A delegation of the International Monetary Fund (IMF) arrived in Islamabad on Wednesday and will stay for two weeks to negotiate the terms of a bailout package that will help the country stabilise its economy.
Fixing Pakistan’s troubled economy is the biggest challenge facing the new government. This is because the government’s expenditures are much higher than its revenue, which leads to a loss of Rs2.2 trillion, leaving it with little money to spend on its citizens. It, therefore, relies on borrowing from banks to meet its expenses.
On the international front, the country’s monthly imports exceed its exports as for every dollar earned, two leave the country. The country is then left with fewer dollar reserves to pay for essential imports (oil, raw materials, machinery etc) and to repay its foreign loans.
At the end of October, Pakistan had only $7.7 billion in its foreign exchange reserves, its lowest level in four years and barely enough to cover for two months imports. This resulted in talks about Pakistan heading to towards bankruptcy. However, the Prime Minister Imran Khan was able to avert the crisis by securing $6 billion in aid from Saudi Arabia. Under the arrangement, Pakistan will receive $3 billion deposit and a credit of $3 billion for oil imports this year.
The Saudi aid provided much-needed support, but the country needs $12 billion to meet its financial obligations till June 2019. For example, $8 billion alone are due in foreign loan payments this year.
The government has been reaching out to friendly countries, including China, Malaysia, and UAE, for further assistance, but an IMF bailout is inevitable.
What to expect from the talks?
Pakistan has prepared a case for seeking around $7 to $8 billion from the Washington-based lending agency. The State Bank of Pakistan Governor Tariq Bajwa will present our case.
The IMF will ask Pakistan for details on how they will pay back the loan. Pakistan will also have to provide its plan about the reforms it will make to put the economy back on track. This may include questions about the arrangements it has made to reduce power sector’s inter-corporate debt, which has ballooned to Rs1.2 trillion.
The government has already taken several measures to reduce its expenses, but they have yet to bring the desired results because tax revenues didn’t increase as expected. This means the IMF can ask the government to impose new taxes, or cut development expenses (think schools, hospitals, roads, and dams too) even further.
The IMF may also ask for a further hike in the State Bank’s policy rate and a free-float exchange rate policy—meaning further devaluation of the rupee.
“Recent policy measures are steps in the right direction, but not yet sufficient,” the IMF said in a statement. “Decisive policy action and significant external financing will be needed to stabilise the economy.”
Why you should care
The IMF dollars come with conditions. Once in the programme, the government will have to take unpopular decisions that may lead to higher inflation and more unemployment. This simply means that the IMF programme will have some impact on everyone—from a daily wage earner to a middle-class banker and head of a large corporate entity.
The government will no longer be able to provide subsidies because it will be asked to reduce expenses. Besides cutting back on development budget, the government has already raised prices of gas, electricity and petrol, and import duties, especially the luxurious items. The effects of these policies were reflected in the latest data as inflation in October hit a four-year high of 7%.
The central bank also raised its policy rate to achieve economic stability, saying the double deficit and rising inflation are likely to compromise the sustainability of the real economic growth path.
A hike in the SBP’s rate means commercial banks will also increase their interest rates, making borrowing more expensive for private businesses and the government, which rely on bank loans to finance new projects.
Expensive loans mean businesses may put a stop to new investment (other than necessary ones) and the government will borrow less and do fewer projects, which slow down job creation.
According to the IMF, the Pakistani rupee is overvalued while a fast rise in international oil prices is also adding to the country’s problems. If the loan comes with a condition to leave dollar value to market forces, the rupee will weaken further and increase inflation.
If prices go up but your income doesn’t increase proportionally, you are heading for a difficult time. However, if the government is able to come up with a good reforms agenda and execute it according to the plan, the country will come out of the economic crisis by the end of the programme, which usually lasts for three years.