catalyst for growth, it is laden with moral hazard. The absence of a radical policy shift suggests that Pakistan may sink deeper into a cycle of mounting debt and slow growth. The more frequently the IMF intervenes without enforcing profound structural reforms to shift resources toward productive, tradable sectors, the greater the likelihood that Pakistan will turn to the IMF for future bailouts.

- Javed Hassan has worked in both the profit and non-profit sectors in London, Hong Kong, and Karachi. He tweets as @javedhassan. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Arab News.