ISLAMABAD: The International Monetary Fund (IMF) has criticized policy reversals by the former PTI-led government, saying program implementation deteriorated soon after the sixth review was completed last November.
The IMF staff report released after the completion of the 7th and 8th reviews and the resumption of the stalled Extended Financing Facility (EFF) program for Pakistan said that amid a tense political landscape, the programmed fiscal adjustment was undone and several key EFF engagements were cancelled.
Two end-June performance criteria (PCs)—on net international reserves (NIR) and the primary fiscal deficit—as well as three continuous PCs were missed. In addition, seven structural benchmarks (SR) were missed.
The report indicates that political tensions have led to significant budgetary slippages. The former government granted a 4-month “relief package” at the end of February 2022 which canceled the budgetary discipline commitments made earlier in the year. The largely untargeted package (i) reduced petrol and diesel prices (through a generous general subsidy and setting fuel taxes at zero taxation); (ii) reduction in electricity tariffs of PRs 5/kWh for almost all household and commercial consumers; and (iii) granted tax exemptions and tax amnesty. These measures have been accompanied by the postponement of regular increases in electricity tariffs, as well as increases in the minimum wage and public wages and pensions, and additional food subsidies. The continuation of these measures, along with additional slippages in the third and fourth quarters, widened the fiscal year 22 budget deficit by more than 1.5% of GDP, far missing the end-June budget target.
However, more recently, the authorities have taken several steps to get the EFF back on track, including adopting an ambitious budget for a primary surplus, dramatically increasing the policy rate, eliminating after-tax fuel subsidies, and increasing taxation. fuel and electricity prices. They also plan to strengthen supervision and take the necessary measures to safeguard the stability of the financial sector.
Key Policy Recommendations: The program aims to restore fiscal discipline and debt sustainability while protecting social spending, preserving monetary and financial stability, maintaining a market-determined exchange rate, and rebuilding external reserves.
New structural benchmarks support efforts to improve social protection (new CP), strengthen the viability of the energy sector and support financial stability. Despite the recalibration, the goals of mobilizing additional quality tax revenue and substantially increasing reserve coverage are out of reach.
Staff View: Staff supports completion of the Seventh and Eighth Reviews, extension of the program through end-June 2023, and increased access by SDR 720 million based on corrective actions and political commitments. Nevertheless, program risks remain exceptionally high and consistent and decisive implementation will be key to improving the economic outlook. This review will make available SDR 894 million and help catalyze critical external financing.
On April 10, Shehbaz Sharif (Pakistani Muslim League-Nawaz) became Prime Minister (PM) of the coalition government with the Pakistan People’s Party and other small parties. The new government took power after a no-confidence vote against former Prime Minister Imran Khan. The political environment, however, is complex: the ruling coalition enjoys a slim majority and includes traditionally opposing parties, while former Prime Minister Imran Khan continues to stage large protests across the country and has good showing in major Punjab by-elections. The government has expressed its intention to complete its term, with elections scheduled for no later than August 2023.
The authorities renewed their efforts to stabilize the economy and put the program back on track. After some initial delay, the new government began unwinding the relief package in late May 2022 by removing untargeted subsidies for electricity and after-tax fuels, beginning the restoration of the Petroleum Development Tax (PDL) , while expanding social support programs.
In addition, it passed the FY23 budget, which involves a large primary balance adjustment, while the SBP significantly tightened monetary policy to address inflationary pressures. Risks to the program outlook and implementation remain elevated and trending downward given the highly complex internal and external environment.
The fallout from the war in Ukraine through high food and fuel prices and tighter global financial conditions will continue to weigh on the Pakistani economy, putting pressure on the exchange rate and external stability.
Political slippages remain a risk, as evidenced by FY22, amplified by weak capacity and powerful vested interests, with the timing of elections uncertain given the complex political context. Socio-political pressures are expected to remain high and could also weigh on the implementation of policies and reforms, especially given the precariousness of the political coalition and their weak majority in Parliament.
In addition, high food and fuel prices could cause social protests and instability. All of this could affect policy decisions and undermine the programme’s fiscal adjustment strategy, undermining macro-financial and external stability and debt sustainability. In addition, high short-term domestic financing needs could overburden the absorptive capacity of the financial sector and disrupt the market.
The debt sustainability analysis (DSA) highlights that public debt remains sustainable over the medium term with strong policies and robust growth, but with heightened uncertainty. Substantial risks stem from higher interest rates, a greater than expected slowdown in growth, exchange rate pressures, further policy shifts, weaker medium-term growth and liabilities related to public enterprises.
Further delays in structural reforms, especially those related to the financial sector (resolution of undercapitalized banks and reduction of SBP participation in refinancing plans), could hamper financial sector stability and reduce policy effectiveness monetary. Finally, climate change risks are increasing, including a trend towards more frequent climate-related disasters.