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1/ How should one evaluate the “structural adjustment” program between IMF and Pakistan?
The program is the result of years of poor policy choices that led to low productivity and unsustainable imbalance as i detailed in 2018.
The program is the result of years of poor policy choices that led to low productivity and unsustainable imbalance as i detailed in 2018.
2/ The immediate challenge is to reduce domestic demand for imports without slowing aggregate demand and output too much. That is a tough task, and only a carefully designed adjustment program will get it done.
There are 3 parts to evaluating the program, and all 3 must succeed.
There are 3 parts to evaluating the program, and all 3 must succeed.
3/ PART I: What will be the impact on medium-term growth?
Program starts with massive devaluation. This reduces imports, but unfortunately Pak’s exports are not much responsive. Thus most of the adjustment will be done through the most painful channel: contracting demand
Program starts with massive devaluation. This reduces imports, but unfortunately Pak’s exports are not much responsive. Thus most of the adjustment will be done through the most painful channel: contracting demand
4/ But devaluation also raises inflation in an import-dependent country. If central bank counters inflation with higher interest rate, demand and output will contract further.
Additional contraction comes from fiscal austerity.
So here's the Big Question for medium-term impact
Additional contraction comes from fiscal austerity.
So here's the Big Question for medium-term impact
5/ Can Pakistan avoid the negative feedback cycle: adjustment makes output fall, which tightens adjustment more, which makes output fall further, and so on..
e.g. austerity => ⬇️ output => ⬇️govt expenditure due to fiscal deficit rule => ⬇️ output, and so on.
OR
e.g. austerity => ⬇️ output => ⬇️govt expenditure due to fiscal deficit rule => ⬇️ output, and so on.
OR
6/ Devaluation => harder to pay back $ debt => $-funding stops => more devaluation ...
Super important to shut-off such negative feedback doom-loops. For this, program has to be transparent, credible, large enough, and most importantly contingent on future state of economy.
Super important to shut-off such negative feedback doom-loops. For this, program has to be transparent, credible, large enough, and most importantly contingent on future state of economy.
7/ PART II: Does the program solve Pak’s liquidity problems?
The question of debt roll-over must be addressed. Pakistan has 30B+ of foreign payments coming due in the next 24 months. These cannot be paid back, and need to be rolled over.
The question of debt roll-over must be addressed. Pakistan has 30B+ of foreign payments coming due in the next 24 months. These cannot be paid back, and need to be rolled over.
8/ PART III: How are long-term expectations anchored?
This is the hardest battle. Financial markets are forward-looking, driven by expectations. Will there be a credible change in the way country has been run? A change markets can believe in?
This is the hardest battle. Financial markets are forward-looking, driven by expectations. Will there be a credible change in the way country has been run? A change markets can believe in?
LAST/ May our people prosper.
