KARACHI, Jan 7 (Reuters) - Pakistan's MQM party said on Friday it will rejoin the ruling coalition, restoring its parliamentary majority, after the government put off reforms demanded by the International Monetary Fund (IMF).
The reforms, including a fuel price increase and a sales tax, are part of a programme agreed in exchange for an $11 billion IMF loan and their delay will likely infuriate the IMF and dismay nuclear-armed Pakistan's Western allies.
Investors would also be dismayed, analysts said.
The Muttahida Qaumi Movement (MQM), the second largest party in the coalition, defected to the opposition on January 2, depriving the government, a strategic U.S. ally, of its majority, sparking a political crisis and raising the prospect of an early election.
"MQM in a gesture of goodwill, for the promotion of democracy and in the face of critical condition of the country, will again sit on the treasury benches," Raza Haroon, a top party leader, told reporters as he stood with Prime Minister Yusuf Raza Gilani.
But Haroon said the MQM would not immediately rejoin the federal cabinet, indicating the party was holding out for more concessions.
The MQM, which dominates the country's financial capital Karachi, cited a new year fuel price increase as the main reason for its defection.
On Thursday, the government cancelled the fuel price rise, prompting sharp criticism from both the IMF and U.S. Secretary of State Hillary Clinton.
In another blow to the economic reform programme, Gilani said on Friday a reformed general sales tax (RGST) would be put off until a political consensus could be reached.
"We have deferred ... We will not go forward until consensus is evolved," he said.
The MQM had strongly opposed the tax, calling it regressive.
The government, grappling with a widening fiscal deficit, has a woeful record on revenue collection. Pakistan has a tax-to-gross domestic product (GDP) ratio of about 10 percent, one of the lowest in the world.
The IMF wants greater fiscal discipline from the government through painful measures such as the sales tax, a condition for the loan's final two payments, worth more than $3 billion and spread over nine months through to September 30.
IMF officials were not available for comment on the decision to delay the sales tax but on Thursday both the IMF and the United States criticised the decision to rollback the fuel price increase.
"We have made it clear, as I did in a meeting with their ambassador, that we think it is a mistake to reverse the progress that was being made to provide a stronger economic base for Pakistan," U.S. Secretary of State Hillary Clinton told a news conference.
The cancellation of the 9 percent fuel price increase, will mean the government will have to make up the difference when prices rise, increasing its spending and widening its budget deficit by as much as 0.2 to 0.3 percentage points of GDP in the 2010-2011 fiscal year, analysts estimated.
The reversal of the price increase would cost the government about 5 billion rupees ($58 million) a month, a senior Petroleum Ministry official said.
Combined with the delay in implementing the new reformed sales tax, analysts said the deficit target of 4.7 percent of GDP for this fiscal year would be almost impossible to achieve.
According to official sources, for the six months ending on December 31, the deficit stood at a provisional 2.6 percent of GDP.
In the past, the IMF has granted Pakistan waivers for overshooting deficit targets and may do the same again to avoid further destabilising the major Western ally, which is vital to efforts to bring stability to neighbouring Afghanistan.
But financial market analysts were dismayed by the government's decisions.
"It sends out a very negative signal to the lenders and investors that the reform implementation will not happen," said Asif Qureshi, director at Invisor Securities Ltd.
"Rather than providing the so-called relief to the common man, it will eventually become an added cost for them. The economic consequences of not implementing reforms will be huge."
Additional reporting by Zeeshan Haider and Augustine Anthony in Islamabad, and Sahar Ahmed in Karachi; Editing by Chris Allbritton and Robert Birsel