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THE finance minister and his cohorts are now repeatedly claiming that the size of the economic adjustment that they are being made to undertake is “the largest ever” and that the size of the macroeconomic imbalances they have inherited are also “unprecedented.” Is this really the case?
It is important to explore and verify this claim of the government, because it is central to how well they are in a position to navigate the politics of adjustment. The real game of politics will begin for this government after the IMF programme is signed, since thus far they have made a go of things by pushing the difficult choices down the road. The real game begins once they have to start telling powerful constituencies that they cannot have all that they wish for. When the finance minister has to turn away supplementary grant requests, and enhance taxes on items of daily use and those that increase the burden on the common man, that is when the politics of adjustment kicks in properly.
At the moment, this government is having a difficult time managing the very beginnings of the adjustment process. Once in an IMF programme, they will have to wade deep into it, own the adjustment, and submit to a review every three months. Fail one review and disbursement of the tranche could be delayed, which sends a terribly disruptive signal to the state’s creditors and all investors.
It takes a great deal of political skill to manage the adjustment process and keep it on track. A government can afford to lose its voter base for a brief period, and plan to return with large spending packages in its final year to regain the affections of its key constituencies among the masses. But losing the support of the elites of its society, with whose permission any government remains in power, is far more costly and difficult to navigate. This is true in practically all countries where there is an electoral franchise. All societies have elites, and no ruler can afford to alienate them.
Once in an IMF programme, the government will have to wade deep into it, and own the process.
The process of adjustment is a little complicated, but it’s not exactly rocket science. At its simplest, it involves raising taxes and cutting expenditures. After that, it involves building foreign exchange reserves, in a sustainable way, which means increasing exports and remittances and decreasing imports and foreign debt service obligations. Let’s consider the first of these: the fiscal adjustment.
At the moment, the government is being asked by the IMF to cut expenditures and increase revenues in quantity equal to almost 4.5 per cent of GDP over the three years of the programme. Of this, something like 1.7pc of GDP worth of revenue generation has to come upfront, while the deficit has to be cut by 0.8pc of GDP in the first year, followed by another 0.8pc in the second. Of course, these numbers could change by the time a programme is signed, but will still be in the same sort of ballpark.
Is the size of this adjustment bigger than any other undertaken by any government in the past? Here is what the document containing the terms of the 2013 facility said about the size of the fiscal adjustment that the newly elected PML-N government had to undertake:
“The initial fiscal adjustment effort includes permanent deficit reduction measures of 2pc of GDP, coming mainly from revenue increases and lower energy subsidies. Tax measures included in the 2013/14 budget — including a one point hike in the GST rate — are expected to yield [0.75pc] of GDP annually. Reduced energy subsidies will produce another [0.75pc] of GDP in savings. The remainder will come from lower current expenditures (0.15pc of GDP), savings of the PSDP budget, and (in the second half of the fiscal year) a new levy on natural gas expected to yield about 0.4pc of GDP on an annualised basis. As a contingent strategy, the government will bring forward the measures identified for years two and three of the programme.”
Notice upfront that the initial size of the adjustment in the first year of the programme is larger than what is being demanded now, when expressed as a percentage of GDP. This puts the figure in the right proportion to make it comparable over time.
The military regime of Pervez Musharraf implemented a very tough one-year standby facility in the first year after the general seized power. That programme envisaged a budget deficit reduction equal to 1.3pc of GDP in half a year (the letter of intent was submitted in November 2000, the target was to be achieved by June 2001). They committed to increase tax revenue by 1.1pc of GDP — no small feat for a government just one year in — and to be achieved in half a year. How did they propose to do this? Not by base broadening, but by raising the GST and extending its coverage into areas like fuel, gas and electricity. In short, by significantly raising the burden on the common man — something a military regime does not have to worry about too much.
The story is the same with the PPP government of 2008. Their programme began in November 2008 while the real macroeconomic targets were worked out by March 2009. So their targets also had to be met starting midway through the fiscal year. The budget deficit had to be reduced by 0.9pc in half of a fiscal year, as per their letter of intent (compared to 0.8pc being demanded from the present government). The bulk of this had to be achieved from the elimination of fuel and power subsidies, which significantly raised prices at the pump and in the power bills, boosting inflation and spreading widespread disaffection.
The story is a simple one: the path of adjustment is tough, but the PTI government is not the first to have to walk it. The others managed and dealt with the fallout. It is time for Imran Khan to do the same.
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, April 18th, 2019
