IMF and Pakistan (1990-2010)

IMF an Introduction
International Monetary Fund was formed in DEC 1945. Reason of establishment of
this organization was collapse of internal monetary rates and exchange due to the depression
of 1930s and world war two. Its object was to stabilize exchange rates and reconstruct the
world’s international payment system. A pool was created from which the countries can
borrow in event of financial imbalance. Currently IMF has 187 member nations and its
headquarters are in Washington.

IMF and Pakistan

Pakistan became a member of IMF in july 1950. Pakistan did not avail any facility from
IMF since 1958 when the country faced problems in balance of payment. This was the start
of relationship with IMF began or as some people refer it as start of ‘living in shades of IMF’.
Later in 1965 when the war began in India and Pakistan, Pakistan again had to seek help of
IMF in 1965 and 1968.

When (OPEC) Organization of petroleum exporting countries increased petroleum prices in

1973, the balance of payments deteriorated and Pakistan once again to go to IMF in 1973and
1979. The 1980-1983 facility was suspended by IMF for non compliance. The later years are
discussed in the main topic.

1990-2010
In this period different governments ( Bhutto, Nawaz Sharif,Musharraf,Gillani) got aid
from IMF. The first decade of this period 1990-1999 is known as the lost decade. Elected
Governments could not complete their tenor, had no continuity in economic policies and
focused on short term progress to gain political advantages. This caused problems in macro
economics of Pakistan and Pakistan had to avail the IMF financing many times during this
decade.Though these facilities were availed by these governments in different envoirments,
the following reasons were common in these periods;

 Remove problems in balance of payments through funds

 To access other financial institutions
  To divert the blame of bad political decisions
 Get debt relief and rescheduling

The success and failures of this relationship shall be discussed in the end; first we discuss
the terms and conditions of these arrangements in detail;

1988-1991 agreement
In 1988 during the regime of Benazir Bhutto Pakistan entered into a three year
economic reform program with IMF due to the deteriorating balance of payment position,
burden of nearly 4 million Afghan refugees and high budget deficit which was above 8% that
time.

IMF lent $900 million to Pakistan under this agreement. The main conditions of this
agreement were;

 Foreign debt was to be decreased from 31% of GNP to 25% of GNP by the year 1990-
91
 Balance of payments current account deficit was to be reduced to 3.3% in 1988-89,
2.7% in 1989-1990, and 2.5% in 1990-91 from 4% in 1987
 1% reduction in bank borrowing and 3.6 percent in non-bank borrowing was to be
done
 Increase collection of tax by expanding the tax base and introducing new tax structure
 The general sales tax structure was to be introduced
 Control the expenditures of both federal and provincial governments

Pakistan faced many problems during this tenor to implement the structural improvements
that IMF asked from Pakistan.

Comparison of economic indicators

The economic indicators showed the implications in this way

 Fiscal deficit that was 8.5% in 1987-88 rose to 8.7% in 1990-1991

 Money growth which was 13.6% in 1987-1988 rose to 12% in 1990-1991
 Inflation rate which was 4.7% in period 1984-1985 to 1087-1989 increased to 9.5% in
1990-1991
  Employment grew at the rate of 1% from period 1987-88 to 1990-91
 GDP growth rate declined from 6.2% to 5%
 Tax to GDP ratio which was 13.8% in 1987-88 declined to 12.7% in 1990-1991
 Sales tax base was widened and stretched even to basic commodities.

1994 agreement
In 1994 under the government of Nawaz Sharif Pakistan again availed the facility from
IMF. The main object of this facility was to reduce the financial deficit from 4% in 1994-1995
to 3% in 1995-1996. Later this target was eased through a renegotiation to 5% in 1994 and
3% in 1995-96.

IMF demanded to reduce the subsidies on Gas, electricity etc and reduce the
government spending. Nawaz Sharif could not comply with these requirements of IMF due to
political reasons.

The targets could not met, the budget deficit in the period remained 5.8% in 1994-95 and
target was set for the period 1995-6 to be 5%.

After failure of this compliance, finance minister renegotiated with IMF to raise the
finances to $850 million from $259 million and its tenor was extended from February to
September 1997.

With this resumptions there came more restrictions from IMF. IMF forced the
government to reduce the budget on a large scale, the Nawaz government in fear of
suspension of fund reduced the budget by 45 billion, and almost 90% of this cut was in
development budget which effected economic performance.

The GDP which was 1412812m in 1994-94 grew to 1929891m in the fiscal year 1996-
97. Duo to this IMF program the external debt for this period rose from 19284 US Million
dollars to 22484 US million dollars in 1996-97. The payment in respect of debt servicing
which was 998.6 million US dollars in fiscal year 1993-1994 rose to 1346.4 million in the fiscal
year 1996-97.

CPI inflation was 11.27% in 1993-94 remained at 11.8% in the fiscal year 1996-97
 The government failed to comply with the requirements during this time period
therefore this IMF arrangement did not go smooth and IMF suspended its funding at times.
The demands of IMF that were

 Reduce the budget deficit

 Reduce the subsidies in public utility sector
 Privatize the state owned corporations
 Levy taxes on agricultural income

And some other measures to liberalize the economy were not fulfilled by the government
which resulted in the suspension of fund. Since the rating by IMF is an important
consideration in all the international lending, this suspension damaged the Pakistan’s rating
in all other international financial organization. This also created problems for the investors of
Pakistan in international dealings and during this period the reserves started to fall, inflation
rates started rising whereas GDP growth rate was only 1.2% in year 1997.

