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The IMF facility that the government has requested is absolutely necessary to resolve the current balance of payments difficulties. It is however only a palliative, not a solution to the fundamental economic problems. The government must use this assistance to address the fundamental economic problems. It is especially necessary to reduce the fiscal deficit. Failing to take corrective measures towards fiscal consolidation could lead to a severe economic crisis.

The containment of the fiscal deficit is vital as the large fiscal deficits have been the cause of the large trade deficits and balance of payments difficulties, besides other adverse economic repercussions. Failure to contain the fiscal deficit this year and in the next few years would be an economic disaster. The country would face a more severe crisis than what Greece faced last year and its political consequences are too horrendous to predict.

Processing
The IMF has indicated that the granting of the loan will depend on their assessment of macroeconomic vulnerabilities, the nature and size of balance of payments needs and government policies to address those vulnerabilities. The government has no alternative but accept the vital IMF assistance and follow the prescribed good economic practices it recommends.

The processing of this loan will take some time. A technical mission to review recent developments and options for reducing the size of the 2016 budget deficit concluded in early February and a statement was issued on February 5th. Another negotiating mission is likely in late March or early April, that will discuss the fundamental issues in macroeconomic instability, advice the government on the needed remedial measures and place certain conditions to grant the loan.

Key factor
Government’s agreement to pursue policies that would address the fundamental economic weaknesses and vulnerabilities will be a key factor in the granting of the loan. In the current economic predicament, the government has no option but accept these conditions with possibly some modifications to cope with political constraints. It is important that these conditions are complied with, not only for obtaining the IMF loan, but as they are imperative for resolving the country’s fundamental economic weaknesses and ensuring economic stability.

No room for complacency
This relief package must not lead the government to be complacent in the management of the public finances. It must be used as an opportunity to undertake far-reaching reforms that are needed to address the core problem of the large fiscal deficits that have been an underlying reason for the balance of payments difficulties. The trade deficit must be brought down to a manageable level and steps must be taken to bring down the foreign debt to less than 60 percent of GDP. These cannot be achieved in a single year. Yet, policies must be in the right direction.

Core weaknesses
The recent IMF statement pointed out that the fiscal deficit for 2015 is likely to be higher than the 6 per cent given in the 2016 budget speech. IMF staff estimates suggest the fiscal deficit could widen further.

The budget had targeted a deficit of 5.9 for 2016, which was disappointing. Amendments to the taxation and expenditure proposals of the budget are likely to result in a much higher fiscal deficit.

Based on the budget framework for 2016 the IMF expects the fiscal deficit to be much higher. The Treasury too sees a widening fiscal deficit. Therefore corrective measures are needed to curtail the budget deficit.

Fiscal management
The IMF facility would be given with advice to contain the fiscal deficit below 5 per cent this year and to bring it down progressively in the next four years. In fact this is likely to be a condition for giving the loan. No doubt there would be severe political opposition to this mainly on the grounds that the government has agreed to IMF conditions, the plain truth is that irrespective of IMF conditions, fiscal sustainability is essential for economic stability and in determining the external value of the currency. One of the reasons for the depreciation of the rupee has been the consequences of the large fiscal deficits.

Economic Policy Statement
An intriguing feature of recent economic policy formulation is that the Prime Minister’s Economic Policy Statement articulated this position very clearly. He said the fiscal deficit should be brought down to 3.5 per cent by 2020 and the direct to indirect tax ratios altered from 20:80 percent to 40:60. This led to expectations that a more progressive taxation system that also collected higher revenue would be an essential feature of the budget a few days later. This was not to be.

Taxation
What is essential for fiscal consolidation is a tax system that yields revenue much higher than the current 13 per cent of GDP. While it is necessary to reduce regressive taxation of basic items to much lower amounts, indirect taxes that fall on affluent consumption should be imposed, in addition to higher rates of direct taxation on high incomes. The reform of the tax system and the much higher efficiency of the tax administration to reduce tax evasion are essential to reduce the fiscal deficit. The possibility of reducing expenditure is very limited and imprudent.

SOEs
It is also likely that the IMF would impose stringent conditions on reducing losses of state owned enterprises. These may include proposals for privatisation of some. While this would be desirable the implementation of such politically opposed reforms must be undertaken in a pragmatic manner. The IMF should be acquainted with the practicalities of some of its recommendations. Pragmatic strategies should be devised to manage politically sensitive reforms of state enterprises.

Conclusion
The IMF facility would provide a breathing space to bring down the fiscal deficit and reduce the balance of payments difficulties. The economy is in a very serious situation that requires firm actions and policy reforms. These reforms must be undertaken to avert a worsening of the financial and economic crisis. Fiscal policy and economic reforms should follow the Economic Policy Statement of the Prime Minister.