Policy prescriptions by the IMF

Business Recorder

EDITORIAL (March 12 2008): Although countries not utilising IMF resources are not bound by its advice, it continues to analyse the economies of its members periodically with a view to offering policy prescriptions on various issues as a part of its mandate.

According to the latest report, the IMF wants the new government of Pakistan to bring agriculture and services sectors into the tax net and reduce exemptions in order to tide over financial difficulties of the country. Talking about the overall budgetary situation, it asserts that "fiscal effort should rely primarily on strengthening revenue mobilisation substantially to reduce deficit, while allowing for increased spending on infrastructure, human capital and poverty alleviation."

Going forward, fiscal adjustment, accompanied by higher levels of investment and vigorous implementation of structural reforms to increase the economy's productivity, constitute the main avenues to improve external competitiveness. In addition to strengthening tax revenues, priority should also be given to other structural reforms of critical importance to increase savings and investment. Besides, the reform of energy sector's regulatory and tariff framework should be pressed ahead vigorously for strengthening public sector financing profile and enhancing the prospects of privatisation of power sector companies.

In the foreign sector, a high degree of flexibility in economic policy making is required to respond quickly to external shocks. In particular, given the need to continue strengthening the foreign exchange reserves position, the authorities should adhere to their plan to rely primarily on active demand management policies in response to external financing shortfalls. However, even with the envisaged reduction in current account deficit over the medium-term, Pakistan would continue to depend heavily on large capital inflows.

We feel that the policy advice given by the IMF is very appropriate to the current situation and can only be dismissed at a great peril to the economy. As the latest trends indicate, weakness in the fiscal outcome has now emerged as the greatest challenge to the health of the economy.

Thanks to a wide-ranging reform process and substantial inflow of external resources, the overall fiscal deficit that averaged nearly 7.0 percent of GDP in the 1990s, was brought down to 3.4 percent in 2005-06 and 3.7 percent during the previous year. This excluded, however, earthquake spending which was an exceptional burden on the budget during these two years. The developments during the current year appear to have washed away these gains which were earned by great efforts and a firm resolve.

The fiscal deficit for 2007-08 was targeted at 4.0 percent of GDP, but it is not likely to be achieved as it has already touched the figure of 3.6 percent during the first half of the year due to lower-than-expected revenue growth (1.76 percent) and higher expenditures (25.28 percent). While revenues stagnated, higher debt servicing cost, increased outlay on subsidies for energy and food and rise in development spending led to a jump in expenditures. The country is obviously heading again towards a fiscal deficit of nearly 7.0 percent of GDP if the sharply deteriorating trend is not arrested in the remaining part of the year which does not seem to be likely at the moment.

Such an expansionary fiscal outcome would have grave consequences for the economy as a whole. While overall spending cannot be substantially reduced for a variety of reasons, the only alternative for the country is to mobilise a much higher level of revenues. It is against this background that the IMF has proposed to the new government to bring agriculture and services sectors into the tax net and reduce tax exemptions.

Everybody knows that agriculture tax is a provincial subject and the vested interests would oppose it tooth and nail but adequate collection of taxes from this source is necessary to improve the fiscal position of the country and for the sake of equity. Further delay in taxing the exempted sectors and punishing the tax evaders will only make matters worse. It also needs to be pointed out that proper fiscal management constitutes an important element of demand management about which the IMF has talked in its report.

Sticking to the target of overall deficit of 4.0 percent of GDP during 2007-08 and further progress in the desired direction in the subsequent years could reduce pressures on the worsening current account and soften inflationary impulses in the economy.

The State Bank has already taken several measures to curb demand by tightening the monetary stance but if fiscal policy of the country is at variance with the monetary policy, the intended objectives of price stability, avoidance of internal and external debt, sustainability in the external sector, higher growth trajectory etc cannot be achieved. We know that the new economic managers of the country would not like to be dictated by the IMF but there is no harm in listening to its advice, especially when it is given in good faith and without a quid-pro-quo.


Copyright Business Recorder, 2008