IMF programme no solution to Pak economic ills: ADB

[Neo]

IMF programme no solution to Pak economic ills: ADB ​

Says Pakistan facing high inflation due to under-utilisation of domestic resources, fiscal restraint is the wrong recipe for its woes​

Thursday, June 04, 2009
By Khalid Mustafa

ISLAMABAD: The Asian Development Bank (ADB) has surprised the economists of the country, saying that the IMF programme loan of $7.6 billion under Stand By Arrangement with its conditions is not the right recipe for Pakistan’s economic ills.

“Indeed, we believe that the IMF conditions will reduce the capacity to engineer a solution to the problems of inflation and falling foreign currency reserves without increasing the unemployed buffer stock,” said Jesus Felipe, William Mitchell and L. Randall Wray, the authors of the ADB’s report titled A Reinterpretation of Pakistan’s Economic Crisis and Options for Policymakers released here on Wednesday.

“While the IMF statement suggested it is keenly aware of the need to deploy a ‘socially acceptable’ solution, we consider that a policy strategy based on fiscal austerity will create unacceptable levels of socio-economic hardship in Pakistan,” the report said.

The report was written at the time when agreement with IMF for the 23-month stand-by arrangement amounting to $7.6 billion was reached to support ‘economic stabilisation programme’ and the first tranche of $3.1 billion was released to Pakistan.

There existed two key objectives of the IMF loan that included I) restoration of macroeconomic stability and confidence through a tightening of macroeconomic policies; and ii) to ensure social stability and adequate support for the poor and vulnerable in Pakistan.

Under the loan terms the external balance is to be targeted via a fiscal tightening from a deficit of 7.4 per cent of GDP for the fiscal year 2007-2008, to 4.2 per cent in 2008-2009, and then 3.3 per cent in 2009-2010.

The tightening is to be achieved by phasing out energy subsidies, better prioritising development spending and implementing strong tax policy and administration measures, interest rate hike to contain inflation, offload central bank borrowings, and build reserves.

As per loan terms the social assistance is to be strengthened but better targeted such that spending on the social safety net will be increased to 0.9 per cent of GDP in 2008-09, an increase of 0.6 percentage point of GDP.

The authors of the report criticised the said covenants of the Fund’s programme loan saying it would not help bail out Pakistan’s economy. “The Fund is less than clear on; (i) the nature of currency sovereignty; (ii) the nature and financing of budget deficits; and (iii) the nature and financing of trade deficits.”

Although Pakistan’s problems are result of misguided policies, it does not mean that the only solution available is to subject the economy to an austerity programme. In the words of Joseph Stiglitz renowned economist and former SVP of World Bank, “Stabilisation policy cannot be separated from growth policy. Failure to stabilise may hurt growth, but stabilisation, in the traditional sense of the term (price stability and fiscal adjustment), does not necessarily lead to economic growth.”

Architects of the ADB report believe that the IMF programme does not correctly portray the sources of inflation pressures, or the constraints on economic development. “Pakistan faces high inflation and insufficient progress toward development,” the report points out and says that the country is not fully utilising its domestic resources.

Pakistan in order to achieve sustainable development should mobilise domestic resources to improve incomes and reduce supply bottlenecks through expansion of domestic capabilities, the ADB report suggests.

Given substantial levels of redundant resources, they say, it should have been obvious that Pakistan’s inflationary bias could not be a simple matter of excessive demand. Thus, in appraising the inflationary impact it is incorrect to presume that fiscal policy has been excessively expansionary.

Using budget deficits as evidence of excessive expansionary policy is therefore erroneous, unless the deficits have pushed the economy beyond full capacity use of its resources. “For this reason, fiscal restraint may not be the medicine that is required in a situation in which a country is actually living below its means - as indicated by idle or under-utilised resources,” they concluded.

