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IMF denies Letter of Comfort to Pakistan

The International Monetary Fund (IMF) has declined to grant the "Letter of Comfort" to Pakistan.

The matter was discussed during the recent meetings of Pakistani finance minister, Abdul Hafeez Shaikh with IMF management in Washington, DC recently on the sidelines of annual meetings of World Bank and IMF. The minister was “politely conveyed” that they had failed to honour commitments of financial reforms which resulted in the termination of programme prematurely, as the last tranche of $ 3.3 billion was not released by the IMF.

“We have to present this development in the IMF board, which will never approve issuance of Letter of Comfort to Pakistan”, the officials concerned told the minister while also “warning that such a situation could further isolate Pakistan and hamper its ability to negotiate with other financial institution, like World Bank and ADB, for whom IMF s LoC is a pre-requisite for any talks with a country”, highly-placed sources informed Dunya News.

Pakistan had agreed to introduce Value-Added Tax (VAT), reduce subsidies in power sector and reduce government s borrowing from the State Bank while starting the $ 11.3 billion loan programme with IMF. “The IMF is not averse to negotiating a new loan for Pakistan, but the non-satisfactory performance will certainly echo in the board meeting when it comes to the approval stage”, the source pointed out.

Finance Minister Shaikh, on the other hand, has been asserting before the media that they had decided to end the programme on their own because the country s financial situation was better. The IMF officials cautioned the minister that the better financial health depended on external factors like increase in export prices and remittances, which were not in control of the government. “It must be remembered that unit price has increased in international market, not the volume of exports”, sources informed.

The mission is foreseeing a global recession in the next year or two, signs of which have already started emerging in Europe, and Pakistan could also face its consequences. “Pakistan was told to prepare for it with focus on internal financial discipline and reforms”, the sources said adding that the much-touted Article-IV consultation process, starting in November with an IMF delegation to Pakistan, was “also likely to result in the same observations”.

The Pakistani delegation had to be disappointed in separate meetings with World Bank and Asian Development Bank. The World Bank told the minister that “they could not grant fund for any new project in Pakistan because disbursement of already initiated programmes had hit a snag”.

A look at the existing WB portfolio in Pakistan reveals that a loan worth approximately $ 240 million has been provided to Pakistan for different projects but only $ 6 million of these have been disbursed despite the lapse of more than a year because of allegedly poor management of bureaucracy in Pakistan. “The same was conveyed by WB to the minister in the meeting”.

In the meeting with ADB, Pakistan requested for assistance in the energy sector because of acute power shortage. “Although there was not a clear refusal, the ADB officials said that they will consider and discuss the possibilities”, the source said adding that “the chances are slim because Pakistan did not pay any heed to previous ADB recommendations for reforms in this sector”.

During the last couple of years, the ADB has done several studies on Pakistan s energy sector and had given some clear recommendations for reforms. “The Bank had asked for rethinking the circular debt problem and how it originated because it could not be solved by government paying it”, the sources recalled adding that the ADB had identified three major reasons for the energy crisis.

“These reasons included non-collection of outstanding dues worth billions by public entities in almost every province of Pakistan, line losses because of administrative inefficiency and need for restructuring of DISCOs (distribution companies) in order to make these operationally and financially independent by disbanding PEPCO”, the source confided.

The finance minister, because of his previous experience of working in the World Bank in senior positions, was already aware of most of the points raised during these meetings. “However, he did request the officials concerned during these meetings with international financial institutions not to make any adverse remarks against Pakistan in public because it will further aggravate the problems for the government”, the sources informed.

When this scribe questioned the finance minister, Abdul Hafeez Shaikh about the reservations expressed by the officials during the said meetings, he termed them baseless. “None of them have any reservations and have in fact appreciated Pakistan s performance”. Speaking separately at a press conference before returning to Pakistan, he said that “Pakistan s financial health was good and there was no need to take extra burden of more loans”.

