Pakistan and the IMF

This post, co-authored by Nancy Birdsall, Milan Vaishnav, and Danny Cutherell was originally featured on Foreign Policy's AFPAK Channel.

Several weeks ago, Pakistan indicated that it would say "thanks, but no thanks" to more than $3 billion in loans from the International Monetary Fund (IMF), as internal political issues proved stronger than the need for Pakistan to bring in much needed money. But while this incident says much about the conflict going on within Pakistan's ruling bodies, it also shines light on the flawed American strategy of trying to use economic aid to ensure better behavior from Pakistan's military and intelligence services.

For the past three years, Pakistan has had an IMF program backed by a loan of more than $11 billion. Of this, the IMF has so far released almost $8 billion in several tranches-each dependent on Pakistan's civilian government making progress on key tax and energy sector reforms. Over a year ago, as progress on those reforms stalled, Pakistan asked for -- and received -- more time to comply with promised changes and collect a final $3.6 billion tranche. But at the end of September the Minister of Finance announced that Pakistan would not continue the IMF program at all, and he has since emphasized that Pakistan would work on its own "home-grown" reform program. Though Pakistan can go back to the IMF anytime (and indeed there were rumors recently that it would), the civilian government clearly wants to avoid locking itself into another IMF program involving promises for reforms that it will not be able to fulfill.

Why would Pakistan, which has benefited this past year from high agricultural prices, but nonetheless is battling serious revenue problems and rising inflation, turn down big IMF money -- and while pressing ahead with its own reform package, avoid seeming to seek a fresh new round of IMF money?

Pakistan walked away from the IMF because a weak coalition government simply could not deliver sufficiently on the reforms it had promised, despite the apparent desire of the country's economic policy team to do so. Attempts by the civilian government to lower subsidies or raise taxes have been met over the past year with street protests and threats of further upheaval, and unsurprisingly, resistance on the part of the legislature.

As a result, measures to increase the size of the tax base ended up being modest and ad hoc. An effort to implement a value-added tax (VAT) failed because of domestic resistance from business elites and some provincial governments. On energy policy, the government raised tariffs, but not nearly enough to address the fundamental problem that less than 10 percent of consumers pay for electricity at cost-recovery level. The World Bank estimates that energy subsidies drive a huge hole in the government budget, to the tune of 1.2 percent of GDP. Rolling blackouts are getting worse, leading factories and households that can afford it to resort to inefficient diesel generation, and forcing smaller companies to close altogether.

Meanwhile in Washington, debate in the U.S Congress about aid to Pakistan -- not just military aid but aid to shore up the civilian government along the lines that the late Richard Holbrooke advocated -- has grown increasingly hostile. Many in Congress assume that Washington's announced annual economic aid package of $1.5 billion provides leverage that can somehow bring both the civilian and military sides of Pakistan's government into line-- and are threatening to withdraw civilian aid in frustration with the inability or unwillingness of Pakistan's military and intelligence agencies to deal with the Haqqani Network and other threats to the security of Americans in Afghanistan.

The IMF saga makes clear that that leverage just doesn't exist. Using economic aid to push weak civilian governments into political steps they cannot take (unless they are willing to give up power altogether) doesn't work. It is even more far-fetched to imagine that the much smaller amount of U.S. civilian aid constitutes leverage with Pakistan's military and intelligence establishment, or that it's removal is a serious threat to them. If the government of Pakistan is willing to walk away from more than $3 billion of IMF money because it cannot implement a VAT, it seems unlikely that the powers that be will change their strategic calculus in Afghanistan for whatever Congress appropriates this year.

As we have emphasized before, the purpose of U.S. civilian aid to Pakistan is not to bribe or reward, nor would withholding aid be a useful punishment. Aid seldom constitutes leverage over tough domestic policy decisions, as the development community knows well. Apparently, so does the U.S. military. On the eve of his retirement, Chairman of the Joint Chiefs of Staff Adm. Mike Mullen told Congress that the U.S. needs to move beyond counterterrorism in Pakistan and focus on the development issues that constitute the foundation of that country's long run success. In his words, "isolating the people of Pakistan from the world right now would be counter-productive."

The issue is whether modest amounts of U.S. aid -- to help educate kids, create jobs, and strengthen democratic institutions -- might help give Pakistan a shot at becoming a more stable, prosperous and democratic country in the long term. Congress should be demanding evidence of that possible effect and targeting aid appropriately, rather than making superficial cuts that hurt America's image and impact in Pakistan for no apparent gain.

Read the full article on Foreign Policy's site here.