“We do recognise that Pakistan’s current situation is one in which robust growth over 5 per cent will tend to generate a current account deficit.” They explained further saying that: “From the orthodox perspective the consequences for Pakistan of having balance of payments (BOP) problems are straightforward.” When Pakistan encounters a BOP problem before short-term capacity utilization is reached, demand is curtailed, disguised and open unemployment increase, and capital accumulation has to be reduced. This leads, in the long run, to a relative deterioration of the country’s export potential compared with that of its main competitors. This situation tends to lead to a vicious circle with further BOP problems.

They said: “We do not endorse the orthodox solution.” Given that Pakistan operates with what we define below as a “modern money regime” that includes flexible exchange rates, we consider it has sufficient domestic policy space to pursue an alternative, sustainable growth path. “It can make use of this space to pursue economic growth and raising living standards, even if this means expansion of the current account deficit and depreciation of the currency.”

They also criticise the orthodox solution to a current account deficit saying it will actually make it more difficult for Pakistan to reduce dependence on imports.

The report is of the view that the IMF programme does not address the failures in the policies of the previous government, largely focused on a consumer-driven growth strategy despite the import dependent nature of the economy.

It is clear that while the country enjoyed very high levels of FDI the funds were largely concentrated in the consumer sector. This had two consequences: (i) it increased demand for foreign exchange; and (ii) it created a foreign exchange liability. The other significant point is that this investment did not generate corresponding amounts of foreign exchange revenue because it did not improve export capacity.

“The policy emphasis on fiscal restraint is also fraught with problems,” the report said saying the targets to reduce the budget deficit as required by the IMF agreement may help lower inflation, but only because the “fiscal drag” acts as a deflationary mechanism that forces the economy to operate under conditions of excess capacity and unemployment. This type of deflationary strategy does not build productive capacity and the related supporting infrastructure, thus offers no “growth solution”.

Likewise, fiscal restraint may not be successful in lowering budget deficits for the simple reason that tax revenue can fall as the taxable base shrinks because economic activity is curtailed.

 

[Neo]

Stand-by arrangement: ADB raises serious reservations over IMF conditionalities​

ISLAMABAD (June 04 2009): The Asian Development Bank (ADB) has raised serious objections on IMF conditionalities under the "standby arrangement", with the argument that the IMF agreement reflects "conventional" approach to dealing with macroeconomic imbalances in Pakistan.

An ADB working paper on the assessment of IMF program and its conditionalities, released on Wednesday, contains policy advice that differs markedly from that of the International Monetary Fund. One of the authors of the report also co-authored an article in Far Eastern Economic Review, together with the Director-General of the Department who deals with Pakistan, titled 'Plea to Pakistan: Fix Your Economy', in February this year.

THE ANALYSIS WAS BAFFLING FOR THREE REASONS:

(i) the forum ie Far Eastern Economic Review was not appropriate as it could have negatively impacted on direct foreign investment to Pakistan;

(ii) it was undertaken by a department which is propped up mainly by its lending to this country and the article was in conflict with the duties of the staff of an IFI; and

(iii) the analysis was shallow and the authors' attempt appeared to be self-aggrandisement rather than a serious analytical piece. A former Advisor to Ministry of Finance, Dr Ashfaq Ahsan, said that he did not agree with ADB point of view about going into IMF program.

Additionally, multilaterals have areas of expertise that they strictly adhere to in the spirit of harmonisation among the multilaterals so as not to duplicate efforts. IMF remains the institution that has the necessary expertise to deal with macroeconomic issues.

Pakistan government went on the IMF program and accepted the conditions based on its economic needs at the time. The result seven months down the line is that the budget deficit has become sustainable; the rupee is stable at around 81/dollar; and growth rate remains positive in contrast to other countries struggling with global recession.

In contrast, ADB is primarily a lending institution that has not even been successful in achieving its overarching objective: poverty reduction at least in this country as is amply borne by the rise in poverty levels as revealed by Assef Ahmed Ali of the Planning Commission. Ashfaq said that whatever policies Pakistan pursued were the right policies and these should be continued in the next fiscal year as well.

