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Inevitable conditionalities of IMF start surfacing

By Sajid Chaudhry

ISLAMABAD: Tough conditions of International Monetary Fund (IMF) have now started surfacing as IMF and the Government of Pakistan (GoP) agreed to discontinue oil import support, eliminate power subsidies and budgetary support of the government, public and private entities.
IMF and GoP have agreed to phase out the State Bank of Pakistan’s (SBPs) provision of foreign exchange for oil imports. According to the schedule, the forex provision for furnace oil will be ended by February 1, 2009, diesel and other refined products by August 1, 2009 and crude oil by February 1, 2010.

According to IMF Letter of Intent (LoI) released on Wednesday, the SBP is committed to pursuing a flexible exchange rate policy. To that end, intervention in the foreign exchange market (including the provision of foreign exchange for oil imports) will be aimed at meeting the programme’s reserve targets.

The fiscal deficit (excluding grants) is targeted to decline to 4.2 percent of GDP (Rs 562 billion) in 2008-09, from 7.4 percent in 2007-08. This fiscal effort is necessary to help reduce the external current account deficit and move toward a sustainable fiscal position, and eliminate SBP financing of the government. To achieve the 2008-09 deficit target, the government will increase tax revenue by 0.6 percentage points of GDP and reduce non-interest current expenditure by about 1.5 percentage points of GDP, mainly through the elimination of oil electricity subsidies.

The government plans to take additional fiscal measures in 2008-09. As noted above, electricity tariff differential subsidies will be fully eliminated by end-June 2009. To achieve this objective, the average base tariff will be further increased during 2008-09

according to a schedule to be agreed with the World Bank by end-December 2008 (structural benchmark), and the government will use fuel and other surcharges, as necessary. The implementation of the electricity tariff increases will be followed up in the context of the programme reviews. On the revenue side, further steps will be taken during the remainder of the fiscal year to strengthen tax enforcement. Moreover, fuel prices will continue to be adjusted to pass through changes in international prices.

Putting in place a more comprehensive and well-targeted social safety net is a key priority under the programme.

The government will prepare, by end-March 2009, a plan for eliminating the inter-corporate circular debt within the fiscal deficit target. The targeted reduction in the fiscal deficit in 2008-09 will help eliminate SBP financing of the budget. The government is committed to limiting SBP financing of the budget to zero on a cumulative basis by October 1, 2008 to June 30, 2009.

Consistent with the government’s objective of substantially increasing tax revenue, a number of tax policy and administration measures are envisaged during the programme period. Specifically, an integrated tax administration organisation on a functional basis will be established at the Federal Board of Revenue (FBR) (integrating both the income tax and sales tax administration). In addition, audits will be reintroduced as part of a risk-based audit strategy that will be implemented by end-December 2008. A full description of the required reforms, together with an action plan will be provided to the IMF by end-December 2008, following a planned seminar to review tax policy and administration.

As part of this process, the government plans to harmonise the income tax and GST laws, including for tax administration purposes, and reduce exemptions for both taxes.

The government’s fiscal framework assumes a further reduction in the fiscal deficit to 2 to 2.5 percent of GDP by 2012-13. Fiscal consolidation will be supported by a strong tax effort, which will allow for higher spending in infrastructure and the social sectors.

The programme envisages a significant tightening of monetary policy. To that end, the SBP recently increased its discount rate by 200 basis points, to 15 percent. Following this first step, interest rate policy will be sufficiently flexible to protect the reserves position, bring down inflation, and allow the government to place T-bills and other securities with commercial banks and non-banks in order to avoid further central bank financing of the budget. A further increase in the discount rate will be considered at the time of the monetary policy statement scheduled for end-January 2009. However, the discount rate will be raised earlier if the actual reserves for end-November and end-December 2008 fall short of the programme monthly floors on the SBP’s net foreign assets. In addition, if the volume of T-bills placed in the auction scheduled for November 19 falls short of the announced target, understandings will be reached with Fund staff on corrective measures in order to meet the programme targets.

The programme will be subject to quarterly reviews and quarterly performance criteria as set out in the technical memorandum of understanding (TMU). Completion of the first two reviews scheduled for end-March 2009 and end-June 2009 will require observance of the quantitative performance criteria for end-December 2008 and end-March 2009.

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