May 15, 2006	Monday	Rabi-us-Sani 16, 1427

BUSINESS cycles is about upward swing when the economy is expanding followed by downward movement when the economy is sliding down into recession. To correct the situation, policymakers can make a good forecast as to what is likely to happen in days to come and accordingly recommend counter cycle fiscal policy or monetary policy or mix of the two.

These policies work with a time lag and demand a timely action from the decision makers. Any delay is likely to worsen the situation.

In economics, government spending and taxes are major components of fiscal policy. Spending on infrastructure and on the improvement of social indicators is reflected in development expenditure. This type of spending helps stimulate aggregate demand, improves standards of living and helps create jobs.

According to Economic Survey of Pakistan 2004-05, the development expenditure as per cent of GDP remained stagnant in last two fiscal years. And since FY2000-01, it has remained between 2.7 per cent—2.9 per cent of GDP. And tax to GDP ratio witnessed no significant change despite the fact that the economy continues to grow and achieved record growth of 8.4 per cent in the last fiscal.

Theoretically speaking, the more you earn the more tax you are supposed to pay (progressive tax system), the more the economy produces the more earnings businesses will realize and pay more tax to the government. Thus government’s revenues tend to go up in times of expansion and go down in times of recession. Did it happen in Pakistan? No. See Table 1.

Property business and investors in stock markets made record earnings but their contribution in the government revenues remained disappointing. It also supports the argument that richer were provided the opportunity to get richer and pay less taxes whereas the poor were made poorer.

Public sector development programmes increased by 17.1 per cent over the last year. The point is that any increase in money in the budget to improve social indicators wouldn’t bear any fruits unless the governance issue is addressed.

Every rupee coming out from Islamabad is being reduced to 20-30 paisa when it reaches to the poor. While allocating more money in every budget should be coupled with ensuring that the money actually reaches to the poor.

In the past, when the economy faced a recession, it was the government that tried to push the economy out of recession through fiscal stimulus.

As per the Economic Survey of Pakistan 2004-05, during the last four years, the growth in monetary assets have outstripped the rise in nominal GDP. The easy monetary policy (see Table 2) invoked in 2001 in the absence of any fiscal stimulus, helped the economy to bounce back from its low 1.8 per cent GDP growth rate in 2000-01 to 8.4 per cent in 2004-05. The demand side management of the economy was undertaken and the SBP is taking the credit for adopting easy monetary stance.

It did work for the economy but its trickle down effect has not yet seen. It may be true that credit was made cheaper and therefore access to credit was made easier for both businesses and households.

However, it should be acknowledged here that the growth in monetary assets created inflationary gap where too much money was chasing too few goods. The local industry, particularly automobile, cement and consumer durables manufacturers either ran out of the capacity or increased it to fuller extent as claimed by Economic Survey of Pakistan. What went wrong ?

Credit to private sector reached to RS370.1 billion during last fiscal, a jump from Rs244.6 billion in 2003-04. Credit to private sector during 2003-05 period surpassed the target.

With easy money stance, cost push inflation started kicking in as acknowledged by the SBP in its annual report. It was mainly due to rising oil prices and hoarding. The economy was thus caught up in between cost-push inflation and demand-pull inflation resulting in erosion of buying power of consumers and negating the impact of having cheaper credit. The double edged inflation played havoc with poor and the middle class.

Consumer finance increased to Rs84.7b in 2004-05 from RS45.9 b in 2003-04. There were three main sectors of direct beneficiary of easy monetary stance; personal loans, auto loans and housing buildings. Demand lead growth in these sectors with limited capacity along with cost push inflation made the economic management rather a difficult job. Add to this the market power of cement and automobile manufactures who were blamed to be netting in too much money owing to the increasing demand.

Hoarding by few manufacturers, led to increase in prices, which weakened the monetary policy cycle. The government miserably failed to check the rise in prices across the board. Thus the market failure was very much evident in this case and it weakened the impact of easy monetary policy.

Another issue that needs to be acknowledged is that growth didn’t produce any tangible increase in the buying power of households. Credit-lead-demand-growth scenario was created in the backdrop of bad loans.

The credit bubble may burst soon if the economy is pushed into recession and unemployment rate rises again. If there was any increase, it remained confined to upper or rich class of the society which constitutes a very small fraction of the population whereas a majority of the population stood aloof from the cheaper credit and benefits of growth.

Policy mix can produce better results if well coordinated and time lag is minimized. Also the economy should have the ability to reflect upon the policy mix within the stipulated time. Policy-makers are certainly aware of these facts but they wouldn’t openly acknowledge that the wrong or ineffective policy mix, acting slowly, led to double digit inflation and increased income inequality scenario.