“Broaden tax-net, manage subsidies properly for economic growth”: Adnan Mazarei

Mr. Adnan Mazarei, an Iranian-American, is currently serving as Assistant Director of the Middle East and Central Asia Department at the International Monetary Fund (IMF) headquarters in Washington, DC. Mr. Mazarei holds a PHD in Economics from the University of California.Prior to joining the Fund in 1993, he worked as a lecturer at the University of California and a consultant at the World Bank. Mr. Mazarei is also the mission chief for Pakistan at IMF for over two and half years now, where he is closely monitoring the issues related to Pakistani economy and the efforts underway to resurrect it. In an exclusive interview with Dunya News, he answered question regarding Pakistan s programme with IMF, need to increase the tax-net and manage subsidies properly as well as the possibilities for future outlook of Pakistani economy.

Question: Mr. Mazarei, thanks for talking to us. Let s start with the recent meetings that the Pakistani delegation, led by Finance Minister Dr. Abdul HafeezShaikh, has recently held with IMF. Can you inform us what was discussed in these meetings?

Answer: First of all, thank you very much for visiting. We have had very good meetings with the mister finance and acting governor of the central bank. The range of issues involved the issues that the Pakistani economy faces including budgetary pressures, issues related to energy subsidies, and also performance under the programme (IMF s loan for Pakistan) that ended at the end of September. It has been made clear that they would like to continue their relationship with IMF, both in terms of seeking advice and working together on a common agenda. We will soon be having our Article-IV mission (to Pakistan), which is our annual visit to all member countries, in November. During the visit, we ll discuss a range of issues and do a general check of Pakistani economy, discuss pressures on the global economy affecting all our membership including Pakistan. We have also discussed ways that Pakistan could re-engage with IMF in another programme down the line. As of right now, Pakistani external situation is fine, external reserves are in good shape, remittances have been high and exports have been quite good, so there is not any immediate pressure on the balance of payments. However, there are issues related to the budget and overall budgetary management needs to be improved, subsidies need to be better controlled and the authorities (in Pakistan) are aware of this. Things are fine right now, but down the line, whenever the Pakistani authorities wish, we ll be very happy to discuss another engagement with them.

Question: You have mentioned Article-IV consultation. Can you explain what it means and what kind of economic indicators you will be looking at during the November visit to Pakistan?

Answer: Sure. An Article-IV consultation is basically a check-up of the issues that an economy faces. We discuss both the policy-making institutions and the policies themselves and the overall economic situation; issues related to budget, issues related to monetary policy, the state of the banking system, unemployment and poverty, besides any other specific issues that any government faces. With the Pakistani authorities, a key issue of interest will be the decentralization of fiscal system. You are aware that under 18th amendment and the National Finance Commission (NFC) award, greater amounts of resources have been allocated to the provinces. Greater responsibilities in terms of expenditures are pushed to the provinces but the “rules of the game”, for instance, need to be better defined. Our particular interest during discussions with Pakistan will be subsidies and the general state of the public expenditure system. As you know, Pakistan spends a considerable amount of resources on electricity subsidies. These subsidies are quite large and some would argue that these need to be better targeted towards those who need it. In many other countries, the resources allocated to these subsidies are often used by those who don t need it the most. It is good to have subsidies but those that are directed towards the people who are in need of it the most. There are other issues that we need to deal with, for instance the banking system. The banking system in Pakistan is relatively good but, like other places, we need to do a health check, and if there are issues to be erased, we ll be happy to do so. At the same time, the social safety net; how the unemployed are doing; how the poor are doing, especially in the context of floods, these are issues we need to follow-on with.

Question: Talking of policy advice for Pakistan, you have mentioned some critical issues in your conversation, i.e. subsidies, increasing tax collection in Pakistan and financial reforms like state borrowing and controlling inflation etc, Have the Pakistani authorities discussed with you what plan they have to tackle these issues considering the political climate and the expected backlash and what advice have you given them?

