Between 2000 and 2007 Pakistan was one of the fastest
growing economies in Asia. Economic growth of 7% a year had
resulted in its external debt being halved, comfortable foreign
exchange reserves were propping up the countrys exchange
rate and international investor confidence had returned.
Then it all went wrong. The onset of global financial
turmoil, the astonishing rise of oil and commodity prices and
political instability sent the economy reeling.
By the end of its 200708 fiscal year Pakistan was
facing four major challenges: a drop off in growth; rising
inflation; widening of fiscal and current account deficits; and
rapidly depleting foreign exchange reserves.
The worsening fiscal and current account balances were
largely the results of external shocks of extraordinary
proportions accompanied by policy inaction during most of the
year. The growing fiscal and external imbalances were financed
by unprecedented borrowing from the central bank and drawing
down of foreign exchange reserves.
Gross foreign exchange reserves at the central bank slid
from $14.2 billion in October 2007 to $8.6 billion in June 2008
and further to $3.4 billion (less than one month of imports) by
October 2008. Worsening macroeconomic imbalances had resulted
in a decline of foreign exchange reserves from $14.2 billion to
$3.4 billion a loss of $10.8 billion in just one
So why did deterioration on such a large scale take place in
such a short period of time?
There are three reasons. First, the speed and dimension of
both domestic and external shocks were of extraordinary
proportions. Second, political expediency prevented the
previous regime from taking corrective measures to address
Third, the incoming government that took charge in March
2008 was initially inept at addressing economic problems in
general, and external shocks in particular.
While the rest of the world was taking corrective measures
and adjusting to higher food and fuel prices, Pakistan lurched
from one crisis to another. Despite a peaceful election and a
smooth transition to a new government, political instability
persisted. For protracted periods there were no finance,
commerce, petroleum and natural resources and health ministers
in the country. The government lost six precious months in
finding its feet. It gave the impression of having little sense
of direction and purpose. A crisis of confidence intensified as
investors and development partners started to walk away: the
stock market nose dived, capital flight set in, foreign
exchange reserves plummeted and the Pakistani rupee slumped in
value by a third.
Pakistans macroeconomic vulnerability had grown
unbearable. It had no option but to return to the IMF for a
The IMF approved a $7.6 billion standby arrangement last
November spread over seven quarters, ending in June 2010. The
IMF programme had two major objectives: to restore
macroeconomic stability and investor confidence through a
tightening of macroeconomic policies, and to do so in a manner
that ensured social stability and adequate support for the poor
during the adjustment process.
The IMF programme appears to have been finalized in haste as
its methodology is inconsistent with its objectives. For
example, one key objective was to restore macroeconomic
stability and investors confidence through tightening
macroeconomic policies. Tight monetary policy was to be pursued
to curb aggregate demand so as to slow down import growth and
thus reduce trade and current account deficits.The IMF was
apparently unaware that over 40% of tax revenues originate from
imports; any policy that curtails import growth would also hurt
Likewise, overall economic growth was targeted at a low
level of 3% for the year. Against this backdrop, raising the
revenue collection target by Rs110 billion from Rs1,250
billion to Rs1,360 billion was simply inconsistent with
the policy design. Accordingly, the 200809 financial year
ended with revenues of Rs1,157 billion, meaning a Rs203 billion
slippage from the IMF target.
In line with the IMF programme, Pakistan pursued tight
fiscal and monetary policies in 200809 with a view to
reducing macroeconomic imbalances. Such a policy stance was
necessary to address the challenges of high fiscal and current
These policies paid handsome dividends. The fiscal deficit
was reduced from 7.4% of GDP a year ago to 5.2% and the current
account deficit to 5.1% of GDP from 8.4% a year ago.
Inflationary pressures also eased. Pakistan succeeded in
minimizing macroeconomic imbalances in 200809 by pursuing
tight macroeconomic policies.
Prudence demanded that Pakistan should have continued with
the same policy stance in the current year (200910) as
well. Tight macroeconomic policies were needed to consolidate
But the government lost its patience and embarked on an
expansionary fiscal policy and a relatively easy monetary
policy with a view to reviving economic growth, creating
employment opportunities and reducing poverty. Such a policy
stance is not viable at all in the face of high
fiscal and current account deficits as well as the rising price
Furthermore, growth cannot be revived on a sustained basis
by creating more macroeconomic imbalances.
Because Pakistan is pursuing an expansionary fiscal policy
this fiscal year, finding the financing to do so has become a
source of anxiety and a major risk to this years budget.
Over 43% of this years budget deficit is to be financed
from external sources the bulk of which is expected to
come from the pledged resources of donors at this Aprils
conference in Tokyo.
IMF STEPS IN
Donors have pledged $5.7 billion to Pakistan over three
years. Pakistan has received little or no money so far from the
Tokyo pledges, and it approached the IMF for additional
resources of $3.2 billion to fund priority spending. The IMF
has approved the additional funding as a bridge financing until
the Tokyo-pledged resources are made available.
So why has Pakistan undertaken such massive spending based
on borrowed resources from the IMF?
It is also strange that the IMF has allowed its resources to
be used for budgetary reasons instead of balance-of-payments
support. This is a major departure from the past it is
as if the IMF has changed its religion. On this logic, the Fund
ought to tell member countries that inflation everywhere is a
fiscal phenomenon and that policy-makers should now learn the
fiscal rather than monetary approach to balance of
The total resources approved by the IMF for Pakistan
amounted to almost $11 billion for the two years up to the end
of 2010. This means that the IMF has emerged as a major source
of external financing. Despite this the programme itself has
been extraordinarily benign asking for little reforms
and with a generous waiver for non-observance of performance
Major reforms should have looked at three areas tax
system and tax administration reform; power sector reform
including resolution of the sectors recurring
inter-corporate circular debt; and enhancing the central
banks enforcement powers in banking supervision.
The introduction of a broad-based VAT regime by mid-2010 is
a key pillar of tax system reform. The progress thus far is not
up to the mark. Pakistan has also promised to improve tax
administration. Political support to boost the tax system and
tax administration reform is vital. If the IMF programme
continues to remain benign, the chances of the success of the
reform agenda remain bleak.Pakistan should have pursued tight
fiscal and monetary policy for another two years with a view to
consolidating the macroeconomic gains. Minimizing the
macroeconomic imbalances should have been the policy thrust of
the government. Macroeconomic stability is increasingly
recognized as being critical for sustained economic growth and
The government has become impatient while the IMF has also
forgotten its own lesson of a sound fiscal position, so vital
for achieving macroeconomic stability.
Ashfaque Khan is professor and dean of the
Business School at the National University of Sciences &
Technology, Islamabad. He was economic adviser to
Pakistans Ministry of Finance from 1998 to