Budget: With or without IMF?

Peek-a-boo between Pakistan and the International Monetary Fund (IMF) is almost as old as the country.

Both sides appease their audience and the recent exchange of statements by the two has to be seen in this light.

IMF’s Mission Chief to Pakistan Nathan Porter, responding to some questions, said: “We take note of the recent political developments, and while we do not comment on domestic politics, we do hope that a peaceful way forward is found in line with the Constitution and rule of law.”

Ideally, the IMF should have avoided this statement as it does not serve any purpose, especially if getting the programme back on track is the goal. A government already under pressure on economic and political fronts was bound to respond to it. And so, it did.

Overall, these statements from both sides have no meaning in terms of the Extended Fund Facility (EFF) outcomes — the ninth review was handcuffed by external financing gaps five months before these jibes were exchanged.

And so it remains.

This statement, however, can strengthen the already widely accepted and deep-rooted perception that the global lender is influenced by political factors while setting conditionalities and implementing programmes.

Worryingly, this may provide the government an excuse to go for a budget without effectively engaging the IMF. To avoid it, both sides need to calm down.

The Fund must give a clarification while the government must pay heed to other parts of the statement, particularly those about exchange rate market flexibility and preparing a budget aligned to committed economic reforms.

This is essential to keep engagements and the programme, whatever of it is left, alive. The programme ends on June 30, but it must end on a good note.

Budget: with or without IMF?

Steering through economic, political and climate crises, the government faces a tough ask to choose between a budget with the IMF or without it. In either case, the budget will be inflationary and hurt the people.

A budget with the IMF will come with a strong implementation of reforms, such as slashing subsidies, increasing energy prices and taxes, and curtailing spending to manage deficits. In this scenario, the government will have to show a primary surplus.

All these measures slow down economic activity while adding to the already historic high inflation. This will reduce the purchasing power of people further. Unemployment and poverty, both on the rise, may cost the government votes in the upcoming election, due in October.

Given this context, the government may not be willing to go with the IMF while preparing the budget as it attempts to protect its interests in an election year.

To what extent will the government balance the tough choices of elections and the IMF? Well, it depends.

No clear answers are possible. But three factors will be decisive in shaping the budget.

One: How committed the government is to hold elections when due, which, according to the election commission’s (in)famous press release, is October 8.

The government will tilt towards an ‘election budget’ if it plans to go ahead with this schedule and considers this the last budget before polls. Otherwise, we will see more of what was agreed to with the IMF; ongoing reforms may continue with or without the IMF in this case.

Two: In the eyes of the government, particularly the PML-N, the probability of making a new government after elections. This will be a delicate choice. If it perceives it has a high probability of winning elections, the government may go for a somewhat more sensible approach in preparing the budget.

It will try to keep hanging onto the IMF by a thread so that it can negotiate the new programme when it comes back to power. Conversely, a lower probability is likely to push it towards expansionary polices — an all-out populist budget to maximise votes and seats.

Three: Most critically, the government will also gauge the odds of external financing support from bilateral partners in both scenarios — with and without the IMF.

A push from friendly countries to remain engaged with the IMF, which has been significant so far, will result in the government preparing a budget with the IMF, especially because it has to manage huge debt repayments which are not possible without the lender onboard. Any unconditional support from friendly countries will do the opposite.

How can govt manage IMF and an election budget?

If one keeps in mind the above context, it is more likely that the government will not let the IMF go. The upcoming budget is expected to be, though not fully, aligned with IMF’s priorities. It is a challenging task. But careful signalling and the right choices can help strike a balance.

First things first. The right signalling can create windows of flexibility within budget preparation. One key signal will be keeping the mini-budget of February 2023 in place.

Any moves to revert its overall structure should be avoided. Exchange rate flexibility can also act as a good non-budgetary gesture to that end. These two measures can show the government’s commitment to economic reforms.

The right choices can help the government sail through this critical budget. What are those choices then? A good practice here would be to evaluate what the IMF does not mind. For instance, the lender does not object to any financed relief measures. If the government can generate tax revenues to support any relief measures, the IMF will not be irked. The budget, therefore, must focus on clearly defined sources of financing for any initiatives.

The IMF is also encouraging targeted subsidies to protect people and small and medium enterprises (SMEs) from the side effects of economic reforms and austerity measures. So the government should avoid blanket subsidies like ‘Sasta Petrol’ and focus instead on direct and targeted subsidies to the people. The Benazir Income Support Programme (BISP) programme, for instance, offers several options for scaling up, which the IMF won’t object to.

Similarly, direct subsidies to small farmers are least likely to cause problems. Tax incentives for SMEs, social enterprises and support for green energy transition (such as promoting solar energy) are likely to go well with the lender. Subsidising large farms and petrol consumption, on the other hand, are no-go areas.

One dilemma will concern support for the export sector. Blanket measures, such as differential treatment of tax rate, tariffs, subsidised energy and support for traditional sectors are likely to not go down well. Here, the government can opt for a two-pronged approach.

It may focus more on non-traditional sectors, such as agriculture, livestock, and low-ladder textile and manufacturing sectors, creating space for this by taxing the untaxed sectors: large-scale farming, real estate and other similar options.

Advice

Pakistan’s best option right now is with the IMF. Any budget without the IMF is not advised.

Of course, a ‘minus-IMF’ approach can be taken, but it cannot be sustained. Pakistan has to pay around $25 billion a year in debt for the next three years, which is not possible without the IMF. Access to multilateral financing, cash-deposit support from friendly countries and borrowing from international markets is linked to the IMF’s support.

Foreign reserves of less than $5 billion make the situation even more complex. Pakistan, simply, needs another Fund programme to come out of this crisis.

Going without the IMF in this budget and going back to the IMF again will make the process, conditions and outcomes even more arduous. It is a tough ask walking with the IMF, but at this critical juncture, it is worse without the IMF.

The government, therefore, should strike a balance and provide relief to the people without compromising the fundamentals of economic reforms. What choice it makes will be clear on June 9.

Letting go of the IMF will bring new challenges and add to existing ones.

The IMF, for its part, needs to understand that political statements do not serve any purpose. And, that a positive signal is due as friendly countries, contrary to the past, are looking towards it for the first time to extend external financing to Pakistan.