Answer: Look, we have had a running dialogue with Pakistan for many years on some of these issues and the issues are relatively well known. The authorities are very good in Pakistan in terms of knowing what the problem is, for instance they all know that public enterprises in Pakistan take-up a huge amount of resources and something needs to be done. They know that electricity system is a major source of a problem and it hinders growth. Of course, they are also aware that electricity is not something that you solve simply by raising tariffs. All of these areas require changes in management, like public enterprises and electricity system. These require a new vision with regards to management and price system or tariff increases are only a part of it. Some people who make the mistake of thinking that problems of electricity will only be solved by forever raising tariffs. That is not the issue. Rather the main problem in the public enterprise and electricity sector is management. The authorities are aware of the political and social difficulties of undergoing reforms and these reforms to succeed, frankly, require not only political will but also greater social debate. On the issue of subsidies for electricity, for example, you need in Pakistan a real debate that who are the beneficiaries of these large electricity subsidies. As I mentioned, it is very good to have electricity subsidies for these who need, people who use small amounts, but large and commercial users, it is better if they paid their (entire) electricity tariffs. The same is with taxation. Poor should be saved from taxes, but there are a lot of people in Pakistan who can afford to pay taxes. There are large segments of the population; large components of the economy that are not in the tax net. Tax system needs to be clear, the burden needs to be equitable and for people to pay taxes, they need to know that their taxes are well spent. So we need a very good, clear and credible expenditure system. The main thing that we bring to Pakistan is the advantage of having experience in these issues in a number of countries. You (Pakistani authorities) know your country and your political and social constraints better; what we bring is technical expertise and with the merger of these, I hope we can move forward.

Question: What are your views on the current financial situation in Pakistan and do you think there are enough indicators in place to hope that these can lead towards an economic revival of sorts?

Answer: The brighter spot in Pakistan right now is the external situation in the following way; last year you had a current account surplus because of high remittances and high exports, and going into this year, you are still in a good position. The level of reserves is high, remittances are fine, exports are fine, but we are worried, not just for Pakistan but the whole world, moving into a very uncertain and risky period. It is very important to maintain good policies. Now the part that needs to be addressed is primarily the fiscal situation and the budget. There was a large budget deficit last year, which was financed through borrowing from the banking system and it led to the diversion of credit from the private sector, and growth and job creation (consequently was left) to the government. If the government keeps taking more and more resources from the banking system, including for circular debt and for commodity operations, there will be less left for the private sector and growth. What we need in the coming period, very quickly and very clearly, is a strengthening of the budgetary position. This means improving the revenue situation through more equitable and better taxation and revenue mobilization and at the same time, better control of resources and expenditures, including, as I mentioned and I repeat, on targeted subsidies, resources to public enterprises and other wasteful areas.

Question: What are your views on Pakistan s programme with the IMF that terminated on September 30th. Are you satisfied with the way it progressed because Pakistan could not get the last tranche of $ 3.3 billion and how much of it will have a bearing when Pakistan comes to IMF for a new programme in future?

Answer: The programme (overall) has had good success in stabilizing the economy. Remember in 2008, we had a very large budget deficit and external imbalance while the inflation was about 25 percent. In the past two and a half years, the authorities have had a good degree of success in stabilizing the economy, but for these successes to become durable and for Pakistan to be able to meet the needs of the people in terms of the spending that is needed, and at the same time to protect itself better against the risks rising globally, it needs to do considerably more on structural reforms. There have been some structural reforms and the government has taken some steps, but much more is needed. Particularly what is needed is better management of the budget. Pakistan has proven to be quite resilient against a background of the globally difficult situation, a very difficult security situation, tragic floods and a lot of other things have gone wrong exogenously for Pakistan, but the economy has weathered well and the policy-makers have been able to work through it. But the agenda of what needs to be done is still quite important, especially structural reforms; allowing the private sector to have clear incentives, to have much better resources from the banking system, and much more certainty in terms of provision of electricity and power supply.

Question: In your interaction with the Pakistani financial managers, looking from outside at the country s economy and all the measures that you just talked about, how confident are you that these goals are achievable? Because the people in Pakistan would like to know if there is going to be any economic revival at any point in future?

Answer: These goals are achievable, but these goals are to be achieved by Pakistanis, for Pakistanis. This has to be done by the Pakistani authorities, by the Pakistani public sector, and various components of the Pakistani society. It requires concerted debate, concrete political action, and firm efforts (for these things to happen).

Dunya News: Thank you Mr. Mazarei. Thanks for sparing time for Dunya News.

Adnan Mazarei: Thanks. It was a pleasure.