1997 Agreement
Duo to defects in the existing plan to Pakistan and the non compliance from Pakistan
IMF entered into a new agreement with Pakistan in 2007. Under this agreement IMF
demanded from Pakistan to make serious structural improvements in the economic system.
The period of this agreement was for 3 years starting from 1 st July 1997 to 30 June 2000.ng
to the conditions of IMF.

During this period Government tried to follow IMF instructions and made some
structural improvements but could not reform the tax structure according to IMF
requirements. The nuclear tests by Pakistan in May 1998 caused worry in international
agencies and so IMF. Later in January IMF sanctioned a loan of $500 million for Pakistan.
Later IMF stopped a trench of $280 million for the time being the issue of IPPs was resolved.
The summary of IPPs conflict is that Nawaz Sharif hesitated to oblige the contracts made by
Bhutto with IPPs considering them to be un affordable by WAPDA and responsible for the
raise in prices of electricity.

During this period IMF sent a delegation consisting of 5 members to Islamabad to

report the performance of the government of Pakistan. This delegation reported that the
government has failed to comply with the policies of the IMF.
 In 1999 Musharraf took over the government and due to economic problems post
atomic tests he had to contact IMF for restoration of the funding and agreed to comply with all
the regulations of the IMF.

The IMF issued new requirements to Musharraf as a demonstration of Pakistan’s

commitment to IMF regulations.

IMF executive board approved a stand-by-credit of $596 million on the following conditions

 Agriculture sector was to be taxed

 Retail sector was to be taxed
 Budget deficit was to be reduced from 6.4% to 5.2%
 Change in petroleum prices according to the international market.

IMF giving credit to Pakistan’s statements of showing commitments resumed the 10

months SBA to Pakistan but did not resume the entire ESAF program. The default was at
door for Pakistan, there was no other choice for Pakistan other than to comply with the hard
requirements of IMF in the period when per capita income was still and reserves were
declining, income of fixed income group did not increase in relation to increase in inflation.

Regime Period Program type Amount drawn % Undrawn

and type in US In US million
million dollars dollars

Benazir Dec 95 march- SBA 562 295 46

Bhutto/Meraj Sep 1997
Khalid/Nawaz
Sharif

Nawaz Sharif Oct 97- Oct 2000 ESAF 682 285 61

Oct 97- Oct 2000 EEF 455 113 75

Pervez Nov2000- SBA 465 465 0

Musharraf Sep2001
Dec 2001- 2004 PRGF 1410 6 out of 12 0
disbursements
The reasons why taking this plan was important include;

 The financial crisis was very severe and the assuming government had intention to
resolve it
 Musharraf was able to make hard decisions because there was no fear that somebody
will remove him based on his political unpopularity.
 The Reforms fitted with the broad strategy of Musharraf
 The technocrats applied on reform process had the ability and capacity to conduct the
reforms
 Improved governance improved the process of application of these reforms

After the successful implementation of reforms by Musharraf government, IMF approved

three year poverty reduction and growth facility program for Pakistan in December 2001.
But due to failure in compliance in some areas this loan was not fully withdrawn and about
half of the amount of the loan remained undrawn.

Year 2004
Year 2004 proved to be successful in IMF and Pakistan relations. This was the first
time when Pakistan successfully completed two programs from IMF. Pakistan successfully
withdrew the full amount from the fund which was $1.47 billion. During 2000-2004 due to
successful implementations Pakistan’s economy grew at a rate more than 5 percent, exports
climbed and this microeconomic performance enabled Pakistan to reenter international
capital market once again.
In this period GDP rose from 2735943 in year 1999-2000 to 4481412 in year 2003-04.

Inflation rate remained controlled in single digit.

Debt servicing was 892.3 m in 1999-2000 and reduced to 810.3m in 2003-04

This period can be called golden era of Pakistani economy after the incident of 9\11 foreign
investment came in Pakistan, per capita income increased and IMF was satisfied by the
reforms that were implemented.

Year 2008
Year 2005 proved to be devastating for both Pakistan and its economy when an
earthquake stroke the northern areas. Later in 2008 when Musharraf resigned and new
government took over, the oil prices raised in the international market and due to recession
the IMF was contacted again.

The question here that only Pakistan is effected by increase in prices of oil and not China or
India?

The answer is that the reserve position of those two countries is much better as compared to
Pakistan, India had at that time $200 billion and china had $2000 billion at that time.

The economy condition deteriorated this much that in DEC 2007 the reserves were
$16 dollars suddenly fell to $6 billion. If Pakistan had to avoid default in the international
payments, governments had three options, collect local resources, take funds from its major
donor countries that were China, Saudi Arabia and USA and third option was to go to IMF.

Government declared that first it will try first two options. Delegations went to different
countries for immediate assistance but could not result in success. As a consequence when
suspicions were increasing about the government’s default, government had to go to IMF.
Government had hesitated due to the restrictions imposed by IMF in negotiations and political
implications of these restrictions.

IMF approved 23 months standby loan in order to help the government tighten its monetary
and fiscal policies and other measures to stabilize the current account deficit to a more
sustainable level and help to improve the socio-economic condition of the country.

