Pakistan needs to break its bailout addiction

Pakistan is up against yet another deadline. Unless access is restored to a $6.7 billion bailout from the International Monetary Fund before it expires on June 30, the country's deeply stressed economy will go into freefall. Pakistan's chronic shortage of foreign exchange is now, in the absence of IMF funding, reaching emergency levels. The central bank's reserves would cover only about a month of imports.

Pakistan's great rival India, when faced with a similar crisis more than 30 years ago, pushed through sweeping reforms that devalued the rupee, reduced the size of the public sector, and raised government revenue. It's time for Pakistan to do the same.

The IMF's bailout package — the 23rd for Pakistan since its independence in 1947 — was suspended in November 2022 because the government had not acted on the IMF's conditions for the loan. These included a list of reforms wearily familiar to Pakistani economists: reducing energy subsidies, privatising state-owned companies, cutting the fiscal deficit, and so on.

Only recently has Prime Minister Shehbaz Sharif's government taken more decisive steps to meet those demands. Sharif, who ousted the improvident administration led by populist firebrand Imran Khan in early 2022, initially put forward a budget for this fiscal year that contained big increases in public sector salaries, as well as a hike in development spending and various tax incentives.

The impulse was understandable: With elections looming later this year, Sharif's government naturally feared cutting subsidies and raising taxes just as ordinary Pakistanis were struggling with stagnant growth and record inflation. Consumer prices rose a record 38% in May, forcing the central bank to raise rates in a recent meeting to 22%.

The budget, however, would have left Pakistan with a fiscal deficit of 6.5% of GDP, too much for the IMF to swallow. After the Fund complained that the budget didn't do enough to fix the sustainability of Pakistan's debt, the National Assembly approved a revised one that increased taxes on fertilisers, property transactions, and petroleum. The IMF now seems to believe that Pakistan may deserve to regain access to its funds.

Even if a deal is struck before the deadline, however, it won't be enough to break Pakistan out of its cycle of over-spending and crisis. The IMF cannot and should not impose even more onerous conditions than it already has. But Pakistani politicians themselves should recognise that their model of development has failed them and should have been replaced decades ago.

Pakistan has three big problems. It doesn't export enough; it spends too much on its public sector; and tax revenue can't cover its government's many obligations. Historically, the gap has been filled by such things as remittances, bailouts, and generous handouts from "friends" such as China and Saudi Arabia.

Exports can be revived by allowing the Pakistani rupee to depreciate, and through business-friendly reform. The size of the public sector can be reduced through privatization (and, of course, by slashing the defense budget).

But increasing the tax base is equally, if not more, important. Most of the new taxes in the revised budget will fall on Pakistan's existing taxpayers, including its beleaguered salaried professionals. That's because the many loopholes in the tax system have not yet been closed.

Agriculture, for example, is barely taxed, although (or perhaps because) some of Pakistan's richest and most powerful people are large landowners. Real estate in cities has also been difficult to tax, although the revised budget does make a start in that direction. Properly implementing a property transaction tax will require the authorities to build up a reliable list of who owns what.

Worst of all, the tax code is riddled with exemptions that make avoidance easy. And unlike India, for example, Pakistan has not standardised value-added tax across the country and has multiple different tax jurisdictions, so it likely loses a lot of legitimate revenue to chancers claiming refunds to which they aren't entitled, on tax they supposedly paid in another part of the country.  

Making a real start on fixing these three problems would help set Pakistan on the path to sustained growth and break it out of its humiliating dependence on handouts. The changes won't be popular in the short run. And it is difficult for any politician to be courageous when facing rising populism and an impending election. But, if none of Sharif's options are good for his re-election prospects, he should at least pick the one that would be best for Pakistan.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.