ISLAMABAD, Pakistan—The International Monetary Fund issued a stern warning to Pakistan to take steps to cut its spiraling budget deficit, said a senior Pakistani government official.
In an official letter to the government of President Asif Ali Zardari, the IMF warned that the state of the nation's economy is far worse than previously realized and urged immediate fiscal belt-tightening measures, according to the official, who has seen the missive.
The IMF withheld $3.5 billion in 2010 from its total $11.3 billion loan package for Pakistan in a bid to pressure the country to take action.
The IMF, World Bank and their most influential members – the U.S., European countries and Japan—worry that unless Pakistan boosts tax revenue, its economy may unravel through escalating inflation. Now, the Pakistanis finance much of their budget by borrowing from the central bank—essentially printing money.
The IMF hasn't disbursed any loans to Pakistan since May, other than $450 million in IMF flood relief, and neither have other donors. The U.S., in particular, has been trying to help the IMF pressure the Pakistani government to make changes. But that effort has stalled with the death of U.S. envoy Richard Holbrooke, who pushed President Zardari to revamp the economy. Mr. Zardari has tried to convince donors to forgive Pakistani debt and provide more economic aid in exchange for help in the war in Afghanistan.
The country called in the IMF in 2008 amid a balance-of-payments crisis. The fund's support was supposed to end Dec. 31 but the IMF Monday extended the loan by nine months to give Pakistan more time to implement reforms.
Pakistan's budget deficit is already 6%, above a 4% target, due to failure to bring in a general sales tax and curb expenditures, which are promises made by Pakistan to the IMF in return for lending.
The budget deficit could go up to 8% this financial year if the government borrowing continues at the same pace, according to Finance Ministry officials.
Pakistan also needs to do more to strengthen the independence of its central bank, the IMF says.
Pakistan's ratio of tax to gross domestic product is below 10% and many of the nation's elite pay no tax at all. U.S. and IMF officials regularly point out to the Pakistani government that other countries with that level of taxation have frequently fallen into economic crisis. Only two million Pakistanis—mostly middle-class professionals and government workers— out of a population of 180 million pay tax.
Analysts said further delay in the implementation on tax reform could lead to an even larger deficit.
More delays "will have disastrous consequences with the fiscal situation already in dire straits," warns Sakib Sherani, a former principal economic advisor to Pakistan's Finance Ministry. "The future for reform under the incumbent administration looks bleak."
Mr. Zardari's government says it has pushed the general sales tax but has been blocked by the opposition Pakistan Muslim League-N among other parties.
Even some members of Mr. Zardari's coalition have argued the administration should implement broader tax reforms, not only the general sales tax, which will hit mainly urban voters and businessmen. In Pakistan, the agricultural sector is still exempt from tax.
"The leaders are still not willing to take critical measures hoping that Washington would bail the country out," the senior government official said.
Failure by Pakistan to complete the IMF program could hurt the country's ability to access international capital markets and may hurt flows of investments, analysts said.
"Pakistan's ability to access the capital market could be hugely affected," said Muddassar Malik, executive vice chairman of BMA Capital, a stock broker.
A political crisis, triggered by the decision of smaller coalition parties to withdraw support for the administration in recent days, has distracted focus from economic problems.
Late Monday, the Muttahida Qaumi Movement, a coalition ally of Mr. Zardari's Pakistan Peoples Party, said it was withdrawing ministers from the cabinet and would decide soon whether to join the opposition.
The PPP relies on the MQM's seats in the National Assembly for a majority.
Pakistan's $167 billion economy is lagging far behind other countries in the region. Growth is forecast by the government at 2.5% in the fiscal year through June 2011, compared with a 9.1% estimate for the current fiscal year in India.
The situation has further deteriorated because of the worst flooding in Pakistan's history this past summer, which affected more than 20 million people and destroyed crops and livestock.
Accelerating inflation, fueled in part by government borrowing, is also hampering growth and has forced the central bank to raise interest rates, which undermines growth further.
In the less than three years since the present government came to power, Pakistan has had four finance ministers, adding to the lack of stability.
Pakistan appointed Hafeez Shaikh, a former World Bank executive to the post in July 2010 after Shaukat Tarin resigned in protest against the government's failure to curb corruption in state institutions.
The IMF says Pakistan needs at least 8% to 10% growth just to absorb the annual increase in the labor force and reduce poverty.
"It is extremely important for Pakistan to achieve higher growth to fight poverty and provide jobs for some two million people entering the job market every year," said Paul Ross, the IMF representative in Pakistan.
A failure to generate jobs makes the country a recruiting ground for Taliban militants, who use Pakistan as a base to fight U.S. forces over the border in Afghanistan, analysts say.
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