Following questions and answers state the agencies position in clear terms on several issues raised about the current IMF’s $7.6 billion support package to Pakistan.

Q: What are the advantages to Pakistan of undertaking an IMF-backed program?

A: Financing from the IMF will help to ease the path of adjustment, as well as restore macroeconomic stability and investor confidence. Further, IMF financial support will help fill the external financing gap, rebuild international reserves, and catalyze additional external assistance from Pakistan’s development partners. Additional assistance from donors is essential to help finance the expanded social safety net and to allow for higher spending on development programs.

Q: How did Pakistan get into these balance of payments difficulties to begin with?

A: Pakistan’s macroeconomic situation deteriorated significantly in 2007/08 and the four months of 2008/09 on account of domestic and external factors. Adverse security developments, large exogenous price shocks (oil and food), and global financial turmoil buffeted the economy. These shocks, combined with policy inaction during the political transition to a new government, led to slower growth, higher inflation, and a sharp deterioration of the external position.

Q: What is the conditionality associated with this loan?

A: The loan supports the authorities’ program, which has two key objectives: (i) restoring macroeconomic stability and confidence in the economy through a significant tightening of macroeconomic policies, and (ii) ensuring social stability and adequate support for the poor. The conditionality associated with the IMF’s financing reflects the targets and policies set out by the Government to meet these two objectives.

These targets, and the associated conditionality, focus on quarterly quantitative targets for: government borrowing from the State Bank of Pakistan, the budget deficit, international reserves and net domestic assets of the State Bank of Pakistan, contracting or guaranteeing of non-concessional loans by the public sector, and external arrears. There are also specific commitments for improvements in banking and tax legislation, strengthening the social safety net for poor households (including working with the World Bank to develop a more comprehensive and better targeted safety net), phasing out electricity subsidies, reducing foreign exchange market intervention by the State Bank of Pakistan, working toward elimination of inter-corporate circular debt, and transition to a single Treasury account.

Q: Why is the Fund asking Pakistan to raise interest rates when in other countries the Fund is suggesting monetary easing?

A: The Fund believes that each country’s interest rate policy should reflect its own situation and economic objectives. In Pakistan’s case, a tightening of monetary policy is necessary to restore confidence in the Pakistani rupee, help rebuild international reserves, and ensure that the domestic financing requirement of the government is met through market placements of government securities. To this end, higher interest rates are needed. Interest rates remain negative in real terms following the recent increases, even when compared with core inflation. The recent increase in interest rates will benefit domestic savers and reduce the implicit subsidy received by borrowers. It will also help reduce inflation, which will benefit the poor.

Q: At the G-20 summit, there was agreement among ministers that fiscal stimulus was necessary to help countries deal with the financial crisis. Why is the Fund advocating fiscal tightening in the case of Pakistan?

A: Pakistan’s circumstances are different from those of most G-20 countries, which have stronger fiscal positions and where a fiscal stimulus is needed to deal with recessionary pressures associated with the global financial crisis. Pakistan, on the other hand, faces severe balance of payments pressures stemming in part from loose financial policies. The global financial crisis is a contributory but not the principal cause of macroeconomic imbalances in Pakistan. Further, although economic activity has slowed in Pakistan, the economy is still growing. Accordingly, fiscal and monetary tightening are needed to address Pakistan’s macroeconomic imbalances.

Q: Is the Fund insisting on cutting back development expenditures? Military expenditures?

A: The Government’s program targets a reduction in the budget deficit to more sustainable levels. The Government proposes to do this both by raising revenues and by expenditure cuts targeted principally at phasing out fuel and electricity subsidies and better prioritizing development spending in 2008/09. The Fund is more concerned with aggregate spending and revenue targets than their detailed composition. However, given the importance of adequate funding for priority development projects in Pakistan, the Fund supported program includes ‘adjustors’ which allow for larger than projected development spending if external assistance turns out to be higher than envisaged. The program also makes specific provisions to ensure an appropriate level of poverty-related spending in 2008/09 and the future. Further, the elimination of energy subsidies will create fiscal space for higher development expenditure in 2009/10. Military expenditures were not part of the discussions.

