Pakistan’s IMF Problem

In exchange for bailouts over the past three decades, Pakistani governments have repeatedly agreed to draconian spending cuts and arbitrary taxes in pursuit of fiscal targets. As a result, the country's economy is as weak as ever, and its state capacity has been hollowed out.

ISLAMABAD – After Pakistan’s recent election, Imran Khan and his Pakistan Tehreek-e-Insaf (PTI) party are now forming a new government. As usual, it will be greeted by an economic crisis. A trip, cap in hand, to the International Monetary Fund seems inevitable.

Pakistan, after all, is an IMF addict. The country has already spent 22 of the past 30 years in a dozen different IMFbailout programs. As the former IMF advisers Ehtisham Ahmad and Azizali Mohammed explained in a 2012 working paper for the Asia Research Center, no American, IMF, or Pakistani official has any incentive to reform Pakistan’s structural economic problems, and so the cycle of bailouts continues.

Unfortunately, few in Pakistan have ever read Ahmad and Mohammed’s paper or debated its significance. If they had, they would know that the IMF’s approach to the country has been a failure. For decades, IMF programs have been undercutting Pakistan’s productivity and growth potential, by eroding governance and state capacity, and creating conditions for ever more rent-seeking and corruption.

Successive IMF programs have required that Pakistan adopt more withholding taxes (never to be refunded), surcharges, and levies on essential goods such as oil and electricity, even though these measures hurt employment and investment growth. And when the government misses its fiscal targets, the Fund and Pakistan’s finance ministry agree on quarterly mini-budgets, which often include new taxes on school fees, bank transactions, Internet access, and so forth.

It should go without saying that if businesses do not even know what tax measures will be included in the next quarterly mini-budget, they will be unable to plan and invest. This is Economics 101.

Moreover, alongside distortionary tax policies, the IMF has forced the finance ministry into unplanned spending cuts without any real reforms, despite the obvious negative effect this has on growth. When such reductions were made under an IMF program in the 1990s, Pakistan’s national bus service ended up on the chopping block, and vehicles were allowed to deteriorate. Since then, funding for public services – including railways, police, health, and education – has been cut to the bone.

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In other words, Pakistan has been the subject of a long-running experiment in austerity. Hastily designed spending cuts have undermined growth, and thus the government’s fiscal position, forcing it to kill off public services and infrastructure projects. The result has been a severe erosion of state capacity.

To be sure, Khan’s new government and the IMF will talk of reform; but such talk is never followed up with action. Reforms to overcome Pakistan’s constant power shortages have been discussed for the last decade, and yet the losses continue to mount. With the costs of mismanagement passed on in the form of price increases, the debt held by private power producers and the government stands at over one trillion rupees ($8.2 billion).

New IMF funding will no doubt lead Khan’s government to repeat past mistakes. It will cling to artificial exchange rates, while avoiding reforms that could actually plug leakages in state-owned enterprises. When the Fund was preparing its 2013-2016 program for Pakistan, I warned the deputy director overseeing the plan that it would be used to overvalue the exchange rate. She insisted that it would not. It was.

The pattern is always the same. With the Fund’s blessing, the government goes on a shopping spree, taking out costly loans for expensive projects, thus building up even more debt and adding new inefficiencies. After a few years, another crisis ensues, and it is met by another IMF program.

The short-term focus of these programs ensures that reforms will be postponed, and that obsolete industries will not be allowed to die. Meanwhile, education goes underfunded, energy and water shortages grow more frequent and severe, economic imbalances worsen, and the government’s policymaking capacity continues to erode. Rapidly achieving stable macroeconomic indicators is all that matters, even if doing so accelerates social and political decay.

It is precisely the rush to meet IMF-dictated fiscal numbers that leads to bad policies. In the absence of due process – such as parliamentary or cabinet scrutiny, ministerial and expert review, and domestic consultation – the finance ministry accrues more power, and governance declines. That is what happened under the previous government – which used an IMF program to push through vanity projects – and Pakistanis are now paying the price.

Sound macroeconomic policymaking cannot be conducted through arbitrary mini-budgets. The way to address economic imbalances is to spur growth in the real economy, which will allow for the accommodation of deficits and debts. As I show in my book Looking Back: How Pakistan Became an Asian Tiger in 2050, economic growth and development require sound governance and ample state capacity. Those criteria can be met only through extensive, well-considered reforms over the long term. The question is whether the IMF will encourage that, or have Pakistan keep doing the same thing while expecting different results.

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