Structural adjustment programmes: Composition and effects

1. Structural adjustment programmes: Composition and effects Chapter 14: Akbar Zaidi Lecture: 25

2. General belief in developing countries : Washington consensus has taken over and is influencing to suit their own interest • Own governments have lost all autonomy: Dictation from WB and IMF • Outside influence is not new

3. Development and Export of Development thinking Model suggested in 1950s and 1960s: Focused entirely on growth ( trickle down) • Industrialization was the mechanism: import substitution • Realized that agriculture was neglected  Green revolution • Poor human development indicators

4. In late 1980s: Loans for stabilization, involvement became more direct and aggressive (SAP) • 1960s and 1980 as parallels: Growth was foremost • In 1980s lesser protectionism, market mechanism • 1990s and 1970s: Social action programs, poverty reduction

5. From SAL to SAP • 1970s: Smaller role, provision of loan for B.o.P • Mid 70s: Commercial bank loans due to petrodollars • Extensive, luxury consumption accumulation of debt • Interest rates in US shot up to 18%Commercial loans no longer available to finance projects and debt servicing • IMF steps in : • Stabilization: BoP, cut domestic demand , money supply, public spending, devaluation • Recovery and growth • Loans of longer duration : more conditions attached

6. SAP: Composition • General: applied to countries irrespective of differences • Trade policy: Export led path • Competitive exchange rate: devaluation • Lifting trade restrictions (quotas) • Fiscal Policy • Reduce fiscal deficits: Cut down public expenditure • Reform tax system • Cut or eliminate energy subsidies

7. 3) Public enterprises • Close down unprofitable public enterprises • Stop preferential treatment to public enterprises 4)Financial Sector • Improve regulatory framework • Relax interest rate ceilings • Restructure institutions

8. 5) Industrial Policy • Remove protectionism • Encourage industries that produce for export purposes 6)Agriculture • Remove bias against agriculture: remove protection to industry • Discontinue subsidies

9. Implementation and Effects • Large number of studies • “We certainly cannot say whether the adoption of programmes supported by the fund led to an improvement in inflation and growth performance. In fact, it is often found that programmes are associated with a rise in inflation and fall in growth rate” • Fiscal cut: Fall in investment and growth, recessionary • Erosion of industrial base in fragile economies due to openness

10. Social unrest • Poverty and inequality have risen • Cuts in health and education expenditure • WB admits : ‘New poor’ • IMF : Solving poverty is not the aim • Change in IMF packages now

11. Structural Adjustment Programmes in Pakistan Chapter 15

12. Introduction • Marked difference in constitution and application of programe prior to and post 1988 • Since 1988, Pakistan’s economic policies, management & performance have almost totally been determined by the country’s adherence to IMF/WB sponsored SAP’s • The SAP’s are so minutely detailed that the govt has little room to be innovative, and it merely follows the steps outlined in the document no independent or original economic program

13. History • First loan: 1958 • Loan cancelled prior to the expiration date, and the entire amount of the loan went unused • Ayub govt: 2 more standby agreements, both with a duration of 1 year each • Z.A. Bhutto govt.: 4 more standby loans • Prior to the mid-70’s, stabilization and SAP’s did not play a major role in the management of the economies of the third world.

14. History • 1980: Pakistan entered into a long-term Extended Fund Facility (EFF) for a period of 3 years under Gen. Zia • Amount was 3 times the amount lent post 1947 • Another long term agreement was signed by the interim govt. after the death of Zia • When Benazir’s govt. overtook office the very next day, it ratified the already agreed program • Sharif’s govt. was also bound by the covenants of the agreement

15. History • Another agreement signed in 1993 • Signed by the interim govt. of Moeen Qureshi, a former WB staff member • Agreed to policy framework paper • Laid the basis for the more comprehensive, long-term agreement made in 1994 • Was the GoP initiating the program based on its own needs, or was it imposed by the WB/IMF members?

16. History • BB comes into power for the 2nd time: handed over a pre-prepared, detailed program to endorse • Signed the extended 3 year facility • Moeen’s govt. was responsible for framing the program and getting it approved by the IMF; BB’s govt. just ‘stamped’ it.

