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".