IMF support and government reforms

“Growth is up, inflation is down, and the economy is on a sound path,” stated International Monetary Fund (IMF) Managing Director Kristalina Georgieva while announcing the approval of Pakistan’s 25th loan, worth $7 billion, for the next three years.

Nevertheless, the IMF cautioned that Pakistan still faces challenges, including a difficult business environment, an outsized state role, and a narrow tax base with low investment levels. It emphasised that Pakistan needs faster implementation of structural reforms, especially in addressing low productivity, economic openness, and resource misallocation.

While welcoming the IMF’s approval, Prime Minister Shehbaz Sharif reaffirmed that this would be the last time Pakistan seeks financial support from the IMF. His optimism seems rooted in recent economic improvements and structural reforms, such as the measures taken to raise the tax-to-GDP ratio, privatise loss-making state enterprises, and enhance the sustainability of the energy sector.

In addition, significant progress has been made on the “home-grown reforms agenda”, which is under review by a seven-member ministerial committee.

If Pakistan can enhance productivity and increase economic openness, it could overcome its debt challenges independently

Among the myriad challenges Pakistan faces, two of the most critical are reducing the debt burden and achieving greater economic openness. There have been positive signs on the debt front, with government and guaranteed debt falling from 81.5 per cent to 73pc of GDP. This level is also far above the 58pc threshold stipulated in the Fiscal Responsibility and Debt Limitation Act of 2005.

Therefore, further reductions in debt level are needed, as studies show that a debt-to-GDP ratio exceeding 60pc keeps a country within the default zone. Even if default fears have receded, in the fiscal year 2023, interest payments consumed 68pc of tax revenue, leaving inadequate resources for essential sectors like education, health, and infrastructure development.

Two options are available to make the debt more sustainable. One is the path Sri Lanka took: default and seek debt restructuring. However, this is fraught with challenges, especially since 60pc of Pakistan’s debt is domestic. Given the political instability, this may not be a feasible option, and it could trigger a resurgence of inflation, creating new problems.

As for foreign debt, Pakistan would face hurdles in securing collective action from creditors. Even if agreements are reached, some creditors might hold out for better terms, complicating the process. The projected $24.8bn in foreign debt repayments for the current fiscal year appears manageable, as it is lower than previous projections. Thus, there is no need to go for the extreme default measure.

A better approach would be to seek reprofiling of debt from major creditors, which involves extending the repayment deadlines, as was successfully done in 2001-02.

The government is reportedly working on reprofiling Chinese bilateral debt for energy plants, which stands at $16bn.

While earlier speculation suggested that this could be achieved in the near future, the finance ministry has since clarified that it will likely be a prolonged process, potentially taking months or even years.

Nevertheless, it is important to note that China has already provided significant assistance by rolling over and extending loans, a critical factor in managing Pakistan’s debt burden.

If Pakistan can enhance productivity, increase economic openness, and reduce resource misallocation as envisioned in the IMF agreement, it could overcome its debt challenges independently. This strategy has worked for many other countries in similar situations.

To raise productivity, the government must focus on developing skills aligned with the needs of a modern economy, such as digital literacy, technical skills, and critical thinking. Although innovation hubs are being promoted, internet connectivity has recently deteriorated. There is a need to embrace Industry 4.0 practices to streamline workflows and foster smart manufacturing and intelligent factories.

Economic openness will require reducing tariffs and non-tariff barriers to encourage international trade. Pakistan needs to consider normalising trade with all its neighbours.

To improve resource allocation, the federal government needs to fully transfer control of devolved subjects such as education, health, and local governance to the provinces. Since it has been almost 15 years since the 18th constitutional amendment was passed, by now, the process of devolution should have advanced significantly further, extending its reach to the local government level.

With the current momentum, the government has a real opportunity to make this the last IMF bailout program. Achieving this goal requires more than just economic reforms. Lowering political tensions and promoting inclusivity by addressing the concerns of all stakeholders will be critical.