AS interest rates drop to historic lows and the government announces a shift in its economic policy approach, away from austerity towards fuelling growth, a sense of optimism hangs in the air.

The government is doing its best to remind us all that this fiscal year has been a bit of a turning point, when growth revived, inflation dropped, the deficit was contained and reserves rose.

Furthermore, they want to point towards the growing external confidence in Pakistan’s economy as evidenced by the improvement in the country’s credit rating and large subscription to debt offerings as well as Pakistani assets in international markets.

Take a look: State Bank cuts interest rates to historic low of 7%

All of this has instilled confidence in the government, undoubtedly, and now we are hearing announcements of a coming change of gear in economic policy.

Falling inflation is a fact and there is little justification for keeping interest rates up as the Consumer Price Index drops to 4.8pc for the first 10 months.

We can assume that the decision to slash interest rates was made independently of the decision to shift from austerity towards growth, but all signs are that there is plenty of coordination between the government and the State Bank in all important policy matters.

Be that as it may, there are grounds for caution ahead. It is true that many macroeconomic indicators are showing an improvement, but that improvement has yet to manifest itself in the real sector of the economy.

Large-scale manufacturing remains mired in low growth, and the external account has shrunk mainly because of a fall in oil prices and not because of any underlying improvement in the country’s competitiveness.

All of this was pointed out by the State Bank in its last quarterly report, although it is hard to see what it can do to address these weaknesses.

What is certain though is that without underlying reforms, measures to pump growth in the economy through interest rates and government spending have, in the past, created unsustainable growth spurts that quickly lead to a speculative frenzy.

The stock market spirals, property speculation thrives, money is funnelled to Dubai real estate in growing quantities and inflation begins to rise. It would be a good idea to remain mindful of the pitfalls of using monetary policy as an accelerator for economic growth, particularly in the absence of key underlying reform that promotes the documentation of incomes and the shrinking of speculative trades.

Governments in the past have procured for themselves a short-lived respite by inducing large growth rates in the economy through measures such as the ones reportedly being contemplated, and the finance minister would do well to explain in his budget speech how the actions of his government are different from those of governments past.

Published in Dawn, May 25th, 2015

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