The amount of loan is $7.6 billion which would help economy of Pakistan to rebuild and
Stabilize.

The IMF Deputy Managing Director stated after approval of the aforesaid plan

“By providing large financial support to Pakistan, the IMF is sending a strong signal to donor
community about the country’s improved macroeconomic prospects”

This current plan of government has got two main objectives;

 Restore economic stability and confidence by taking macroeconomic measures

 Ensure social stability and adequate support for poor people in this process

In order to bring the reserve condition to an acceptable level IMF issued first trench of
$3.1billion immediately which eased the concern in the government. IMF decided to
constantly monitor the level of compliance by the government of Pakistan.

Major requirements from Pakistan included

Bring Fiscal deficit down from 7.4% in year 2007-08 to 4.2% in year 2008-09 and 3.3% in the
year 2009-010. This was to be achieved by generating more revenues from taxes and by
removing subsidies in public utility sector specifically the energy sector

Requirements from state bank included, reduce the inflation to 6% in 2010 which was near
20% in year 2008, enhance its capacity to resolve economic problems, minimize its lending to
government, avoid supporting the stock market by the use of public resources and try to
increase its reserves using monetary policy controls.

Increase expenditure on social safety to protect poor with the help of targeted electricity
subsidies on electricity and cash transfers. Increase spending on public safety from 0.6% to
0.8%.

Implications of this program

This program was first one in the history of Pakistan that was given for budgetary
measures rather than for balance of payments. The total resources that have been approved
by IMF in this period amount to $11.00 billion. Though there have been a little reforms in
some sectors yet IMF has not paid attention on many of its requirements.

Some major reforms include

 1. Reforms in electricity tariff
2. Reforms in Tax structure and administration
3. Increase in the powers of SBP to govern commercial banks

The objectives of the program were not consistent with each other because the clause of
restoring investor confidence by restoration of macroeconomic stability would ultimately
result in reduced imports and as 40% tax comes from imports that will contradict with
revenue generation clause.

Year 2009
The year 2009 brought troubles for the country’s economy because of internally
displaced persons due to military operation in Pakistan.

On the basis of these three million internally displaced people and poor security
condition Government was able to get more funding of $3.2 billion from the IMF. In a review
of progress under $7.6 billion standby agreement. During a discussion in August the directors
of IMF decided to grant another funding amounting to $3.2 on request of Pakistan
government because of increased pressure on Balance of payments. This about amount was
approved due to US influence in the organization and as Pakistan is a front line state in war
against terror, IMF may continue to adopt relax policies about Pakistan program.

Year 2010
The first half of year ran smooth but later flood hit in a large area of Pakistan. That was
the most destructive flood in the history of Pakistan.

The consequences of this flood were

 Almost $10 billion loss according to world bank

 Decrease in exports duo to destruction of manufacturing facilities and crops
 Increase in imports of goods required for rehabilitation
 Increase in rate of inflation due to shortage of food items
 Problem in balance of payments
 Increase in government borrowing to coup with increased spending on relief and
recovery operations.
 The reserves with the state bank amounted to $13.2 billion after an increase of $200
million. Although the requirements of IMF were not met properly yet IMF provided $450
million as emergency assistance in September.

This new money was in addition to the existing Stand-by-Agreement and was made
available to authorities immediately in order to meet most urgent budgetary needs.

Another problem that occurred in IMF and Pakistan relationship and is still unresolved is
Value added Tax that was presented in national assembly of Pakistan. This was the
requirement of IMF and was going to be implemented in order to increase tax to GDP
ratio under the tax reforms. Delegations met with IMF in this regard because it was hard
for the ruling party ‘Pakistan People’s Party’ to add more taxes keeping in view the high
inflation rates specially food items. Government could not approve that bill due to intense
opposition from other political parties and general public. Government also faced
problems in eliminating the subsidies in electricity and the public protested against
government.

Regardless of these problems of compliance IMF continued to grant funds to Pakistan

throughout the year.

Reasons for getting IMF plans repetitively

The governments in Pakistan, specifically during 1990’s could not manage the
economy of the country when they were left to do this on their own.

Rapid changes in governments caused renewal in IMF plans frequently. The finance
ministers of the governments that were dismissed often say that if their governments were
not dismissed, the results of the IMF plans would have been different.

The policies of the two governments that ruled in the 1990’s had similar vision and
policies about the reforms needed. Economic mismanagement was the main reasons that
spoiled the track record with IMF and created uncertainty and discontinuity in the IMF
programs.

According to some analysts another reason for failure was that most of these
programs funded funds in order to meet short term requirements for replenishing foreign
exchange shortages and reserves. Instead of applying long term institutional and economic
reforms, the focus remained on improving short term indicators.

Another problem had been of various interest groups who helped the governments
approving the funds and later gained their own interests. These interest groups had a lot
influence in these governments and played a vital role in the failure of long term structural
improvements in Pakistan.

Another theory about this is that IMF could not fully understand the economic
conditions and their conditions were not viable. The unavoidable factors were not considered
while deciding conditions by the IMF. The focus on Quantitative indicators by IMF rather than
focusing on overall policy implementation also caused problems between IMF and the
country government.

