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The IMF in Pakistan

By Farhan Bokhari, The Financial Times
Thursday 2 September 1999

PAKISTAN: IMF medicine may not work Farhan Bokhari reports on concerns about very low economic confidence, faltering reform and political uncertainty

The IMF's seal of approval for Pakistan, expected to be granted in a letter of intent in the next few days, is the latest in a series of international rescue measures to resurrect the country's battered economic confidence.

The letter would precede a decision by the Fund's executive board later this month which should recommend disbursement of a $280m tranche from a $1.56bn loan agreed last year.

But many analysts are sceptical an IMF-led rescue can translate into an economic recovery. Ishaq Dar, finance minister, who predicts an upturn in the months ahead, is faced with critics arguing the IMF medicine is just not enough to revive economic growth, narrow the international trade deficit or increase equity and direct investment.

Mr Dar has recently announced fresh incentives for exporters and successfully concluded debt restructuring with western lenders. But even before he announced his annual trade policy for this financial year (July-June), critics were quick to argue that the government's economic targets were just too ambitious.

In one sign that added to the scepticism, Pakistan's international trade deficit of more than $200m in July was twice that in the same month a year ago. Critics also say that the target of $800m for this year's trade deficit may already be beyond reach.

The gap between Mr Dar's expectations and independent assessments is largely the consequence of battered confidence, faltering reforms and, above all, political uncertainty in the fallout from almost two months of fighting between Pakistani and Indian troops along the disputed border in Kashmir.

Critics say the IMF's next tranche would not necessarily mean smooth sailing for Pakistan in its relations with the Fund. Many reforms urged by the Fund, including the recent imposition of a 15 per cent general sales tax (GST) on imported and processed food, gas and petroleum, have yet to show that they can yield more in tax revenues. The revenue collection system still suffers from widespread corruption and inefficiency.

The opposition hopes to build on traders' unhappiness with the sales tax in mustering support for a protest strike on Saturday.

The IMF's loan is vital to hold together subsequent agreements such as a $3.3bn debt restructuring agreed with the Paris Club of lenders and a $512m trade facility rescheduled with foreign banks.

The trade agreement has set a target of $9bn for exports, an 18 per cent rise over last year. Imports are projected to rise approximately 5 per cent to $9.8bn, while the projection for the trade deficit of $800m is almost half of last year's deficit of $1.57bn. Additionally, Mr Dar hopes overall economic growth will recover sharply, rising twice as fast as the 3.1 per cent increase in gross domestic product last year, which barely kept up with the country's annual population growth rate.

"The government has done everything possible. We have provided the conducive environment," says Mr Dar, while appealing to businessmen to support new investments.

He expects a strong recovery in the agriculture sector to yield large surpluses of exportable crops such as cotton and rice, a recovery in large-scale manufacturing and a worldwide economic recovery to lift Pakistani exports.

The trade policy has included ambitious measures such as removing import duties on polyester staple fibre to benefit domestic textile manufacturers. Other incentives include a 1 per cent income tax on consultancy and engineering services which earn foreign exchange, and a reduction to 0.5 per cent in the 1 per cent tax on exports of rice, fish, precious and semi-precious stones.

"Exports and new investments are the key to your economic outlook. Without a recovery in those two, the economy is unlikely to move," says Salman Shah, a respected economist and former chairman of the privatisation commission. "Confidence has been badly battered and there is a continuing fallout."

Sceptics warn that the outlook for foreign investment may not be different from last year. Then, foreign direct investment of $296m fell from $436m the year before, while portfolio investment of just $4.7m was substantially below the $203.8m of a year earlier.

The reasons for the pessimism, above all, include the fallout from Pakistan's controversial treatment of foreign investors in the 19 private power projects agreed five years ago.

The government has only relented in the past few months from its claims of corruption in those projects, under pressure from the World Bank. But businessmen say that new agreements on future tariffs for all of the power projects have yet to be concluded.

Businessmen also say that the decision to freeze almost $11bn deposited in onshore bank accounts last year, to prevent a run on banks, has damaged confidence. The uncertainty has also harmed domestic confidence.

In addition to economic factors, Pakistan's recent clash with India over Kashmir has thrown in doubt its relations with the IMF. US and Pakistani officials denied reports last month that the Clinton administration had considered blocking the next IMF tranche if Pakistan refused to withdraw fighters from Indian controlled areas.

However, bankers in Karachi say that the mere suggestion of the linkage between IMF lending and its use to promote strategic objectives is likely to have a detrimental effect on the country's image. "During future crises investors would keep an eye out for a link between strategic goals and IMF funds," says one.