According to ADB report, it is believed that the IMF program does not correctly portray the source of inflation pressures, or the constraints on economic development. There is still latitude within the constrained policy environment to pursue more sustainable outcomes than those established by the limited horizons set by the IMF agreement.

THE PROBLEM WITH THE FUND'S APPROACH IS THAT IT IS LESS THAN CLEAR ON:

(i) the nature of currency sovereignty;

(ii) the nature and financing of budget deficits; and

(iii) the nature and financing of trade deficits. This matters because while it is true that Pakistan's problems are largely the result of misguided policies, it does not mean that the only solution available is to subject the economy to an austerity program.

The Bank has recommended that tax policy needs to be reformulated to replace regressive taxes with progressive direct taxes to reduce the burden on low-income and low-wealth households. The raising of taxes is a highly problematic policy for a nation whose growth was already slowing even before the global crisis generated recession throughout much of the world.

The ADB said that another government policy emphasis has been to stabilise the exchange rate. The typical method used in many nations is to target inflation, reduce budget deficits, and encourage exports. This is exactly the logic of the current IMF agreement. It is possible that this package of policies can generate short-run benefits by allowing accumulation of foreign currency reserves that can be used to appreciate the currency.

However, this outcome conflicts with promotion of long-run economic and political sustainability. Indeed, there are some inherent conflicts between maintaining a strong currency and promoting exports--a conflict that can only be temporarily resolved by reducing domestic wages, often through fiscal and monetary austerity measures that keep unemployment high.

The best way to stabilise the exchange rate is to build sustainable growth through high employment with stable prices and appropriate productivity improvements. An export-led growth strategy based on restraining wage increases sacrifices domestic policy independence and places maintaining a stable exchange rate as a top policy goal.

The IMF is particularly concerned with SBP financing of the budget deficit. Since July 1, the government is said to have borrowed about $2.5 billion from the SBP; the government's goal is to reduce that to zero. Such borrowing is thought to be effectively "government printing of money" to finance its deficit; the orthodox view is that this is highly inflationary.

Hence, the goal is to eliminate such borrowing for the remainder of the year, forcing the government to turn to "markets" for its borrowing. It will then need to offer sufficiently attractive interest rates on its debt; this will allow the government's borrowing costs to rise to market rates (as mentioned, this would be at least 15 percent now).

The ADB has further argued that the IMF conditions will reduce the capacity of the government to engineer a solution to the problems of inflation and falling foreign currency reserves without increasing the unemployed buffer stock.

The Bank further disagreed with the orthodox analysis that Pakistan needs to foster conditions that will reduce its dependence on imports. The growth and development path chosen will make a difference to the country's capacity to import.

However, it considered that the orthodox solution to a current account deficit will actually make it more difficult for Pakistan to reduce dependence on imports. The ADB believes that the IMF conditions will reduce the capacity of the government to engineer a solution to the problems of inflation and falling foreign currency reserves, without increasing the unemployed buffer stock.

While the IMF statement suggests it is keenly aware of the need to deploy a "socially acceptable" solution, the ADB considers that a policy strategy based largely on fiscal austerity will create unacceptable levels of socio-economic hardship.

Further, the ADB thinks the program addresses the failures in the policies of the previous government, largely focused on a consumer-driven growth strategy despite the import dependent nature of the economy. It is clear that while the country enjoyed very high levels of FDI, the funds were largely concentrated in the consumer sector.

THIS HAD TWO CONSEQUENCES: (i) it increased demand for foreign exchange; and (ii) it created a foreign exchange liability. The other significant point is that this investment did not generate corresponding amounts of foreign exchange revenue because it did not improve export capacity.

The policy emphasis on fiscal restraint is also fraught with problems. Targets to reduce the budget deficit as required by the IMF agreement may help lower inflation, but only because the "fiscal drag" acts as a deflationary mechanism that forces the economy to operate under conditions of excess capacity and unemployment.

This type of deflationary strategy does not build productive capacity and the related supporting infrastructure, thus offers no "growth solution". Likewise, fiscal restraint may not be successful in lowering budget deficits for the simple reason that tax revenue can fall as the taxable base shrinks because economic activity is curtailed.