As a conclusion, in the first decade the main reason for the continuation of these
funding was that the governments were able to put the economy back on track which was
necessary in uncertain situation of that decade. Some of conditions by IMF could create
political problems for governments and were hard to make and so the governments delayed
their application or the application was totally artificial.

The results of IMF plans would have been much better if the governments had
considered long term progress of the country.

The later decade was relatively successful due to commitment of the government and
due to certain conditions and events. First time in the relationship with IMF, facilities were
completely availed. After 9/11 foreign investment increased which facilitated the success of
IMF plans. The government and policies were relatively stable and for the first time a
government completed its tenor in Pakistan. The growth in that period can be to some extent
attributable to successful implementation of IMF plans.

Recent facility from IMF has faced many problems. Government in reluctant in
reducing or eliminating subsidies from public utilities due to public pressure and opposition
parties. There is trouble in the approval of reformed general sales tax and widening the sales
tax by including agricultural income in the tax net. Flood, war against terror are also some of
the problems faced by the current government and IMF.
Suggestions to avoid IMF
In order to avoid borrowing from IMF the governments should maintain enough
resources to enable the country sustain eras of problems without foreign aid.

Government should impose tax reforms and include all incomes including agricultural
income to increase revenue collection. It should increase exports in order to keep balance of
payments to a certain level.

In order to avoid IMF government should maintain these indicators at level shown
below

Indicator Level to be maintained

Fiscal deficit 3-3.5% of GDP
Current account deficit 2-2.5% of GDP
Foreign exchange reserves 4-6 months of imports value
Public debt 40% of GDP
External debt 20% of GDP

The IMF should also free the government of Pakistan to make decisions about the
policies rather than dictating all the term and conditions which creates a perception in
Pakistan about unfair involvement of IMF in matters of Pakistan.
Annexure
The following web pages were used for help

http://www.scribd.com/doc/26183528/Pakistan-s-Economy-and-the-Role-of-IMF-and-World-
Bank

http://www.imf.org/external/np/vc/2003/092303.htm

http://findarticles.com/p/articles/mi_6788/is_1_36/ai_n28701376/pg_12/

http://www.nationsencyclopedia.com/Asia-and-Oceania/Pakistan-ECONOMY.html

http://www.eurojournals.com/irjfe_44_07.pdf

http://www.imf.org/external/pubs/ft/survey/so/2008/car112408c.htm

http://nbs.nust.edu.pk/Faculty/Dr%20Ashfaque/2009/Oct%202009/Managing%20Pakistan
%2027%20Oct,%202009.pdf

http://en.wikipedia.org/wiki/International_Monetary_Fund

http://www.pakistaneconomist.com/issue1999/issue38/cover.htm

The articles on next pages were also used for help,

 Doing without the IMF support

By Aftab Ahmad

In a recent Cabinet meeting, the hope was expressed that the current IMF programme might be the last
one and that the economy would be able to function without the IMF support after the conclusion of
the current Stand-by Arrangement (SBA), at the end of the current year. However, in the absence of
required steps taken by the government, the aforesaid resolve should be called no more than wishful
thinking. In the past, IMF support was needed from time to time, to improve the country’s
deteriorating balance of payment (BOP) position or because of resource constraints, which became
unbearable in the event of an external shock or a natural calamity such as an earthquake, flood or
famine etc. The position remains unchanged, as the country still suffers from a vulnerable BOP
position, as well as resource constraints.

Pakistan’s economy was in a much better shape than at present during the 2001-05 period. Still the
economy could not bear the shocks resulting from the devastating earthquake of 2005, global food
inflation and the unprecedented surge in world oil prices in 2008. Foreign exchange reserves of $16
billion deteriorated rapidly and the country had to fall back on IMF crutches towards the end of 2008,
to avoid default on its international obligations.

When the international oil prices had ballooned to $147 a barrel in July 2008, why did the economies
of China and India remain unaffected? It was inter-alia because China had foreign exchange reserves
of $2,000 billion and India over $200 billion, at that time. Although, China’s exports registered a
negative growth during the global recession – as in case of Pakistan – its economy was able to bear the
shock. China’s resource position remained strong and the Chinese government was able to launch a
massive stimulus package to neutralize the effects of the global economic slowdown on its economy.
Even India’s economy was able to bear the shock and it is now gradually returning to its 7-8 per cent
yearly GDP growth.

The question arises why Pakistan could not increase its revenue resources and build its foreign
exchange reserves like other countries in the region, so that it would not have to fall back on the IMF
support, again and again. There are many reasons for this failure. One, ours is a consumption-oriented
society due to which the country’s national savings rate has always been the lowest in the region. For
this very reason, successive governments have never been able to cut their non-development
expenditure and they have preferred to reduce the development expenditure, instead. Two, the rich and
wealthy in the country do not want to pay their due income taxes. The agriculture sector has a larger
share in the GDP than the manufacturing sector. However, the manufacturing sector contributes more
than 50 per cent to government revenues, while income from agriculture sector has always remained
exempt from tax payment, which has no justification. As a result, the economy always suffers from
resource constraint.

Three, due to rampant corruption and poor governance, over-invoicing and under-invoicing could not
be checked so far and the exporters often do not bring their export proceedings to the country in time.
Four, industrial development in the country is still in the primary stage due to which we do not export
any hi-tech and high value items. We have also failed in achieving import-substitution, to the required
degree. As a result of the above, trade/current account deficits are a permanent feature and the
country’s foreign exchange reserves have also remained at a lower level.

