Wednesday, 24 July 2013

IMF Agreement: Frieghtenning or Blessing

The article was published in the "Money Matters" on 22 July 2013 entitled "  External Debt     A blessing for an ailing economy"

The International Monetary Fund (IMF)’s bailout programme remains a hot topic in the country. And while the caretaker government refused to go back to the IMF, it only took the new government a few weeks to acquiesce to an ‘inevitable’ IMF deal.

Economists in the country are divided over the controversial programme and its pros and cons, while some seem to enjoy the empty rhetoric when it comes to the controversial loan programmes.

Some are even scared that Pakistan will be colonised if we take loans from the IMF, a sense of trepidation that partly arises from the mystification created by the media and politicians, who readily attack the IMF to improve their own standing with the people.  

Dr Meekal Ahmed and Dr Ashfaque Hasan Khan are among those who have been vocal about the country’s immediate need for the loans since it will raise our forex reserves, which have been declining for the last two years. Capital inflow will stabilise the exchange rate and country will not face the risk of default, they argue.

On the other hand, some have slammed, ridiculed and maligned the government for going back to the IMF despite campaigning against the “begging bowl”. However, most such commentators or analysts totally ignore the worrying balance of payments and other issues facing the country.

The word “IMF” in our society is dreaded and unpleasant to say the least. It is considered a sort of a phantom, which will steal our belongings while we sleep. Most believe that the IMF, which works like a bank and provides loans to countries with ailing economies, often, ends up maintaining a debt crisis in the country it aims to assist.

The IMF first carries out research on any given country and then suggests different options to help the country move towards development and eventually a successful repayment of their loan with interest. However, it is generally believed that the conditional loans are only repaid by requesting more assistance and without much improvement in the economy. It’s tough to totally disagree with this statement, nevertheless, there are number of misconceptions attached to it.

A survey using purposive sampling, one that is selected based on the knowledge of a population and the purpose of the study, to verify the public’s knowledge about the IMF and objectives associated with its loan programmes reveals that 90 percent of the respondents are simply clueless when it comes to the IMF and its functions.

Further, around 70 percent of the respondents are unaware about the role these loans play when it comes to exchange rate stability, increase in the debt repayment capacity, reducing the speed of forex depletion etc. Most significantly, more than 80 percent are not aware of the share of IMF loans in total debt.

The recent $5.3 billion bailout package signed between Pakistan and the IMF is a three-year programme under an Extended Fund Facility. Pakistan has requested an additional $2 billion, which will be considered by the IMF Executive Board on September 4, as the country has to repay $4.6 billion in the next three years and it does not posses significant investment in foreign exchange reserves. The only way to pay the amount is to borrow more or post a current account surplus by reducing imports and increasing remittances in the short run.

Before proceeding further it is important to understand what the Extended Fund Facility (EFF) entails. Among various IMF programmes, EFF was launched in 1974 to provide assistance to countries which were experiencing long-term payments imbalances because of structural impediments. It can also be used for an economy which has low growth and inherently weak balance of payments position. This programme’s duration is usually longer than other IMF programmes, such as Stand-By Arrangements between 3.25 and 5 years. Usually, the countries enrolled in this programme can repay the loans between 4.5 and 10 years. Another important characteristic of this programme is that IMF works with the country to design and implement adjustment policies to ensure that the particular country overcomes its structural weaknesses. Moreover, EFF is also available if country is facing serious medium-term balance of payments issues.

The IMF programme comes with conditionalities, which may or may not be optimal in the short-term but is certainly better in the long-term. But as Keynes pointed out “this long run is a misleading guide to current affairs. In the long run we are all dead,” the country’s future depends on our negotiators, who must protect the lives of their people and accept conditions which remove the obstacles to growth in the long-run without hurting people in the short run.

For the past two decades, IMF’s major focus has been on structural adjustment. It could be through the privatisation of state-owned enterprises or through fiscal austerity by raising share of direct taxes, removal or reduction in import duties and cutting down expenditures especially subsidies.

Pakistan has requested the IMF management to increase the present level of access of 348 per cent of quota ($5.3bn) to 500pc of quota ($7.3bn) with appropriate front loading of disbursements to match Pakistan’s repayment obligations under the previous IMF program-me to ensure that net outflows don’t exceed fresh disbursements.

The country can borrow up to 200 percent annually of their allocated quota under the EFF, which is equal to 600 percent over the three years. It seems the IMF delegation, which is due to come back in September to discuss the additional $2 billion request, is likely to approve Pakistan’s request as the government is simply accepting IMF advice and asking for less than the designated quota of 600 percent. 

The real question is what impact the IMF bailout package will have on our economy? After the agreement was singed between Pakistan and the IMF, the Karachi Stock Exchange (KSE)’s benchmark index rose by 211 points, a sign that the deal has boosted investors’ confidence. However, uncertainty surrounds whether the move will boost investors’ confidence across the board. With comparatively lower interest rates and policies geared towards reforming the economy towards macroeconomic stability, many are questioning whether private credit will increase and whether the government will continue borrowing from schedule banks.

Depleting reserves have put immense pressure on the exchange rate with the rupee already crossing the Rs100/$ mark. To prevent further depreciation, the State Bank of Pakistan (SBP) will inject foreign exchange into the market. However, this exercise may stabilise the exchange rate but the country will slowly but surely lose all of its forex reserves.

A more practical solution is to let the exchange rate move freely and invite capital to inflow into the country. Several options can be exercised such as reduction in the oil import which is one third of total transactions in the current account. Moreover, the country can invite more remittances into the country.

But in reality, it’s either wait for any of the abovementioned solutions or take loans from the IMF to correct the balance of payments issue. The inflow of forex reserves due to the IMF loan will stabilise the exchange rate to a certain limit. The stabilisation of the exchange rate will be short-lived with the pressure mounting soon after the payments to IMF are made. Moreover, if balance of payments problem persists which is normally the case in Pakistan then currency will depreciate further.

Overall the EFF arrangement will help stabilise the economy if everything goes well. Since forex inflow stabilise the currency in the short run, the State Bank of Pakistan will not need to intervene in the market.

Although the IMF loan has various conditions, including reduction in fiscal deficit, if the country manages to reduce the fiscal deficit there will be greater control on government borrowing, especially borrowing through SBP and commercial banks.  As a result, transitory component of money supply will be lessened. Hence there will be no surprise inflation. Therefore, monetary stability will be achieved along with stable growth, lower fiscal deficit and lower inflation. However, this does not mean that the growth rate will be higher.

And while certain members of the educated class continue to spew venom against the IMF, an organisation whose functionalities they don’t even understand, the current IMF bailout package is nothing short of essential for the country in many ways with repayment of previous loans amongst the most important component at present. The loan will stabilise the exchange rate in the short run, improve the position of portfolio investment and if everything goes the country will be on a stable path of economic growth in the next 4-5 years.
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