17. History • The only time a democratically elected govt. itself took a loan was Nawaz Sharif’s second govt (97-99) • A total of 4 agreements made b/w this govt. and the IMF • All 4 agreements suspended or abrogated

18. History Which governments have completed programs? • Nawaz Sharif’s second govt. completed its program or fulfilled the agreement/ commitments to the IMF and WB • Musharaf: Poverty Reduction and Growth Fund (01-04) • Previous governments (88-99) had incomplete implementations but core policy measures – devaluation, price, exchange rate, interest rate and trade liberalization; public enterprise reform; and subsidy withdrawal were implemented however reluctant and slow they may have been in the implementation

19. History Based on the above: • There are major political connotations to the SAP’s in the context of Pakistan • How much autonomy has the GoP had, since most of these agreements were signed by interim governments.

20. Implementation of the SAP’s: an examination of the 1988 program Structural adjustment programs are very specific and are designed in detail - References to trivial concerns, such as • Telephone charges • Deregulation of bus fares • Water and sewerage tariffs • Taxes and user charges for roads, rails and aviation

21. An examination of the 1988 program Larger issues which the1988 program addressed: • Improve financial internal and external balances • Increase savings rate (esp. in the public sector) • Encourage private sector investment

22. An examination of the 1988 program Key objectives: • Reduce the overall budgetary deficit gradually to a sustainable level (4.8% by 1991) • Contain the rate of inflation (gradual reduction to 6.5 by 1991) • Reduce the external current account deficit o sustainable level (2.6% by 1991) • Reduce the civilian external debt-service ratio (22% by 1991)

23. Increase gross official foreign exchange reserves • Contain the growth of domestic credit and money supply in line with the growth of nominal GDP • Sustain real GDP growth at above 5% • Three key areas of reform: fiscal policy, foreign trade policy, and the financial sector

24. An examination of the 1988 program Fiscal Policy • Emphasis put on resource mobilization • Raise revenue to GDP ratio from 17.6% to 20% in 1991/92 • Gradually impose sales tax on imports and also on domestically produced goods (GST) • Restructure the income tax system for greater equity • Increase prices and user charges of utilities for revenue • Take measures to strengthen the tax administration

25. Reduce the growth of current expenditures • Lower/eliminate subsidies on fertilizers • Tighten control over provincial expenditures, so that they make efforts to generate their own revenues

26. An examination of the 1988 program Trade • Non-tariff barriers to be replaced by tariffs • Reduce the number of banned commodities from 400 to 80 • Reduction in the maximum tariff rates (from 125 to 100%) • Increase exports, particularly higher-valued exports • Private sector to be permitted greater involvement in the export of rice and cotton

27. An examination of the 1988 program Financial Sector • Remove controls so that this sector plays an important role in allocating resources • Improve efficiency and profitability of the banking system: competition • Tighten prudential regulations • Strengthen the legal framework for debt recovery • Establish a credit information bureau within the State Bank

28. An examination of the 1988 program Financial Sector • Abolish negative real interest rates on concessional credit programs • Govt expected to pursue cautious domestic credit policies so that inflation remains under control • Monetary expansion to be kept in line with nominal GDP

29. Achievements and Failures of the 1988 Program • How can we determine the extent of its success? • Identify program targets and then examine whether those targets were met • Targets? • GDP growth rates of 5.5% or above each year • Increase investment and improve its efficiency • Deregulation • Adjustment in administered prices • Better fiscal efforts

30. Achievements and Failures Fiscal Policy: implementation was weakest in this area • Tax revenues as a % of GDP remained stagnant • Steps taken in taxation • numerous income and wealth tax exemptions were eliminated • simplification and rationalization of the tax structure • Attempts to improve tax administration • Actual results? • Number of tax payers and coverage remained low • 121 commodity categories exempt from the GST, so progress in reducing concessions remained limited

31. Achievements and Failures Trade and Balance of Payments: CA deficit declined • Step-wise reduction in maximum tariff rates • Elimination of many non tariff barriers • Import licenses were abolished • Exports increased sharply (11.5% p.a.) • Deterioration in services balance • Noticeable increase in FDI and foreign portfolio investment due to foreign currency accounts: CA deficit decreased

32. Achievements and Failures Financial Sector • Resident Pakistani’s were allowed to open foreign currency accounts in Pakistan (frozen in 1998) • Banks were authorized to increase interest rates on deposits • MCB and ABL were sold to the private sector • 10 new private sector commercial banks and 8 investment banks were sanctioned • Increased activity and capitalization in the stock market • Rate of return on T-bills increased from 6 to 13%

