THE current economic crisis has forced Pakistan to traverse the territory on which it has never travelled before. The country has dealt with many deep economic crises in its 61-year history.
On most occasions the economy ran into difficulties because of state profligacy: the government spent much more than it earned through taxation and other forms of revenues. Fiscal deficits increased which by the simple laws of economics produced large and unsustainable current account imbalances.
When governments spend beyond their means and finance the difference by printing money, it increases demand for goods and services, including demand for imports. When the crisis develops these contours, the situation is a relatively simple one. The governments in trouble — and that has included Pakistan on several occasions — turn to the International Monetary Fund for a cash infusion.
The IMF support does not come free; it arrives with many conditions. The standard Fund recipe is to push the government towards narrowing the fiscal gap by cutting expenditures, sometimes severely. This, in the Fund’s language, is called ‘adjustment’. In this context the period of adjustment becomes an issue between the government and the IMF. The Fund usually wants to compress the period of adjustment; the governments usually want a broader timeframe within which to bring about the needed changes.
The Fund also likes to reduce aggregate demand by asking the central bank — in Pakistan’s case the State Bank of Pakistan — to raise interest rates. That reduces the demand for credit which, in turn, reduces the rate of growth of GDP. And the Fund usually suggests currency devaluation, another way of reducing demand.
However, with different exchange rate mechanisms in place in most parts of the world, the Fund has advised governments to let the market forces determine the price of the domestic currency. Even Pakistan does not determine the value of the rupee; it leaves it mostly to the market. In Pakistan’s case, the rupee has lost 44 per cent of its value in the past 10 months. This means massive devaluation even when we factor in the sharp rise in domestic prices.
Pakistan is now negotiating with the Fund to obtain a significant amount of cash infusion. This will happen since the IMF has large amounts of resources currently available to it. Pakistan will receive the Fund’s support under a facility called the ‘Stand-By Arrangement’.
The amount of money available is based on a multiple of the share a country has in the IMF’s capital. For Pakistan three times its share — called the ‘quota’ — would ordinarily be available. This would amount to $6bn. A larger multiple is possible if Pakistan is able to develop a robust programme and persuades the Fund of the urgency of the situation it faces.
However, not all of this will be given out at once; it will arrive in tranches after the Fund’s review of Pakistan’s compliance with the various aspects of the programme agreed to. One-third of the total amount would be given in the first tranche. The full disbursement will take a couple of years with the timing of tranche releases determined by the country’s performance with reference to the targets agreed with the Fund.
The SBA is an expensive facility; it carries a large interest rate and it needs to be paid back quickly. In other words, its aim is to provide immediate relief, not to help with the long-term development of the economy.
At this point, Pakistan does not have much leverage with the Fund. The country is depleting its reserves rapidly. The loss of confidence on the part of the business community in the country’s economic viability has resulted in capital flight which has further strained the balance of payments situation. Thus weakened, Pakistan will be subjected to fairly rigorous Fund conditionality. Some of this may be politically embarrassing. Some of it may inhibit long-term growth. It is important that the approach to the Fund is made with some strengthening in the country’s external accounts situation.
Leverage with the Fund could be increased if a somewhat different approach were to be followed. To demonstrate what I mean by this I should perhaps explain how I managed this kind of a problem 12 years ago. In 1996-97, I took a leave of absence from the World Bank to take charge of the Pakistani economy as a member of the caretaker administration headed by the late prime minister Meraj Khalid.
I was in fact the finance minister in the Khalid government. The crisis I had to deal with had some of the attributes of the one that the Zardari government is currently handling. However, at that time reserves had been depleted to even lower levels.
President Farooq Leghari and I decided to appeal to the countries where we had good contacts. These were China and the UAE. Because of my tenure as director of China operations at the World Bank from 1987 to 1994, I had good relations with some of that country’s leaders. One of them — Zu Rongji — was known to me when he was the mayor of Shanghai. During his tenure as mayor I had negotiated a programme of assistance to develop Shanghai. When I joined the caretaker administration he had become China’s prime minister.
Following a call to Beijing from Islamabad, I was invited to meet the prime minister. Subsequently $500m was deposited by the Chinese in Pakistan’s account at the Federal Reserve Bank in New York. Leghari used his contacts with the senior leaders of the UAE who provided us with another $350m. With our reserves now at a less dangerous level, we had increased our leverage with the Fund. The deal we then negotiated suited us better than would have been the case if he had gone to Washington with a weak reserve situation.
My suggestion, therefore, is that the approach to the Fund should take place in a much broader context. While the quick-disbursing money the Fund can provide has become critical to meet our worsening situation, the Fund’s programme should be placed in a broader context.
I am in favour of going to a selected group of donors with a comprehensive programme covering stabilisation of the economy as well as setting the economy on a long-term trajectory of sustainable ‘inclusive’ growth. The emphasis on inclusive means that the rewards of growth would be more widely disbursed among different segments of the society and among different regions of the country.