Can the IMF force Pakistan's elite to reform?
The recent crackdown on illicit trade gives some cause for optimism.
Note: This was initially written for a foreign audience, so disregard the change in tone.
Fool me once, shame on you. Fool me twenty-three times, and you’ve just understood the dynamic between Pakistan and the IMF.
At first glance, positing Pakistan as a successful example of IMF intervention is ludicrous. After all, it has undertaken more IMF programs than any other country in history. And it’s not done yet. The most recent program, signed after painstaking delays, is a short one that will only take the country through to June 2024. After that, it is assumed that a newly elected government will negotiate yet another agreement. A failure to do so would likely result in a sovereign debt default.
Why then, would one cite the country as a positive example? Here is where we arrive at the events of early September. On September 4, 2023, the open market exchange rate for 1 US Dollar (USD) was 334 Pakistani Rupees (PKR). This was a continuation of the rupee’s freefall, with the currency having depreciated by 100% against the dollar in the last couple of years. And yet, by September 8, it had strengthened to 304 PKR/USD. It has continued its recovery since then, hitting 280 PKR/USD in recent days, and being branded as the “top performing currency globally” this month.
Unlike previous spikes of appreciation, which were driven by the central bank’s intervention in currency markets to artificially inflate the rupee’s value, independent analysts suggest the recent gains were due to a crackdown on illegal currency traders and smuggling routes. The political significance of these actions cannot be overstated enough.
Illegal currency traders are the bread-and-butter of the country’s elite. Officially, a citizen with a valid national identity card can walk into any registered money exchange and purchase up to 800 USD in cash per month at the publicly displayed open market rate. Unofficially, an individual without any proof of ID could approach an illegal currency trader, or even a legal one, and purchase much larger amounts of dollars as long as they were willing to pay a substantial premium on the market rate.
This was the preferred method of operation for those looking to circumvent the tax net or “whiten” their earnings from the undocumented economy. A crackdown then seems quite surprising, as this was a vital avenue for members of the political and economic elite to purchase dollars at a time of heightened capital controls.
According to the president of the Exchange Companies Association of Pakistan (ECAP), this “black” trade was worth $5 billion annually, compared to $7 billion worth of transactions in the regulated open market each year. ECAP also estimates that the push to curb this practice has led to an additional $900 million entering the regulated open market in the past month alone.
Even more surprising was the action taken against “smuggling” at the border. Here’s some context. Afghanistan and Pakistan have a trade agreement whereby goods meant for the landlocked country are exempt from paying import tariffs when they land at Pakistan’s southern port in Karachi. They are subsequently transported to Afghanistan via their land border in the northwest.
What was actually happening was that imported goods meant for Pakistan were being labelled as for Afghanistan, thus circumventing the initial import tariffs in Karachi. Once in Afghanistan, they were immediately “exported” back to Pakistan via the land border—where some money would exchange hands and the goods would re-enter the country at undervalued or tax-exempt rates. And how was the Pakistani importer behind all this paying their Afghan counterpart for the favour? Through dollars purchased via the illicit currency trade. Estimates vary, but anywhere between $70-150 million were leaving the country through this route every month.
This “smuggling” could not take place without under-the-table agreements with the border authorities, namely the Pakistan Army. Thus, any action taken assumes far greater significance, as it affects the interests of the country’s most powerful institution. Notably, the current Interior Minister didn’t just name the Army as being involved in this trade, but also stated that military personnel involved in the practice would be subject to court-martials.
Why would Pakistan’s military and economic elite voluntarily clip their powers like this? And what does any of this have to do with the IMF? The answer lies in one of the provisions of Pakistan’s most recent agreement with the IMF. Under the terms of the deal, the country must ensure that the value of the rupee in the open market is no more than 1.25% apart from its value in the more tightly regulated interbank market (only banks can buy dollars in this market).
Essentially, the IMF suspected that the country’s central bank was coercing commercial banks to keep the value of the rupee artificially inflated in the interbank rate. This temporarily helped Pakistan by keeping its imports cheaper, but hurt its export competitiveness in the longer run. Since the central bank did not exercise such control in the open market however, its valuation of the rupee would often be vastly different from the interbank rate.
By imposing the 1.25% condition, the IMF attempted to clamp down on this practice. And with the looming threat of an IMF review in November, it actually worked. On September 4, the interbank rate was 305.6 PKR/USD while the open market rate was 334, a vast chasm of 8.49% difference in value. By September 8, this difference had fallen to 0.53%. It has remained within the acceptable band since then.
It is too soon to suggest that this represents a fundamental shift in the economic vision of Pakistan’s elite. Taking a step like this, unprecedented as it is, is still far more straightforward than tackling systemic issues such as stagnant export growth, poor tax collection, and an import consumption-driven economy. It could also be that this is merely a temporary measure designed to win over the IMF before things revert to the way they were—an often-repeated trick by the country’s rulers.
For now, however, it is a small IMF-assisted step in the right direction.
What I’m reading this week:
How Fauji Foods finally became profitable—by replacing faujis with business professionals (Nisma Riaz, Profit)
A recent Islamabad High Court judgement could mean that we finally start treating asylum-seekers as refugees rather than criminals (Arjumand Bano Kazmi, Dawn)
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