Asad Umar and the IMF – An Unpopular Opinion

Picture taken from DAWN's website

Perhaps the economic team under Asad Umar could have done better in communicating their economic policies. But what Asad’s team did do will make the IMF program relatively less painful.

One reason for which Asad had been criticised during his tenure was for taking too long in striking a deal with the IMF. The argument goes that markets do not like uncertainty. Higher policy uncertainty forces firms to delay their investment decisions thus depressing growth. Moreover, expecting depreciation, individuals may convert their savings to dollars. Likewise, exporters may temporarily park their foreign currency earnings overseas.

While these arguments have obvious merits, the core thesis ignores the other side of the story. Specifically, it ignores the cost of entering an early IMF program. This is mostly done out of convenience. It is much harder to predict how the economy would have turned out had we made different decisions in the past.

Before proceeding further, let us get an important point of confusion out of the way. There is not much you can negotiate when you are seemingly negotiating with the IMF. A favourable deal is easier to achieve through using your international relations rather than forwarding competing economic arguments.

It is also important to appreciate where the country stood at the time when Asad took charge. First, the consumption led growth model had once again brought the country at the verge of a balance of payment crisis. At 5.7 percent of GDP, current account deficit was almost three times bigger than in FY13. Second, foreign currency reserves had depleted in the process of financing the import bill and defending the overvalued exchange rate. Third, the build-up of circular debt due to factors including unfunded subsidies required a Rs3.82 per unit increase in price of electricity as proposed by NEPRA. Fourth, a new phenomenon of circular debt in the gas sector had emerged after the outgoing government dragged her feet on increasing gas prices during preceding years. At one point, OGRA had proposed a 300 percent increase in gas prices for domestic consumers. Fifth, the budget presented by the outgoing government pushed a significant proportion of salaried class out of the tax net. Sixth, the collection of advance tax during previous fiscal year to artificially shore up revenue collection, blocked refunds and Supreme Court’s ruling against tax on mobile cards further depleted revenue sources. In short, everything was in a mess!

Considering these challenges, the question was never about what steps had to be taken. The economy had to be slowed down to contain imports; exchange rate could no longer be defended; electricity prices had to go up to contain circular debt; gas prices had to increase to prevent the supply-chain in the gas sector from collapsing; the tax base had to be restored; the process of refund had to start to resolve financing problems of exporters; finally, tax exemptions and unfunded subsidies had to be withdrawn.

Instead, the only relevant question was how and when. The economic managers under Asad had to decide if they would do this at once or gradually in phases. To their bad luck, the IMF came down hard demanding a rather immediate adjustment across all these dimensions. Commentators at the time were of the view that the government may be better off entering an IMF program at once. The argument went that the new government should expose the economy they had inherited; enter an IMF program; and, start with a clean slate.

The argument had its merits. But, perhaps, most commentators did not fully appreciate the implication of what they were proposing: a front-loaded adjustment program. Imagine if the government would have entered an IMF program right after coming to power. What would have happened? First, exchange rate would have been left to free float. As a result, exchange devaluation would have been much steeper and much bigger. Second, electricity prices would have increased by close to Rs3.8 per unit. Third, average gas prices would have more than doubled. Fourth, tax exemptions would have been withdrawn and new taxes would have been imposed.

All this would have led to a much higher rate of inflation and, consequently, a much higher interest rate. The growth rate, as a result, would have been much lower than the 3.3 percent achieved during fiscal year 2019. Perhaps, in our counterfactual world, the commentators would have been criticising the government at an even higher pitch. 

We now also know what steps the IMF was demanding when the government first started discussions with the IMF: a prior increase of 600 basis points in interest rates; an average increase of 94 percent in gas prices; an average increase of 50 percent in power tariffs; an increase in tax-to-GDP ratio to 13.2 percent; and, a shift to a free floating exchange rate regime. All these actions would have lead to an inflation rate at 19 percent and, consequently, an interest rate at 21 percent. What would have happened to the GDP growth rate is not even worth asking.

Instead, Asad’s economic team continued to ‘negotiate’ with the IMF while undertaking gradual adjustment. Despite some mismanagement, exchange rate was allowed to adjust in several steps. Electricity prices were increased by one-third of the recommended amount. Likewise, gas prices were increased by an average of 35 percent. This was contrary to the initial proposal of increasing gas prices by three times the actual increase. The tax concessions were partially reversed. A mechanism was designed to start the process of refunds. The interest rate was increased but by less than what the IMF wanted.

These steps did increase inflation and slowed down economic growth. However, by delaying the IMF program, Asad and his economic team effectively spread the adjustment process over a longer period than what the IMF would have allowed. Now that almost half of the adjustment has already been made, a similar IMF program will be less painful as the magnitude of required adjustments will be less than it would have been.

Yes, there were episodes of economic mismanagement during this time. Yes, the economic climate is not going to get better any sooner. However, the pain would have been much greater had Asad conceded to a front-loaded IMF program right after taking charge.

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Ahmed Jamal Pirzada has PhD in Economics. He teaches at the University of Bristol and is also a visiting fellow at the SDPI. He tweets at @ajpirzada

Bilal Lakhani is a Fulbright Scholar and alum of Columbia University’s Graduate School of Journalism. He tweets at @MBilalLakhani