As regards Pakistan’s dependence on the IMF, the country has remained a regular user of the IMF
facilities, as laid down in the book entitled ‘Pakistan under IMF shadow.’ As stated in this book,
Pakistan had joined the IMF in July 1950 – three years after its birth. For the first time, the country had
sought IMF financial support under the SBA in December 1958, to overcome its BOP difficulties.
Nearly 50 years after the aforesaid happening, Pakistan had once again sought the IMF’s BOP support
in 2008. It shows that we had not learnt any lessons from history and had failed to develop the
capability to do without the IMF support during the last five decades.

It was also in 1965 and 1968 that the country had to avail itself of the IMF facility under the SBA
when the BOP came under an added pressure due to defense goods and food imports. The IMF
assistance helped in improving the BOP situation, for the time being.

In 1974-75, the country’s import bill rose substantially due to increase in oil prices by the Organization
of the Petroleum Exporting Countries (OPEC) in 1973. The deteriorating BOP situation forced
Pakistan to avail IMF support in 1972, 1973 and 1977. In 1979, the international oil prices witnessed a
second hike. At the same time, budget deficit also had increased alarmingly as revenue had stagnated
and expenditure had gone up. As a result, Pakistan had to use the Extended Fund Facility – newly
created by the IMF- to overcome its BOP and budget difficulties. The three-year (1980-83) facility
was, however, suspended within two years due to non-compliance of IMF conditionalities.

Pakistan did not seek IMF support from November 1983 to November 1988. However, IMF assistance
was repeatedly sought during the 1988-1999 period, although none of the IMF programs during that
period could be successfully completed due to non-compliance of IMF conditionalities by the then
governments. During the aforesaid period, Pakistan’s economy constantly remained under pressure.
Tax collection lagged far behind the growing expenditure. Most of the government revenue was
consumed by debt-servicing and defense, with the result that development spending continued to
decline. Public debt as a percentage of the GDP grew. Increasing indebtedness, together with higher
budget and current account deficits, resulted in depletion of foreign exchange reserves and depreciation
of Pak rupee. In October 1999, when the new government took over, the threat of a default prevailed.
Accordingly, the new government sought IMF support to overcome its economic difficulties. The new
arrangement with the IMF was for the 2001-04 period. Although the IMF conditionalities were quite
tough, the new government ensured compliance of all conditions agreed with the IMF, to show its
legitimacy and capacity to deliver. Due to this and favourable aid environment in the wake of 9/11, the
aforesaid IMF program showed good results. Fiscal deficit was brought down to 3.3 per cent in 2005,
while the current account showed a surplus in 2002, 2003 and 2004. Government’s indebtedness was
reduced from about 90 per cent in 2001 to 62.5 per cent of the GDP in 2005, while foreign exchange
reserves continued to grow and ultimately reached $16 billion at the end of 2007.

However, after successful completion of the IMF program, the government could not successfully
manage the economy when left to do so, on its own. Macro-economic stability achieved during
previous years was lost. In a bid to boost GDP growth, car financing and consumer financing policies
were introduced. In addition, the government followed an expansionary fiscal policy. As a result, the
consumer demand witnessed an extra-ordinary upsurge. Fiscal, trade and current account deficits went
up. Later, the devastating earthquake of 2005, global food inflation and an unprecedented rise in
international oil prices aggravated the government’s difficulties. Foreign exchange reserves, which
stood at $16 billion in December 2007, slumped to $6 billion in November 2008, when the present
government had to seek IMFBOP support, to avoid a default on its international obligations.

The brief history of Pakistan’s relations with the IMF during the last 50 years, summarized in the
preceding paragraphs, shows that Pakistan had to approach the IMF for help again and again since its
weak resource position could not bear any internal or external shocks. It, also, shows that the
government could not successfully manage the economy when it was left to do so, on its own. The
remedy, therefore, lies in improving the resource position to a level where the economy would be able
to bear all internal and external shocks. To achieve this objective, it would be necessary to tax each and
every income, irrespective of its source and reduce the government’s non-development expenditure to
the minimum. To build the foreign exchange reserves, it would be vital to boost exports earnings and
bring down trade and current account deficits to a sustainable level.