33. Achievements and Failures Liberalization and Privatization: • A forceful program of liberalizing the economy from govt control undertaken • Power generation, commercial and investment banking, and air and sea transport opened to priavte investors • Sanctioning of private investment abolished • Regulatory restrictions abolished • Registration of technical and foreign loans • Procedures for employment of foreign workers

34. Achievements and Failures Other Areas: • Agriculture • Performance of the agricultural sector, particularly cotton, improved significantly • Subsidies on pesticides, seeds and agricultural machinery were eliminated • Prices of fertilizers adjusted upwards • Industry • Industrial value added increased by 6.3% p.a. • Large investments undertaken in all major energy sources • Cotton industries dominated

35. Achievements and Failures • Domestic savings increased (due to FCD’s) • Energy prices increased by an average of 4% in real terms

36. WB’s own opinion ‘While performance during the adjustment period has been strong in GDP and export growth and in structural reforms to encourage private sector economic activity, it has been weaker in achieving a sustained reduction in the fiscal deficit and in improving external sector balances….lack of significant improvement in poverty and social sector indicators.’

37. WB/IMF’s evaluation of the 1988 program • 4 key indicators which reflect the state of an economy: • GDP growth rates • Budget deficit as a %age of GDP • Current account deficit/GDP ratio • Inflation rate • The latter 3 indicators were way off target : the SAP of 1988 has not been much of a success

38. WB/IMF’s evaluation of the 1988 program • William McCleary (WB): • Pakistan’s economy was doing well for itself, and then the IMF intervened, after which it did somewhat better for a few years • Pakistan’s economy did well because the conditions imposed on it were being followed, and because the govt. of Pakistan was thinking like the IMF • The IMF/WB policies were sound and things went bad because of the poor management of the government

39. WB/IMF’s evaluation of the 1988 program • Mohsin Khan (IMF): • The changes that have been made, as far as openness and outward orientation are concerned, have been marginal • savings/investments were off target • Large fiscal deficits persisted • Efforts at resource mobilization were not successful

40. Microeconomic effects • The impact was sever particularly on labor and the poor • GST and the subsequent inflation hurt the poor • Cuts in govt. hiring to release pressure on govt. expenditure increased unemployment • Poverty returned to Pakistan following the IMF programs • Low GDP growth, its sectoral distribution, lower employment and real wages, cuts in public expenditure and in social development

41. Are Governments Autonomous? • Govt.’s in underdeveloped countries are dependant on and pressurized by events, factors, agencies and institutions outside the realm of the govt. itself • Foreign patronage of Third World Countries has been the norm • Local sensitivities are ignored since the govt.’s existence depends on approval from abroad

42. Are Governments Autonomous? • Numerous important political and governmental decisions were influenced by Pakistan’s relationship with Washington in its early years • Foreign aid has been one of the sources of development and growth in Pakistan • Early Ayub period • 1965 – Soviet invasion: Pakistan in US’s political disfavour • Zia resisted external pressure from the IMF and WB, since he was in a position to do so • Post 9/11: govt.’s are willing to do anything to adhere to the Washington consensus.

43. Did Pakistan need to go to the IMF? Countries that apply to the IMF/Bank have the following characteristics: • Bad economic state • BOP is in critical deficit • Budget deficit is high • Rampant inflation • Growth rate is too low and unsustainable in the long run

44. Did Pakistan need to go to the IMF? • The overall growth performance of Pakistan has been good • 1980’s: all the main economic indicators showed very decent trends • Till 91-92, the economy continued to do quite well • GDP growth rates at around 5% p.a • Private investment increasing at 20% p.a since 1988 • Exports increased substantially • Overall, the economy showed signs of immense prosperity • Pakistan’s economy was functioning adequately without any assistance!

45. Did Pakistan need to go to the IMF? • Contrast with Bolivia in 1985: • Inflation rate: 11,000% • Fiscal deficit in excess of 30% of GDP • GDP per capita was 20% less than that in 1980 • Pakistan has never been in such critical conditions, though it may have gotten there on account of following these programs! • While Pakistan’s economy needs better management, reform and alignment, does it need to run to the IMF every 3 years? • Why does each govt. accept the stringent conditions, more loans and more debt?