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Vendors push a hand cart in Lahore. The IMF says Pakistan needs to improve debt management and broaden its tax base. Arif Ali / AFP
Vendors push a hand cart in Lahore. The IMF says Pakistan needs to improve debt management and broaden its tax base. Arif Ali / AFP

Pakistan juggles the IMF, debt and taxes

Islamabad is in a bind: it is servicing a heavy external debt while trying to borrow more and is facing demands to reform its systems and collect more taxes

Week-long talks between Pakistan and the IMF in Dubai ended last week without the release of the next tranche of a US$11.3 billion (Dh41.5bn) standby loan.

Teams led by Dr Abdul Hafeez Shaikh, the Pakistani finance minister, and Adnan Mazarei, the IMF's Pakistan mission chief, reached a broad agreement on fiscal and economic measures whose successful implementation in the coming budget would be a precondition for the disbursement of a $1.7bn tranche in July.

Further delay in IMF disbursements would be a setback at a time when legislators in the US have called for a review of US aid to Pakistan after the killing of Osama bin Laden. Pakistan has relied on the IMF to prop up its economy since 2008, but the IMF suspended its loan programme in May last year over the government's failure to implement tax reforms.

The suspension has pushed the country into a fiscal emergency. The government is forced to borrow from the central bank to run its affairs, while the central bank is printing money to provide the government about 2bn Pakistani rupees (Dh85.3 million) a day. The seven-day talks in Dubai with the IMF mission set budget targets for the coming fiscal year starting on July 1. The inflation target was set at 14 per cent, while tax collection has been estimated at 1.5 trillion rupees.

There was no mention of any new disbursement from the IMF.

"The IMF remains committed to the ongoing dialogue with Pakistan and discussions will continue in the weeks ahead and a mission is planned for July 2011," it said in a statement after the conclusion of the Dubai talks. "Reducing the budget deficit will require higher revenue through tax reforms to broaden the tax base, including steps to implement reforms in the general sales tax."

The IMF has asked Pakistan either to implement a reformed general sales tax or withdraw exemptions in the general sales tax system. The two sides agreed to have a full review of the macroeconomic situation in July. That review is expected to lead to a formal revival of the $11.3bn standby programme.

The IMF did not agree to the government's plans to fix a fiscal deficit target at 4.5 per cent and insisted that it should be less than 4 per cent, a target set originally for the current fiscal year under the standby programme. Islamabad assured the IMF it would increase power tariffs by 2 per cent from June 1 and that a subsidy on electricity and petroleum would be removed from the upcoming budget, which is likely to be unveiled on Saturday.

The IMF has pressed the country to expand its tax base through tax reforms and improving its debt management to reduce the deficit.

The budget deficit for the first nine months (July-March) of the fiscal year 2010-2011 was 4.5 per cent of GDP. Although the government claims to have kept the deficit below 5.5 per cent of GDP for this year, analysts doubt that can be achieved.

The country's total external debt servicing reached about $7bn during nine months of the current fiscal year mainly because of the rising burden of foreign debt and scheduled payments on bank borrowings. The immense spending on debt servicing could create an alarming situation for policymakers in Islamabad, as the country's foreign reserves are already declining. The government's borrowing from the banking system for budgetary support has risen dramatically.

Islamabad faces a violent backlash over the killing of bin Laden by US forces inside Pakistan, fearing revenge attacks and struggling to fend off tough questions over how the al Qa'eda mastermind escaped detection so long on Pakistani territory. US legislators have questioned whether the US might pull back on its bilateral aid to Pakistan, which would make the IMF funding even more critical.

Pakistan was to get more than $1bn a year of aid from US, but the country has so far received only $300m, while its security-related expenditures increased from 177bn rupees in 2009-2010 to 800bn rupees in 2010-2011.

"[The] US disbursed $8.5bn as civilian and military aid to Pakistan since 2002, whereas the government estimates losses in economic productivity due to the war against terror to be around $43bn," according to a report of Pakistan's finance ministry. US aid to Pakistan is split almost evenly between civilian and military assistance, with civilian aid totalling $4.5bn and military aid amounting to $4bn.

With a tax collection target of 1.9tn rupees for the next fiscal year, 2011-2012, nearly 1tn rupees will be taken up by debt servicing and more than 495bn rupees by defence, leaving about 457bn rupees, or about 23.4 per cent, of actual tax revenue to run the government's affairs.

Some analysts warn that the nuclear-armed nation may go bankrupt if the rich still avoid paying taxes and the government continues to allocate huge resources to subsidies and defence.

The deepening economic crisis may become a political crisis that would be difficult to handle, as the country is already facing a Taliban-led insurgency in its north-west and a Baluchi insurgency in its south-west.

 

Syed Fazl-e-Haider is a development analyst in Pakistan. He is the author of books including The Economic Development of Balochistan, published in May 2004

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