Dr Akmal Hussain
As Pakistan enters into its 13th IMF programme, it may be helpful to consider the likely economic, political and security consequences. Since the financial crisis is more acute than at any other time in our history, and given the adverse constellation of external political forces, the conditionalities of this programme are likely to be more severe.
Two questions related with IMF conditionalities may be worth considering: (1) what is the analytical basis of the economic programme and the lessons of past experience?; and (2) Given the specific economic and political situation at this juncture, what would be the probable impact of the financial measures embodied in the programme on the real economy, the stability of the prevailing political system and national security?
The principal aim of an IMF programme is to substantially reduce the twin balance of trade and fiscal deficits. They try to do this by essentially reducing import demand through the device of contracting the economy. The policy instruments deployed are: devaluation of the exchange rate; increasing interest rates; and reducing public expenditures, which in our case means drastic cuts in development expenditures. I have argued elsewhere that these policies are counterproductive, even from the IMF’s own limited objective of reducing the twin deficits. This is because first, the economic conditions (Marshall–Lerner Conditions) for successful devaluation are not met in Pakistan: the volume of imports and exports is inelastic with respect to dollar price reduction. So even if the dollar prices of exports fall and rupee prices of imports rise following devaluation, foreign exchange earnings would tend to fall, rather than rise. Second, whatever little increase in export orders occurs following a dollar price reduction, orders cannot be supplied in a situation where there is lack of underutilized productive capacity in the manufacture of exportable goods. In Pakistan, almost 50 percent of the textile industry is paralyzed due to acute cash flow problems. Most of the industrial units which are functioning are operating at full capacity, and would need to expand capacity in order to increase supply. Third, the inflation rate has to be brought under control before devaluation; otherwise, rupee inflation will neutralize the effect of devaluation on dollar prices. Here, the inflation rate is rising rather than falling.
So, given the fact that the necessary conditions for successful devaluation do not exist currently in Pakistan, such a policy cannot be expected to achieve its objective of a large reduction in the balance of trade deficit. Nor did it actually do so in the last eight months, when a huge devaluation was undertaken. According to the Second Quarterly Report of the State Bank (2018-19), despite the exchange rate depreciation, “… the balance of trade in goods and services stagnated at last year’s level”. At the same time due to an increase in the rupee price of imported inputs following devaluation, the cost of production of domestic manufactures has increased, thereby pushing up prices. Devaluation has also increased the prices of fuel and fertilizers that have turned on the four main switches to inflation in Pakistan: electricity, gas, petrol/diesel and food prices. To make matters worse, the sharp reduction in development expenditures and increase in interest rates has reduced investment, causing an almost 50 percent decline in the GDP growth rate. So, IMF policy measures (undertaken even before we had signed the agreement) have failed to achieve the objective of a substantial reduction in the balance of trade deficit. But they have succeeded in accelerating inflation, a sharp slowdown of the economic growth rate and consequent increase in unemployment and poverty. Thus we have failure in the financial sphere and misery for the people in the real economy. This has been Pakistan’s historical experience during the last 12 IMF programmes: while there has been no sustainable improvement in the balance of trade, the people of Pakistan have repeatedly paid a heavy cost in terms of unemployment and poverty. As we sign yet another IMF programme, the same policies in a more accentuated form can be expected to produce an even higher inflation, unemployment and poverty than before. The IMF policy framework postulates that financial ‘stabilization’ might reduce GDP growth in the short run but quickly leads to a higher growth rate through improving the expectations of investors. Empirical research by independent economists over the last two decades has shown that this postulate is invalid. For example, the econometric exercise on data from 130 developing countries that had adopted IMF programmes by Barro and Lee (2005) has shown that in fact these programmes have had a significant negative effect on GDP growth. A subsequent study by Dreher (2006) also clearly showed that IMF programmes have a negative effect on economic growth, not only on short term but also on long-term economic growth. William Easterly (2005) conducted research on countries (including Pakistan) where IMF programmes have been repeatedly adopted. The results reveal that none of the top 20 recipients of repeated IMF adjustment lending were able to achieve high growth. Professor Easterly definitively concludes: “If the original objective was adjustment with growth, there is not much evidence that structural adjustment lending generated either adjustment or growth”. Reducing public expenditure on health and education, as has happened already in Pakistan’s case, reduces human development. As our own Dr Mahboob-ul-Haq concludes in the famous 1990 UNDP Human Development Report, “It is short sighted to balance budgets by unbalancing the lives of people”.
At this juncture when the civilian political structure is more fragile, the consequences of the IMF programme in its conventional mode could place severe stresses on the existing political system. Such an eventuality at a time when Pakistan faces increased external threats and internal sub-nationalist tendencies fueled by hostile foreign forces, a major political upheaval could threaten national security, God forbid. It would be tragic indeed if the attempt at financial stabilization through an IMF programme destabilized the economy, political system and state of Pakistan.