The book ‘Pakistan under IMF shadow’ suggests the following benchmarks to be followed by the
government in order to avoid a situation where IMF support would be unavoidable. Fiscal deficit
should be maintained around 3 to 3.5 per cent of GDP, while current account deficit may be kept
below 2-2.5 per cent of the GDP. The country’s foreign exchange reserves may be maintained at a
level equal to 4-6 months of annual imports, while public debt should preferably be kept below 40 per
cent of the GDP – with external debt being less than 20 per cent of the GDP.
Pakistan and the IMF : 1988-20021
A case study
ISHRAT HUSAIN2
Pakistan entered into nine different agreements with the IMF during the period 1988-
2000. Except for the last Stand-by Arrangement (SBA), most other arrangements were not fully
implemented and consequently almost half of the agreed amount remained undrawn. The
1990s, however, was a ‘lost decade’ for Pakistan’s economy. During the previous four decades
the annual average growth rate was almost 5 percent and the incidence of poverty had declined
from 40 percent to 18 percent by the end of 1980s. During the 1990s, growth in per capita
income dropped to slightly over 1 percent. Poverty resurfaced and about one third of the
population now lives below the poverty line of $ 1 per day. Social indicators are worse than
other countries with comparable income. The country has turned from moderately indebted to a
heavily indebted country and was also perceived as one of the most corrupt countries in 1996.
Institutional decay has been pervasive adversely affecting the implementation and
administrative capacity.
Since 2000, however, the SBA was fully implemented without any hiatus and the
progress on the Poverty Reduction and Growth Facility (PRGF) approved in 2001 is also on
track. The external sector has been secured and macroeconomic stability indicators look good.
Growth rate has, however, remained dismal and poverty reduction has not made much
headway.
This case study examines the following three questions:
(a) Why did successive governments opt for the IMF programs?
(b) What is different this time? and
(c) What are the lessons for the IMF from this experience?
Why did successive governments opt for the IMF programs?
Pakistan has had nine different governments (Bhutto, Jatoi, Nawaz Sharif, Mazari, Moeen
Qureshi, Bhutto, Meraj Khalid, Nawaz Sharif, Musharraf) during 1988-2001. Pakistan entered
into nine different kinds of agreements with the IMF during this period. The motivations and
intentions of each government may be different but it can be deduced from their actions that
there were a number of underlying factors common to all of them. The exact weight of an
individual factor may have varied during different periods but a more formal principal
component analysis would have revealed their significance. These factors are:-
1) Need to obtain financial resources for resolving balance of payments problem;
1A paper presented at the International Expert Workshop organized by the German Foundation for Development
(DSE) at Berlin on July 1 – 2, 2002.
2 The views expressed in this paper are those of the author and do not represent the views of the State Bank of
Pakistan or the Government of Pakistan.
2
2) Secure access of funds from other international financial institutions and bilateral
donors;
3) Get a ‘Seal of approval’ for seeking commercial and export credit facilities;
4) Shift the blame for some of t he politically unpopular decisions to external pressures
and compulsions;
5) The attempt of reformist economic managers to restrain and block the pursuit of
populist policies by political leaders;
6) In post 1998 period to get debt relief and rescheduling.
The above catalog of motivating factors appears to be quite plausible and reasonable.
The question then arises is: why did success in implementing these programs prove so elusive?
There are several explanatory hypotheses, which are presented below.
First, it is interesting to note that the frequent changes in the government leadership led
to new agreements with the IMF and one of the reasons cited for dismissal of directly elected
governments was economic mismanagement. Whether the continuity of elected governments
and completion of their full term would have made any significant difference as far as
implementation of the IMF programs was concerned is the moot question. There is a viewpoint
shared by the economic managers of the dismissed governments that these programs, even if
they had gone off track temporarily, would have been back on track if there were no disruption
of the political process. It would be pertinent to point out that there was no difference of
opinion among the two major political parties who alternated in power in the 1990s as far as the
nature of reforms was concerned. Their views also coincided with the IMF program contents.
In other words, economic management and meeting the commitments with international
financial community cannot be divorced from political management and the overwhelming
reason for Pakistan’s poor track record can be ascribed to the uncertainty and discontinuity
caused by frequent changes in the government.
The second line of reasoning has been espoused by this author in his 1999 analysis of
the Political Economy of reforms. According to this viewpoint the main motivation underlying
these programs was not longer-term transformation of the economic structure but short-term
injection of liquidity to avert foreign exchange shortages and replenish reserves. Adjustment
was thus taken as a purely short-term palliative measure to buy time rather than an opportunity
to introduce much desired policy and institutional changes. The vested interest groups which
were likely to lose out from these reforms, had strong political and economic hold on the
decision making process under every elected government. They were therefore instrumental in
ensuring that only some cosmetic changes were made to obtain IMF and other external
financing and then go ahead with business as usual. The leadership in Pakistan during this
decade remained preoccupied mainly with the challenges of retaining power in the face of a
vigilant military oversight and in building coalitions and alliances to preserve political power
and thus sticking to the lowest common denominator acceptable.
3
The third hypothesis can be termed as ‘Blame the IMF syndrome’. The proponents of
this hypothesis argue that the diagnosis of the economic problems carried out by the IMF staff
is partial and incomplete. As they do not have any grounding in the specific political realities or
awareness of the institutional capacity their technical analysis is sound but does not capture the
full feasibility of implementation of reforms. More damaging is the indictment that the design
of the program is driven too much by dogmatic and ideological agenda of Wasgington
Consensus i.e. liberalization, privatisation and deregulation. The IMF holds a uniform set of
universal economic precepts to be valid across countries and the initial conditions, market
imperfections, structural rigidities, immobility of factors and other peculiar features of
developing economies do not seem to figure in the design and formulation of the programs.
A variant of this hypothesis argues that even when policy content is appropriate there is
