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EFSAS Commentary

Pakistan’s latest IMF bailout will not succeed without major cuts in the defense budget


The International Monetary Fund (IMF) issued a statement on 12 May announcing that it had reached a Staff-Level Agreement (SLA) with Pakistan for a 39-month Extended Fund Arrangement (EFF) for about $6 billion. The SLA would need to be approved by the IMF’s Executive Board, and will be also a subject to the timely implementation of prior actions by Pakistan and confirmation of its international partners’ financial commitments. If approved, it will be the 21st loan that Pakistan has taken from the IMF in the last 60 years, and the 13th bailout since 1988. Over the years, the country has borrowed an astounding total of $27 billion from the IMF as per the current value of Special Drawing Right (SDR). As it pursues this 13th IMF bailout programme, Pakistan already has an existing $5.8 billion debt to the IMF from past programmes.

Prime Minister Imran Khan upon assuming his post last year first sought to tide over Pakistan’s grim financial woes by imploring “friendly countries”, including Saudi Arabia, China and the United Arab Emirates, to grant billions of dollars in loans. Khan, apprehensive of the stringent conditions that the IMF was likely to place in return for a bailout, had publicly articulated his disinclination to approach it. However, despite managing to squeeze about $7 billion out of the aforementioned three countries, the economic situation of the country showed no sign of improvement. Quite the contrary, inflation spiked to over 8.8%, the Pakistani rupee lost a third of its value over the past year, and foreign exchange reserves depleted to an amount that was barely enough to cover two months of imports. This forced Khan to reconsider his earlier reluctance to fraternize with the IMF.

The IMF’s decision to back the bailout would have come as a relief to the Pakistani government, especially as there had been rumblings in the high echelons of the United States (US) administration over the IMF granting Pakistan another bailout just to enable it to repay its billions of dollars of debt to China for the China Pakistan Economic Corridor (CPEC) as earlier brought out in EFSAS Commentary of 07-09-2018. While the US seems to have been mollified after achieving its primary goal of arm-twisting Pakistan into sending the Taliban to the negotiating table in Doha, the tough conditions dictated by the IMF are proving to be difficult to digest within Pakistan. Michael Kugelman, a South Asia expert at the Washington-based Woodrow Wilson Center, opined that “the IMF deal, with the austerity measures it will entail, will be a political blow to a Pakistani government that had promised to build out a new welfare state. The IMF package will make it quite tough for Imran Khan to achieve his economic promises and therefore undercut the populist image that he has sought to showcase to the electorate”. The Pakistani government will also have to contend with the disagreeable reality that the IMF conditions could undercut common strategic objectives that it is pursuing with China in the CPEC.

Several prominent Pakistani commentators have underlined that the country was being obligated by the IMF to undertake major structural reforms that would put even more stress on the already stretched financial resources of a beleaguered population, and that the poorer sections of society would be worst hit. Among other belt-tightening moves, the bailout package demands cuts in fuel subsidies, thereby putting more burdens on a struggling population, and tightening of the fiscal and monetary policy which are likely to further slowdown growth. Pakistani economist Kaiser Bengali believes that “the IMF has an agenda to privatize the assets of the country, which will lead to massive unemployment”.

Pakistan's economy has been in the doldrums with escalating current account and fiscal deficits and uncompetitive low-value exports as well as imported machinery leading to an adverse balance of payments situation. Discontent has been brewing over recent measures Khan's government has taken, including devaluing the Pakistani rupee by about 30% since January 2018, which in turn sent inflation to a five-year high. In April, consumer price inflation (CPI) stood at 8.8%, up from roughly 3.8% at the same time last year.

One of the IMF’s conditions is that Pakistan shifts to a market-determined exchange rate. Once it does so, its currency will crash further and additional depreciation of the Pakistani rupee would mean that the cost of servicing foreign debt will increase. Meanwhile, to keep inflationary pressures in check interest rates will have to be hiked even beyond the current 11%.

It is no surprise, therefore, that the IMF has predicted that Pakistan’s GDP growth, which was 5.8% in 2018, will slow down to 2.9% in 2019 and hover around 3% in the midterm. To put the current state of the Pakistani economy in perspective, its currency-adjusted GDP that is currently $280 billion is expected to fall below Bangladesh’s $274 billion in the coming months. With the IMF’s conditions in play, Khurram Husain, business editor at Pakistan's Dawn newspaper, assessed that “there will be severe contraction of the economy, plummeting investment and rising inflation. The IMF programme will increase costs on the common citizenry, and raise the cost of doing business. It will administer costs and pain on both the citizen and investors”. In return, Pakistan would get an IMF loan of $2 billion a year (for 3-years) while it’s total foreign debt is a massive $90 billion. Husain’s bleak assessment seemed to be shared by the Karachi Stock Exchange, which on the day after the IMF statement shed 816 points to close below the 34,000 mark for the first time in more than three years. The Pakistani rupee on 15 May hit an all-time low of 146.25 rupees against the US dollar amid looming fears of further devaluation.

