Failure as the trump card

In November 2008, facing dwindling foreign currency reserves and the looming prospect of default, the fledgling civilian government of Pakistan entered into what was to become an $11.3 billion standby loan agreement with the International Monetary Fund (IMF). That infusion of funds stabilised the economy over the short term, but over the course of past six to nine months, the agreement has effectively ground to a halt.

Talks between the Pakistani government and the IMF most recently went into overtime on March 9, 2011, as Hafeez Shaikh, Pakistan’s finance minister, issued fresh pledges that the government would institute a 15 percent surcharge on income taxes, approve a 2 percent increase in electricity rates, remove sales tax exemptions on certain products and sectors, and pass a new Reformed General Sales Tax in time for the June budget process.

Image: IMF

These pledges bought Islamabad the IMF’s ear for a few more days, but do not appear to have succeeded in loosening its purse-strings. While the IMF has extended the programme framework through September, until it sees tangible action by the government, it has refused to release the remaining two tranches of loans, totalling some $3.7 billion, or to issue a Letter of Comfort sought by Pakistan affirming support for the government’s fiscal management. That letter is critical as a seal of approval for other donors; without it, over $1.5 billion in direct budget support from the World Bank, Asian Development Bank, and Islamic Development bank may now be imperiled.

The reticence of the IMF and other international donors is understandable. The Pakistani government has consistently failed to meet its commitments to donors to implement new revenue-generating measures and curb deficits in ways that might set it towards a path of fiscal sustainability. The need for such reforms is serious: While the problem by no means originated under the current government, Pakistan spends beyond its means. Recent government estimates indicate the country loses almost as much to tax evasion as it takes in (between 7-9 per cent of GDP). Borrowing to offset the gap has fuelled rising inflation and mounting internal and external debts, the annual servicing alone of which now amounts to almost as much as Pakistan collects in taxes. And for all its new promises, the mechanism by which the PPP government plans to implement its latest revenue-generating efforts is no clearer than previous pledges, given its shaky governing coalition and the opposition of nearly all other parties to those measures or to any unilateral executive action in the absence of parliamentary support.

Persistent domestic terror attacks and the devastating floods of August 2010 have had a serious impact on the country’s economy, but the primary source of Pakistan’s chronic shortages of revenue is structural and not the product of any single crisis. The country’s most potent mainstream political organisations— the PPP, PML-N, and MQM — each draw their primary base of support from the country’s three biggest potential sources of revenue — Sindhi agricultural landholders, Punjabi trade and industry, and Karachi’s urban class. Each holds a vested interest in shielding their respective constituencies from taxation as long as Pakistani politics remains a zero-sum system in which temporary state capture regularly interrupted by military expulsion defines the rules of the game. Coalitions with smaller Islamist or regional parties may give one party or another an edge in forming a government, but none have been able to amass the political capital required to force through a redistribution of wealth from their rivals, nor have they been able to reach a compromise that could provide for shared sacrifice by all Pakistanis in support of the country’s future development.

The country’s most powerful political organisation, and the one that is capable of redistributing wealth away from its rivals, remains the Pakistani military. The military has been notable in its absence from current discussions about revenues and spending cuts, with its budget still opaque to its nominal civilian overseers. Development spending has already been repeatedly slashed in order to meet IMF fiscal deficit targets, but Pakistani military spending is on the rise. The military’s system of domestic economic holdings provides some cushion for its members from the vagaries of the government’s budget; but more critical is the external assistance it receives from the United States, China, and Saudi Arabia. By leveraging its role as frontline state in the “global war on terror”, the Pakistani military has been able to establish its own parallel line of credit, allowing it to field a force far beyond what it might otherwise be able to afford were it forced to compete on even standing with other serially under-funded non-military priorities.

The collective inability of Pakistan’s political leadership to take the hard steps necessary to mobilise domestic revenue have trapped it in rentier state status. The government’s principal option remains stringing international donors along with promises of eventual reform, coupled with warnings of the dangers of letting the state collapse should Pakistan’s creditors pull the plug. The likelihood that the current government will be able to push through substantial reforms on the scale sought by the IMF is slim, and the relationship with the United States has become increasingly strained over Pakistan’s continued support for terror proxies like the Haqqani network and Lashkar-e-Taiba. But the argument that Pakistan is “too big to fail” has resonated with donors for the past decade and serves as its biggest trump card.

It remains to be seen whether the current IMF stance represents a true shift in broader donor attitudes towards conditionality and reciprocal commitments, or whether Pakistan will be able to continue leveraging its role as a regional spoiler and nuclear power to extract further aid. The end of open credit would undoubtedly exacerbate crises and accentuate political divisions within Pakistan, the resolution of which would be destabilizing internally and potentially regionally. But the rentier state model is unlikely to survive over the long term either. Pakistani leaders and their international backers must continue to push for reforms if the country is to move away from international dependency and towards a more sustainable future.