a great deal of resistance in accepting deviations and variances from the specified performance
criteria. Nobody has perfect economic foresight to predict accurately the evolution of key
variables over time. Unanticipated exogenous factors outside the control of the policy makers
do influence the outcomes and the IMF staff and Board are more often inclined to ignore or
give less weight to these factors during their review placing unreasonable demands for further
adjustment upon the authorities. If the targets themselves resulted from unrealistic assumptions
in the program design then throwing the entire weight upon the country is considered
unreasonable. The strict adherence to quantitative indicators rather than a feel for the overall
policy direction does create a dissonance between the Fund and the country authorities. The
tendency to micromanage and second guess the authorities has been a consistent complaint
against the IMF by those who have been engaged in negotiations with them.
What do we conclude about the relationship between the IMF and the successive
governments during this period of 1988-99? My own reading of the evidence suggests that
short term economic gains in tackling external sector imbalances by getting infusion of IMF
and other external financial flows was the main driver of this relationship. Fundamental
structural reforms that entailed heavy political costs were largely avoided or were cosmetic in
nature, as these reforms would have added to the political insecurity with which these
governments were already suffering. The struggle for surviving in the office was already quite
messy and unpopular economic reforms would have accelerated their exit from the office
sooner than later. This need for survival translated itself into poor governance and wasteful
expenditures. The time inconsistency problem where the benefits of these reforms would have
accrued to their opponents later while the costs would have been borne by them was upfront a
real one.
What is different this time?
An interesting question that is raised these days in Pakistan is: why is it different this
time that we have been able to complete the SBA without any hiatus and are on track in
implementing the PRGF?
It must be recalled that the relationship between Pakistan and IMF in the early days of
Musharraf Government was quite rocky and uneasy. The dismissal of a democratically elected
government and take over by a military leader was not taken lightly by the major shareholders
of the IMF. On the top of this, the new government had to inform the Board about the
misreporting of the fiscal deficit data in the year 1998-99. Thus there was an air of suspicion,
scepticism and lack of credibility about the country. Voices were raised at higher level of
management and the Board about the country’s track record in delivering on its commitments
4
and promises to the international financial community. There was a little sympathy to the
proposal made by the GOP that they were willing to implement all the conditionalities
contained in the suspended ESAF/EFF program and that this program should be resumed. The
IMF responded that a number of key conditionalities should be imple mented as prior actions to
demonstrate good faith by the new government. Even if these actions are taken the IMF
management will only recommend a 10-month SBA for Pakistan and not the resumption of the
medium term ESAF/EFF program. At that time the country had very few options, as default on
external debt appeared quite imminent. An agreement with the IMF was thus essential in order
to obtain rescheduling of its Paris Club debt. The GOP had thus to pay a heavy price for reestablishing
the country’s lost credibility and had to take some very tough measures as prior
actions. These actions triggered the approval of the SBA by the IMF Board. Subsequently, the
Government had to implement an equally tough set of additional measures to meet the
performance criteria, structural benchmarks etc. during the next ten months. I would not go into
the details of the measures at this stage but I am not aware if any other developing country had
embarked on such a wide range of deep-rooted reforms during such a short span of time. This
happened at a time when per capita incomes were stagnant, investment had declined during the
previous five years, poverty was rising, fixed income groups had their salaries frozen since
1994 and widespread unemployment was a serious economic and social problem.
Why was there political willingness to implement these unpopular reforms that had
been resisted for a long time by successive governments? My own reading leads me to the
following conclusions: -
(a) That the country was on the verge of a serious financial crisis and the new
government had assumed power with a commitment to avert this crisis;
(b) These reforms fitted in well with the strategic vision of President Musharraf;
(c) The team of technocrats commissioned to carry out the reforms possessed the
requisite capacity and commitment; to design home grown program and
(d) Improved governance structure has facilitated the reform process.
(e) Stakeholder consultation provided a vehicle to broaden ownership in the
formulation of the Poverty Reduction Strategy Paper (PRSP)
President Musharraf had committed to the nation at the time of take over that good
governance, economic revival based on strong fundamentals and freedom from debt and social
harmony were his main priorities. The distortions in the economy according to him were great
inhibitors in achieving this vision and had to be removed. The diagnosis of the problems
confronting the economy and the prescriptions required to fix them were shared by the
government’s economic team and the IMF and World Bank staff. Although there were
differences of opinion about the intensity, sequencing, timing and phasing of various measures,
there was no serious disagreement on the nature of the reforms to be undertaken. The thrust of
reforms suggested by the IMF was in the areas of fiscal prudence; reducing indebtedness,
competitive pricing of outputs, inputs and public utilities, widening tax base and strengthening
tax administration; removal of concessions, exemptions and privileges, extension of a level
playing field to all economic agents; greater reliance on market mechanism rather than
5
administrative discretion in allocation of resources; privatisation of state owned banks, energy
companies and other large enterprises. This concurrence between the new government’s
agenda, and the IMF program contents, the shared diagnosis of the problems and agreement on
specification of remedial actions paved the way for smooth and uninterrupted implementation.
It was not easy by any means. Public opinion, intelligentsia and popular media were all
generally opposed to this program and several public office holders wished that the pace of
reforms could be slowed down. But the clear headedness and steadfastness of the key decision
maker of the country did not allow any significant slippages to take place. The GOP, also, for
the first time made Poverty Reduction and Social Safety nets as explicit and integral part of
its economic revival agenda. The underlying logic was clear: reforms would hurt the poor in
more than one way, particularly, if subsidies are withdrawn and market prices are introduced.
