Pakistan needs IMF help badly

October 22nd, 2008 Aimon · No Comments

It seems only months ago that the International Monetary Fund had to fend off attacks on its legitimacy and role. With few full-blown emerging market crises around, its funding model of extending loans to countries in need of foreign currency looked increasingly outdated. But now, amid global financial turmoil, countries are queuing up for support. Pakistan is the most precarious case. It needs help but the IMF has to tread carefully.

Pakistan’s economy is in trouble: growth is slowing; inflation is at a 30-year high; the current account deficit widened to 8.5 per cent of gross domestic product in the past fiscal year; and the IMF estimates the budget deficit to have been 7.7 per cent of GDP. As foreign investors withdrew capital, foreign exchange reserves and the rupee plunged. Markets fret about a balance of payments crisis and Pakistan’s ability to service interest payments on its foreign currency debt.

A loan from the IMF, possibly jointly with other international institutions and bilateral donors, would shore up confidence. Pakistan may need up to $15bn over two years. This should stave off any immediate crisis. In order to address longer-term problems, however, structural reforms are needed, as they have been for years.

Crucially, a shift of spending from defence to education is needed. Literacy rates are among the lowest in Asia and the military monopolises resources, including foreign aid. Most of the $12bn aid the US has supplied during the “war on terror” has been earmarked for the army.

But the IMF faces a dilemma: how far can it force reform by attaching conditions to the loan? Heavy-handed intervention would be deeply unpopular in Pakistan. But if some aspects of conditionality look too risky, Pakistan’s government should nevertheless be induced to endorse tax reform, raise spending on education and commit to rebuilding the country’s institutions.

Pakistan’s strategic importance means any loan will have a political dimension. The country has an unresolved conflict with its arch-rival, India, over Kashmir; has been sucked into fighting on its Afghan border; has a weak government; and is nuclear-armed. After supporting General Pervez Musharraf, the west needs to show real commitment to making civilian government work.

President Asif Ali Zardari must be given the means to try to overcome the current crisis as well as improve the country’s long-term prospects. The best hope is an IMF loan, augmented by individual countries, that is flexible on conditions without compromising on the most vital of reforms.