Q: The program calls for fiscal restraint and monetary tightening. Won’t this hinder the government’s ability to invest in health and education?

A: Fiscal restraint and monetary tightening should not hinder the government’s ability to invest in health and education. The program allows for continued spending on health and education in the near term. Over the medium term, the strong tax effort envisaged in the program will help create the fiscal space needed for higher expenditures on health, education, and physical infrastructure.

Q: The program calls for the removal of energy and electricity subsidies-which will adversely affect the poor. How does the program plan to protect the poor from these price increases?

A: Developing effective and well financed safety nets to ease the burden of macroeconomic adjustment on the poor is a high priority which the Fund fully supports. To this end, the Government’s program envisages a strengthening and better targeting of the social safety net in order to protect the poor and cushion the impact of the elimination of subsidies on vulnerable groups. Social safety net spending is targeted to increase by 0.6 percentage points of GDP in 2008/09, to 0.9 percent of GDP, to protect the poor through both cash transfers and targeted measures, and the government is discussing a plan with World Bank staff to develop a comprehensive and better targeted social safety net. Also, electricity tariffs incorporate a “lifeline” minimum tariff that will shield low-income households consuming small amounts of electricity from tariff increases. Additional external assistance is being sought from bilateral donors to cover the cost of the expanded social safety net.

The targeted reduction in inflation will also help the poor. The poor are most severely affected by the current high level of inflation because they do not have the ability to protect themselves through investment in assets such as foreign exchange and real estate.

Q: Will agricultural income be taxed under the program?

A: The IMF-supported program does not envisage a new tax on agricultural income.

Q: What will the charges be for this loan? Is Pakistan paying more than other countries who are borrowing from the Fund? Why were the previous loans to Pakistan much cheaper?

A: Pakistan is paying the same rate as other countries that have stand-by arrangements with the Fund. Stand-by arrangements are subject to the IMF’s market-related interest rate, known as the “rate of charge,” and carry a level based surcharge. The current “rate of charge” is 2.1% and varies on a weekly basis, in line with short-term interest rates in major international money markets. Large loans, i.e., credit above 200 percent of a member’s quota carry a surcharge of 100 basis points above the regular rate of charge, and the surcharge rises to 200 basis points for use of credit above 300 percent of quota. Thus, based on today’s interest rates, the average charge that Pakistan would pay when it has the full amount of $7.6 billion outstanding is about 3.0%.

In the past, Pakistan has had both stand-by arrangements and an arrangement under the Poverty Reduction and Growth Facility (PRGF). Loans under the PRGF carry an annual interest rate of 0.5 percent. However, PRGF loan amounts available are limited to a maximum of 185 percent of quota for the initial three-year arrangement, and then to 90 percent of quota for second time the facility is used. Given Pakistan’s large financing needs, borrowing under the PRGF was not an option.

Q: Will the loan that Pakistan is receiving from the Fund be used to repay bondholders?

A: Disbursements of the IMF loan will be made to the State Bank of Pakistan to rebuild the international reserves position. At the same time, the program assumes that the government will remain current in all its external obligations.

Q: Where is the IMF’s money going? Will it be used for anti-terrorism military operations?

A: IMF disbursements will be used to build the international reserves position of the State Bank of Pakistan. They will not be used to finance budgetary expenditures nor anti-terrorism military operations.

Q: Is the Fund concerned that in the absence of stronger measures the program will not succeed?

A: The program seeks to address the current macroeconomic imbalances while preserving social stability and protecting the poor. With sustained and forceful implementation, the program should succeed. Building domestic consensus around the measures included in the authorities’ package constitutes a key factor in the period ahead. The policies in the program should help bring down inflation and reduce the external current account deficit to more sustainable levels. At the same time, a restoration of investor confidence is expected to help strengthen the reserve position.

Q: What contingency measures are the authorities considering if things turn out worse than expected?

A: The authorities believe the program is well-designed and adequate to address the current economic challenges. However, if things turn out worse than expected and contingency measures become necessary, the authorities are open to considering a further tightening of fiscal and monetary policies. The authorities are also confident that further financial support will be forthcoming from bilateral donors.

The matter has been picked up from the IMF’s site posted on 3rd December 08 and reproduced here.