To help the poor cope with this burden the Government had to put in place poverty targeted
interventions and social safety nets.
The results of the efforts during the last two and half years have been mixed. External
sectors has been secured, debt burden indicators are falling, foreign exchange reserves are at a
record high inflation is low, exchange rate has remained stable and governance has improved
significantly among the higher echelons of the public officials. But growth has remained
anaemic, investment is still elusive, poverty has not been dented, government revenues and
exports have not reached the desirable levels and unemployment is still a burning issue. Of
course, there have been a series of continuing exogenous shocks such as the unprecedented
drought for last three years, global recession worsened by September 11 events, the war in
Afghanistan, and growing tension with India. Domestic non-economic factors such as a
virulent campaign against extremist and sectarian elements in the society and joining hands
with the international community in their fight against terrorism have not helped much either.
Institutional capacity constraints and the revolt of the previous powerful vested interests against
this regime have exacerbated the situation.
What are the lessons for the IMF?
One of the important lessons that emerges is that the insistence on prior actions and
conditions is widely perceived in Pakistan as an infringement of its national sovereignty. So
even desirable policy reforms are resisted and opposed on this ground. It would thus be
preferable if there is a minimalist approach in the specification of conditions by the IMF and
more reliance is placed on the actions proposed and initiated by the governments themselves.
This reading of Pakistan case study would be incomplete if the changes in the attitude,
behaviour and response capacity of the IMF are also not recognized. Once the track record and
credibility of Pakistan were established the dialogue between the two sides became more
productive and fruitful. There was a genuine desire to resolve outstanding issues in a spirit of
openness and frank exchange. A better appreciation was exhibited about the variances and
slippages from the agreed targets and when it was demonstrated beyond doubt that policy
actions were appropriate and timely but other factors outside the control of the authorities could
explain the deviations – waivers were granted consistently. For example, in relation to tax
revenue targets where it became obvious that the underlying assumptions behind those targets
were not validated by actual course of events the IMF staff accepted this deviation. The IMF
staff and management were more forthcoming and showed understanding as far as fiscal deficit
target was concerned when some one-off adjustments were made to clean up tax refunds to
banks, to meet the accumulated losses of KESC, and to increase the defence expenditure due to
troop mobilization at the borders. As long as the policy direction showed the trend of reduction
6
in overall fiscal deficit and generation of primary surpluses, the IMF did not have a serious
reservation on short term slip in fiscal deficit. So long as inflation remained muted the IMF did
not object to the ease in monetary stance. But at the same time they were very vocal about the
slow down in social sector spending or a cut in overall development expenditure. They were
also keen on monitoring the impact of poverty related expenditures including targeted
subsidies or transfers. The missions had interactions with a much larger segment of the Federal
and Provincial Governments, business leaders, trade unions representatives and banking
community. The Fund Resident Representative took advantage of public seminars and
conferences to respond to the invalid criticism at the Fund program and was accessible to
media. The transparency in putting out the Letters of Intent (LOI) and other documents is, in
my view, a step forward to explain to the public at large the rationale and logic behind IMF
assistance to Pakistan.
Of course, the image of IMF in developing countries and in Pakistan remains tarnished
because of the burden of historical legacy, the increasing debate about the efficacy of the IMF
programs during the Asian crisis and the political antecedents of a disproportionate influence of
the US and Western countries on decision making. More success stories of mutual cooperation
and trust between the countries and IMF have to be generated to improve this image. The
feedback and second opinions emerging from the analyses of the Independent Evaluation
Office (IEO) should also help improve the quality of internal governance within the IMF.
Conclusion:
The history of prolonged uses of fund resources in Pakistan can be divided into two
periods. The first period between 1988-99 can be characterized as less successful in achieving
the objectives set out in the programs agreed between the authorities and the IMF. Frequent
changes in government reduced the time horizon of the decision makers and they avoided
taking decisions with long term positive benefits but short term and immediate costs. They used
IMF and other foreign resources to fix the external payment imbalances during the pendency of
their regime but did not stick to the complementary policy reform which would have taken care
of the root problems underlying these imbalances. Poor economic governance was very much
an inhibitor in the pursuit of sound economic policies, programs and investment decisions.
The second period beginning in the year 2000 has started on a more positive footing.
There is an essential concordance between ownership and conditionality as the agenda
designed by the Government has the right mix of policy actions which can be reinforced and
strengthened by conditionality of the IMF and other IFIs. The economic managers can turn
around to these conditionalities to protect themselves from the pressures of undesirable policies
and unproductive expenditures. But for this to happen on a sustained basis there is a need for
the IMF to be more flexible and open minded in its approach, examine the evidence and the
consequences of various policy options without benchmarking them to established orthodoxy.
The IMF management have to give a much freer hand to the country missions and Area
departments in the design and review of the programs compared to the current practice where
the central departments almost enjoy veto powers and are the guardians of the Fund’s
orthodoxy. The highly intrusive role of the Fund’s Board is also counter productive in so far as
the staff and management keep on second guessing the Board members’ reactions to the
various innovative and untested ideas. The incentives for new approaches and nonconventional
ways of thinking are thus non-existent and the urge to conform to the usual
contours and space is highly compelling. The Managing Director’s initiatives for the IMF to
become a more learning and responsive cooperative institution trusted equally by African,
7
Asian and Latin American member countries, will remain unfulfilled unless the role of the
Board and the Central departments within the IMF are redefined. It is suggested that the IEO
should be asked to examine the internal decision making process within the IMF..