To deal with the issue of crisis management, the ADB has proposed that it is highly likely that the IMF will continue to provide loans as needed, but with conditions that include fiscal restraint. Unfortunately, this is a risky time for budget cuts, which would entail both economic and political repercussions. Significant budget cuts can only be made in the areas of military spending, food and fuel subsidies, pensions, or development. For obvious reasons, cuts in all of these areas would be problematic.

The alternative is to raise taxes--again a highly problematic policy for a nation whose growth was already slowing even before the global crisis generated recession throughout much of the world. The ADB further objected that the policy emphasis on fiscal restraint is also fraught with problems.

The report could be found on the ADB website (Asian Development Bank (ADB) - Fighting Poverty in Asia and the Pacific - ADB.org Pakistan/default.asp) under the title: "A Reinterpretation of Pakistan's 'Economic Crisis' and Options for Policymakers".

 

[ajpirzada]

my biggest problem with IMF conditions is the high interest rate to control inflation. it was a really bad choice which has and further will slowdown our growth rate

 

[Neo]

Donors differ on ADB views: Pakistan needs funding to finance C/A, fiscal deficits on sustainable basis ​

ISLAMABAD (June 09 2009): Donors in Pakistan have entered into a policy debate differing with one another on the points of view of achieving stabilisation on the one hand, and addressing exports growth, on the other, to face up to current account deficit problem that arises each time the GDP growth crosses 6-7 percent, say officials. One side of the argument is that the balance of payments crisis can not be addressed just by making exchange rate adjustment.

It is a deep-seated issue and needs a structural answer. A recent publication of Asian Development Bank said: "This suggests that Pakistan's relative poor economic performance cannot be attributed to an overvalued exchange rate. The cause of Pakistan's relatively poor export growth is structural and deep-seated: it is not one that can be quickly and easily solved by an exchange rate adjustment".

Another donor, talking to Business Recorder, differed with this argument and said that Pakistan needs funding to finance its both current account and fiscal deficits on sustainable basis, so that investors, putting money here can have a long-term view of the country.

This is in addition to the exchange rate adjustment. The investors are not sure of repatriating profits or are unsure of secure investment. They would not even step into the market of Pakistan, says another donor, stressing on contradicting ADB's point of view which he said is just focusing on one side of the problem.

ADB's paper further quotes Economic Survey (2007-08), which recommends that its top priority should be "correction of imbalances through shaving off aggregate demand by appropriate policies. In other words, in spite of the high unemployment and the damage this would do to investment, the remedy advocated for the BOP problem is to curtail economic growth.

This would certainly solve the problem, as a slower growth of output would reduce the rate of increase of imports, while exports would be largely determined by the growth of world markets and hence unaffected by the reduction in domestic growth".

The Paper further says that Pakistan is running into, or is actually, experiencing a BOP constraint. However, the solution is not to reduce aggregate demand, but to introduce policies that will increase the growth of exports and thereby obviate the BOP constraint.

Other donors (opposing ADB's view), believe that stabilisation does not prevent growth ultimately, and without achieving stabilisation any country can not have growth, and there is a whole range of policy prescriptions designed by Finance Ministry with IMF, which concentrate on social safety nets and medium-term development framework (MTDB). They also opine that the same stabilisation will induce a higher growth path in medium term.

ADB's paper refers that the heart of the current problem lies in collapse of exports growth, which does not bode well for future growth. For example, since the 1960s "Pakistan's performance is clearly substandard, with only Afghanistan, the Kyrgyz Republic, Mongolia, Sri Lanka, Turkmenistan and Uzbekistan having lower export growth rates.

Other donors also believe that demand management does matter in achieving macro stability which provides spending for gaining better productivity. The government's support in improving productive capacity of industry always matter. In case the government's fiscal side is not balanced, how it would spend on industrial and overall infrastructure? This kind of spending on continuous basis would pave the way for a better investment scenario for local and foreign investors, conclude the officials.