IMF gives Pakistan bailout, but demands central bank freedom

Imran Khan government must have flexible exchange rates and end monetary financing, IMF says
IMF HQ 2
The International Monetary Fund
Photo: Henrik Gschwindt de Gyor/IMF

The International Monetary Fund approved a major bailout for Pakistan on condition that the government would give the central bank more autonomy and bring in flexible exchange rates.

The IMF’s executive board announced on July 3 that it had agreed an extended fund facility of 4,268 million in special drawing rights (about $6 billion) for the country.

In exchange, the IMF requested the government implement a flexible exchange rate, increase central bank independence and end monetary financing of state spending.

The agreement came after months of difficult negotiations between the IMF and the government of prime minister Imran Khan.

Pakistan’s previous central bank governor resigned during the negotiations, saying he wanted to avoid conflict with the government, and he was replaced by a former IMF official. This is the 22nd programme of support approved by the IMF for Pakistan. The fund will implement it for the next 39 months and disburse $1 billion immediately to the national authorities.

“The fund-supported program[me] is expected to coalesce broader support from multilateral and bilateral creditors in excess of $38 billion, which is crucial for Pakistan to meet its large financing needs in the coming years,” said the IMF in a statement.

“A flexible, market-determined exchange rate and an adequately tight monetary policy will be key to correcting imbalances, rebuilding reserves and keeping inflation low,” said David Lipton, acting managing director of the IMF.

He said more central bank autonomy and an end to monetary financing would help the State Bank of Pakistan to deliver price and financial stability.

What the IMF was expecting us to do then, there was no way we could have imposed those conditions on our people
Prime minister Imran Khan

The adoption of a free-floating regime was the main point of friction between the Pakistani government and the IMF during the negotiations leading up to the agreement.

“What the IMF was expecting us to do then, there was no way we could have imposed those conditions on our people,” said Khan in an interview with the Financial Times on March 27. “They wanted a free-floating exchange rate. Given the big current account deficit, God knows where the rupee would have ended up, so we couldn’t take that risk.”

But the frailty of Pakistan’s economy seems to have weakened the government’s position. It has recorded increasingly large budget deficits over the last years. In 2018, it stood at 6.4% of GDP. This process contributed to increasing public debt to 72% of GDP in 2018, from 63% in 2014 – a very high ratio for a low-income economy.

To bridge the gap between tax revenues and public spending, the government has resorted to central bank financing, but monetisation has had the unintended consequence of boosting inflation. The IMF expects it to rise to 8.4% in 2019, up from 5.2% in 2018.

Insufficient reserves

Another factor boosting prices is the depreciation of the Pakistani rupee. While the government attempted to sustain a fixed exchange rate, falling foreign exchange reserves have weakened their defence of the currency. Over the last year, the rupee has depreciated by almost 21% against the US dollar.

According to the central bank, foreign exchange reserves stood at $7.6 billion in May, just 2.4% of GDP, down from $10 billion in March.

Former governor Tariq Bajwa left the central bank abruptly on May 3, and was replaced the next day by Reza Baqir, who previously led the IMF’s regional office in Egypt. Local media reported that prime minister Khan had requested Bajwa’s resignation in an attempt to facilitate the agreement with the IMF.

On May 20, the central bank first acknowledged the level of reserves was insufficient in the first policy statement issued by Baqir.

“The current level of reserves is below standard adequacy levels (equal to three months of imports cover),” read the policy statement. “As noted in previous MPC statements, deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors, and improve the trade balance.”

In the first policy meeting, Baqir further aligned the State Bank of Pakistan’s policies with the IMF’s policy recommendations, increasing interest rates sharply. The central bank hiked the policy rate by 150 basis points to 12.25%.

Khan’s hefty concessions to secure the programme do not guarantee economic success. In the interview with the Financial Times, he said: “This would be the last time Pakistan will ever have to go to the IMF.” It remains to be seen whether his prediction will be accurate.

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