Opposition parties in Pakistan have come down strongly against the government for agreeing to the IMF’s conditions. Pakistan Muslim League-Nawaz (PML-N) spokesperson Marriyum Aurangzeb said, “Imran Khan, you handed over the country to the IMF for just $6 billion”, while the Vice President of her party Maryam Nawaz tweeted on 13 May, “IMF or no IMF – the incompetent rulers were not sure. Finally when it does come, it’s a complete sell out of our sovereignty and rightly REJECTED by stock market. After just 9 months, country is on the brink of economic disaster”. Khursheed Shah, a senior leader of the Pakistan Peoples Party (PPP), predicted an “unbearable inflation” in the country as a consequence of the IMF conditions, while Amir of the Jamaat-e-Islami Senator Sirajul Haq said that “the government has bowed down to the IMF’s condition of imposing more taxes. The people of Pakistan will become the IMF’s slaves after the agreement while it will also increase the gas, electricity and oil prices”.

Some senior leaders of Imran Khan’s party have also voiced their reservations about the IMF package. Asad Umar, who was Finance Minister in Khan’s cabinet and was involved in the negotiations with the IMF, was recently replaced by Abdul Hafeez Shaikh, who has worked for both the IMF and the World Bank. Umar said that he was not prepared to inflict pain on the Pakistani people by succumbing to the IMF’s requirements.

Importantly, the IMF has made its bailout package contingent upon Pakistan “continuing anti-money laundering and combating the financing of terrorism efforts. Former Pakistani Finance Minister and economist Dr. Hafeez Pasha underlined that this meant that the Executive Board of IMF would approve the bailout only after the Financial Action Task Force (FATF), on whose grey list Pakistan presently is, clears the country of money laundering and terror financing charges. A meeting of FATF is being held in Beijing from 15 to 17 May to review Pakistan’s compliance on a total of 19 points, including money-laundering and terror-financing. It is paramount that the IMF expands its outlook, and in addition to economic indicators also takes a close look at Pakistan’s role in fomenting terror in the region. If it fails to do so, it may end up becoming an unwitting partner that funds terrorist activities promoted by Pakistan.

The IMF has thus far in its negotiations with Pakistan apparently glossed over the aforementioned US reservations on Pakistan using the IMF largesse to service Chinese debts on account of the CPEC. As Jed Babbin, deputy undersecretary of defense in the George H.W. Bush administration, pointed out in The Washington Times in June last year, Pakistan’s economy is in shambles due to large-scale corruption and a growing debt crisis. The money it owes other nations and non-Pakistani entities is more than 30% of its GDP partly because of the extensive loans it has received from China to build parts of CPEC, by which China is building roads, power plants, railroads and military bases in Pakistan. Describing this as “de facto colonization of Pakistan through CPEC”, Babbin believes that through China’s “debt trap diplomacy Pakistan is becoming so indebted to China that it will be compelled to follow China’s policies in Southwest Asia and beyond. In fact, the debt trap has already been sprung with the eager assistance of the Pakistan’s government, ISI and army”. He concluded that “another IMF bailout for Pakistan would be a Western contribution to China’s transformation of Pakistan into a tribute state”.

One-third of Pakistan’s population lives under the poverty line, and the country is ranked 150th out of 189 countries in the latest United Nations Human Development Index. It is bewildering, therefore, that while imposing stringent conditions that directly and adversely impact the poor masses, the IMF has chosen to turn a blind eye to the Pakistani military establishment and its hogging of the country’s resources. As Taha Siddiqui, an award-winning Pakistani journalist, brings out, “it is instructive that after debt servicing, the military is Pakistan’s biggest economic burden. Already, over 20 percent of the annual budget officially goes to the military, but the armed forces have been pushing for more every year. Just in the last budget cycle, it won a 20 percent hike in its yearly allocation. The actual expense of the military is even higher, but it is hidden by moving some of the expenses to other budget lines. The parliament neither seriously debates the military budget nor subjects its spending to audit. By contrast, the country spends less than 5 percent of GDP on social services like education and health care, well below the regional average. The military mainly protects itself by keeping the threat of India alive. The two nuclear-armed neighbors have been in conflict since the partition of South Asia in 1947. The militaries have fought four wars, with three of them over Kashmir valley. Even though Pakistan initiated these conflicts, it has told the public that it was only countering Indian aggression. In recent years, Pakistan has avoided a direct war, perhaps because it lost all previous ones. But it relies on militant groups based in Pakistan to keep tensions alive. This February offered a glimpse of such dynamics at play. In turn, the Pakistani Army gets the perfect excuse for its oversized burden on the country’s economy. Like a mafia protection racket, the military creates its own demand… The country that got freedom from its colonial masters has now become hostage to its own military”.

The IMF requirement that Pakistan’s primary budget deficit, which is the total revenue minus non-interest expenditure, be brought down to 0.6% in next budgetary year from about 2% at present implies that the defense budget would ideally need to be clipped. Given the power dynamics in Pakistan and the country’s track record, it is almost certain that this will not happen and ways will be unearthed by the establishment to circumvent it. However, if the IMF was in a position to be intrusive enough to direct Pakistan to free its currency from central-bank control, it could also have directly demanded a cap on the country’s profligate defense budget by stipulating an annually decreasing proportion of the GDP that could be spent on defense.

By choosing not to do so, it has all but ensured that its current bailout package will achieve as little as earlier ones did, and that Pakistan will be knocking on its doors yet again, palms open, in the not too distant future. It is not without reason that Pakistan has been under IMF bailouts for as many as 22 of the last 30 years.