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Dr.Akmal Hussain
Dated: Thursday, 10 December 2015

Pakistan is in the midst of yet another IMF lending program and is assiduously attempting to fulfill loan conditionalities in the face of mounting evidence that these programs have repeatedly failed to achieve their objectives. The IMF claims that its macro-economic stabilization programs, which many developing countries have adopted, will achieve exchange rate stability by correcting imbalances in the balance of payments and controlling inflation. It is further claimed that such macroeconomic stability will ensure accelerated and sustained economic growth. In this article I will attempt to show that these claims of the IMF have neither a sound analytical nor empirical basis.

Within the IMF framework the policy focus is on reducing the balance of payments deficit and the budget deficit. This they think can be done by compressing aggregate demand which in their model would reduce import expenditures on the one hand and the inflation rate on the other. The logical consequence of compressing aggregate demand through raising interest rates and cutting down of public expenditure is to slow down economic growth.

The IMF believes that macroeconomic stabilization even at the cost of slower growth in the short run would soon accelerate GDP growth through improving expectations of entrepreneurs and hence higher investment by them. This is an essentially flawed proposition.  Recent research has shown that investment and future expectations of the private sector are determined not just by stable exchange rates and low inflation but more fundamentally, by the institutional structure of a country, the control of violence in society, contract enforcement and reducing corruption. In Pakistan’s case additionally there are physical constraints to growth beyond the financial sphere, such as a shortage of electricity, gas and water. Furthermore the lack of a trained labour force with a highly educated stratum that is capable of innovation is also a key constraint to investment and sustained growth. It is these critical institutional and governance constraints that are ignored when the IMF stabilization programs are undertaken in the belief that ‘stabilization’ will induce sustained growth.

Neither long run stability in the balance of payments nor inflation are necessarily susceptible to the IMF medicine of high interest rates, reduced public expenditure and exchange rate depreciation as past experience shows. This is because inflation in Pakistan as in many developing countries is triggered by cost push factors such as the prices of fuel, electricity and food to a far greater extent than demand pull factors. At the same time exchange rate depreciation is unlikely to improve the balance of payments for three reasons: (1) The lower dollar price of Pakistani exportables resulting from exchange rate depreciation would be neutralized by domestic inflation. (2) Even if the dollar price of exportables could be maintained at a lower level, exporters are unlikely to be able to cater to increased orders for their goods in time due to the physical constraints to increasing export volumes in the short run. These include severe shortages of electricity and gas, bottlenecks at Karachi port and transportation constraints. (3) Given Pakistan’s export structure which is heavily weighted towards low value added semi finished goods (yarn, grey cloth, leather, rice) export demand is price inelastic, that is the growth in demand is proportionately less than the dollar price reduction. Consequently the total foreign exchange earnings can be expected to fall following exchange rate depreciation. On the other side of the coin Pakistan’s imports are largely necessities such as industrial raw materials, intermediate goods, fuel, fertilizer and cooking oil. Therefore their import demand is also inelastic that is, the reduction in import demand following an increase in rupee prices associated with exchange rate depreciation, would be proportionately less than the price increase. Under these circumstances the combined export earnings and import expenditure effects of exchange rate depreciation over time are likely to worsen the balance of trade and hence the balance of payments, rather than improving it.

Continued economic stagnation associated with repeated IMF programs will have serious consequences for society, state and the federal structure of government. The latest estimate of poverty made by Malik, Darosh, Nazli and Whitney is that if the poverty line is taken as Rs.2,028 per person per month, the percentage of the population in Pakistan living in poverty is 35.6. At the same time we must remember that 3.1 million persons, out of whom 2.1 million are youngsters, are entering the labour force annually. If GDP growth continues to stagnate, both poverty and unemployment particularly of the youth will increase further. This will provide grist for the mill of militant extremism. At the same time with the IMF pressure to direct scarce government revenues to debt servicing, the amount of revenues left for the provinces will be further squeezed to a point where not only will Baluchistan, Sindh and Pakhtunkhwa have less to spend on development projects, but even their capacity to pay salaries to government officials will come under stress. The federal structure is already fragile with an insurgency in Baluchistan and seething tensions in Sindh. The political consequences of directing federal government revenues to debt servicing rather than providing succour to the provinces can build up the narrative of grievances in the relatively backward provinces with grave consequences for the federal structure.

At the same time the heroic war against terrorism conducted by the military and the brilliant victories they have achieved must be backed up by economic and social consolidation in the liberated areas. This will require large public expenditures and improved quality of governance.

I have so far questioned the analytical basis of IMF programs. There is now a corpus of empirical research showing that IMF programs neither lead to stabilization nor accelerated growth in the long run. For example, the study by Dreher (2006) analyzed the impact of IMF programs and conditionalities on the short and long run economic growth of 98 developing countries from 1970 to 2000 through a panel data econometric analysis. The over results of the study have shown that IMF programs and conditionalities are negatively associated with economic growth both in the short and the long run. Similarly the study by Butkiewicz and Yanikkaya (2005) also shows that IMF lending has an overall negative impact on the long term growth in developing countries. Barro and Lee (2005) analyzing data from 130 countries from 1970 to 2000 come to the same conclusion.

Easterly (2005) analyzed the impact of IMF Structural Adjustment Programs on the macroeconomic performance of 20 countries where these programs were repeated several times during the period 1980 to 2000. Easterly concludes his study by stating “if the original objective was adjustment with growth, there is not much evidence that structural adjustment lending generated either adjustment or growth”.

Pakistan went to the IMF because it was in dire straits on the foreign exchange front. Given the weakness of the IMF analytical framework the uncritical adoption of their program can have serious adverse consequences for Pakistan’s economy, society and political structure. There is now considerable evidence from the developing world that IMF programs neither lead to financial stability on a sustained basis nor the long run growth they claim to achieve. Therefore it is of crucial importance for policy makers to undertake new thinking for an independently formulated economic growth strategy.


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