IMF's tenth review

 

This past week saw the start of the eleventh review of the 6.64 billion Extended Fund Facility between the International Monetary Fund (IMF) team and the Pakistani government in Dubai. Given the post-ninth review decisions made by the government, which may have led the Mission leader, Harald Finger, to hold a conference call with Pakistani media on January 12 of this year, there is not much speculation as to the worries of the Fund employees.

The Voluntary Tax Compliance Scheme (VTFS), a tax amnesty program referred to by Ishaq Dar and representatives of his Ministry and organizations under his administrative supervision, including the Federal Board of Revenue, will be discussed during the negotiations. Technically, this is the second tax amnesty program to be introduced by the prime minister in two years, however, few people are under the impression that he had any input with the program or that the name is suitable.

Even a first-year student specializing in economics is unlikely to be misled by the term and accept the government's assertion that the scheme is not a tax amnesty scheme, even though it is very simple to mislead the uninformed general population. It qualifies as an amnesty plan because, notwithstanding its limited scope (which could make it subject to legal challenge), it grants people who take advantage of it amnesty from a tax audit.

The Fund personnel voiced concerns not only after the first tax amnesty scheme was announced (in December 2013), but also more recently following the second. The second mandatory staff review, which was posted in March 2014, condemned the first scheme, stating that "The package tries to improve the investment climate by decreasing tax scrutiny. The package increases potential money laundering concerns and creates another loophole in the system, in addition to the ones that currently exist for remittances and equities stock investment.

The self-assessment process is hampered by the immunity from normal audits, and the amnesty that results from eliminating fines and interest is likely to hurt compliance and collections since taxpayers will start to expect future exemptions. The harmful effects of the package are lessened by a few things. The government will refrain from implementing another amnesty during the duration of the program since they view this scheme as a one-time event. Instances in which non-compliance is found through other sources are not exempt from routine audits.

Less than three weeks after the Dar-led Finance Ministry's December 2015 Letter of Intent commitment to the Fund that it would not issue any tax amnesty schemes, it unveiled the VTCS. This was two years later. It is understandable why Harald Finger, the mission leader for the ongoing Extended Fund Facility for 6.64 billion dollars, reiterated in the conference call what was noted in the second staff review: "International experience, for example, indicates that tax amnesty schemes can undermine tax compliance and weaken revenue collection by penalizing compliant taxpayers and potentially creating expectations also for further tax amnesties.

Therefore, we consider it crucial that the existing agreement be carried out in a way that minimizes these dangers. Although opposition parties opposed the plan, it was adopted by the national assembly on January 21. The Fund may view this as a shut-up call, but it would value getting the government to make yet another commitment not to announce a third amnesty program.

Privatization is the second and related source of worry for the Fund. "Privatizing these public companies through strategic sales is a fairly involved process, a sophisticated process, and it also needs to be done well," Finger said during the conference call. Rushing it in a way that would jeopardize its success would not actually benefit anyone. Therefore, we will need to continue talking about these issues. In our next discussions with the authorities, we will talk about the best course of action for resolving the fundamental issue with the loss-making public sector entities. In PIA, I believe we must reach a consensus on the best way to move forward with the parliamentary process.

 It is troubling that the staff of the Fund, who are notorious for placing politically unfavorable demands on debtor governments, is urging our democratically elected government to be more inclusive and consider the views of the parliament. It is also troubling that PML-N leader Mushahid Ullah, a non-member of the economic team, held a press conference to announce the postponement of the PIA sale by six months. Mushahid Ullah then claimed that the sale was never intended to be privatization because government shares would have been higher than those sold to a strategic investor. Additionally, the PIA's financial situation would not significantly improve in six months, which was the deadline for abandoning the sale, if the government does not alter the main decision-making staff.

Thirdly, the increase in borrowing to keep the budget deficit within predetermined bounds is a source of worry for the opposition and the general public. According to Finger, there is still economic inequality. The fiscal deficit is still bigger than it ought to be, which naturally necessitates a sizable amount of borrowing. This borrowing must come from someplace, and on the domestic front, it primarily comes from the banks who, for various reasons, don't have the same motivation to lend to the private sector, which is something we believe is crucial to helping jump-start that greater growth.

The loss in public sector growth due to provinces cutting development spending by up to 40% is a poor condition established by the Fund, but Finger admitted that government borrowing is limiting private sector growth.

Fourth, the anti-money laundering bill was not implemented as agreed because Saleem Mandviwalla, the chair of the senate committee on finance, limited its application to sales tax, even though money laundering is more relevant to income tax. Autonomy for the State Bank will probably be granted in writing but not in spirit.

Fifth, a very high exchange rate. According to Finger, "we believe that Pakistan's nominal exchange rate should remain determined by the market and that any implied overvaluation of the real effective exchange rate can be corrected over the medium term with continued structural reforms, gradual increases in Pakistan's competitiveness, as well as with the aid of supportive policies. And by policies, I specifically mean fiscal and monetary ones as well as those about the financial sector.

However, the Fund noted in prior reviews that the authorities disagreed concerning over-valuation, and given Finger's admission that "the model estimates showed significant variation and thus they are only indicative" - a variation that prior reviews showed to be between 5 and 20 percent - it is almost a given that the authorities if the Fund insists on a prior condition in this regard, would try to minimize the correction with obviously continued negligibility

So what has the program accomplished with roughly 8 months left in the EFF? According to Finger, "At the start of the program, the macroeconomic stability was indeed in jeopardy and the nation stood on the verge of a crisis. Over 8% of GDP was spent on the budget deficit. A few weeks' worth of imports were left in the foreign exchange reserves. The nation was in danger. This government was able to turn things around and create conditions that almost eliminated any crisis risk and greatly reduced the underlying vulnerabilities by significantly reducing the fiscal deficit and substantially increasing foreign exchange reserves.

What about the compromise between deficit reduction and growth? Finger claimed that this correlation does not apply to Pakistan since there are too many disparities in an interview with the Business Recorder from last year. But to reach the deficit reduction goals, development spending has been drastically cut, which is slowing down both growth and the pace at which the China-Pakistan Economic Corridor is being implemented. However, this only resulted in the government borrowing from the commercial banking sector, which is undoubtedly not encouraging for private sector investment and growth. Finger claimed success in preventing the government from borrowing from the SBP, which he stated "is quite encouraging for the medium term."

What about the Sharif administration's alleged significant reliance on external borrowing, which was leveled both by the opposition and economists? "An SBP report did highlight that Pakistan has not experienced inflows on this scale since 9/11, even though many of them are debt-creating," stated Finger in the conference call, summarizing everything.