DWINDLING foreign reserves may nudge Pakistan soon towards IMF loans and their associated reform conditions.
Clearly, Pakistan must reform to make economic progress, but it must pursue pro-growth rather than low-growth reform. Growth must be pro-poor and inclusive to disproportionately benefit the poor.
Steering economies is like steering trains on narrow tracks between two ditches. The movement forward of all passengers represents inclusive growth. The ditches represent the fiscal and external balances. If either balance breaches in moving rapidly, the resulting inflation and currency depreciation sharply reduce investment and growth.
So, sound steering involves moving rapidly without courting the ditches. Countries experiencing stagnation, inflation and currency depreciations simultaneously (stagflation) face trade-offs between financial (inflation and currency) stabilisation and growth. Money supply and fiscal deficit reductions ensure stabilisation but reduce short-term growth. Sensible stabilisation enhances long-term growth; but over-stabilisation stunts it.
Two main roadmaps beckon economic drivers. Neo-liberalism prioritises financial stabilisation while flashing ‘go-slow’ signs for immediate growth. This helps avoid both ditches. But growth remains elusive given neo-liberalism’s prolonged go-slow advice, as in1980s Latin America. Keynes prioritises real variables (growth and investment), i.e., speed over caution. Unsurprisingly, developing countries following Keynesianism often fall into ditches. Keynes emphasises macro-economic (fiscal and monetary) tools that suit developed countries more than developing ones, which lack credit for large-scale Keynesian-style deficit spending.
Additionally, since developed country recessions usually reflect reduced consumer demand due to income constraints, Keynesian-style spending helps increase demand there. However, recessions in developing countries also reflect reduced producer supply due to supply-side constraints. Thus, more multi-dimensional tools, including macro-economic policies, micro-economic supply-sided interventions, regulatory changes, administrative steps, and political policies, are required there.
Developing countries must balance growth and stabilisation based on whether real or financial variables need most attention presently. So, inflation can be reduced by cutting money supply or increasing goods supply. When inflation is high, countries must reduce money supply immediately and sacrifice short-term growth, for high inflation ravages long-term growth.
International and local research shows that moderate inflation does not hurt growth. Moderate inflation hurts poor people. However, slowing growth to tame it hurts them more. Moderate inflation must be controlled from growing further but not necessarily decreased immediately if this reduces immediate growth. Instead of cutting money supply by increasing interest rates and reducing growth, countries should remove supply-side constraints so that goods supply rises to balance money supply. This protects immediate and long-term growth and achieves low inflation in the medium-term.
Pakistan currently faces stagflation. Among real variables, growth is around three per cent while the investment-GDP ratio is 13 per cent. Since both are extremely low, over-stabilisation and reduced growth could ignite upheavals. Among financial variables, the debt-GDP ratio is officially around 60 per cent. The fiscal deficit currently ranges between seven-eight per cent; the tax-GDP ratio is around nine per cent and the currency is depreciating steadily and foreign reserves cover only two months of imports. Pakistan’s fiscal deficit reflects typical reasons: government profligacy and inability to increase taxes and control expenditures.
However, the present external deficit reflects atypical reasons. Pakistan’s external deficits usually originate in current account deficits (CAD). In 2006-08, CAD averaged five per cent of GDP, ultimately necessitating the 2008 IMF loan. However, CADs have been minimal recently. Thus, dwindling reserves largely reflect financial account deficits, i.e., low foreign investment, capital flight and large IMF repayments.
So, ironically, the solution to the 2008 external deficits (IMF loan) is now partially causing external deficits. Given global recession and national stagflation, it was unrealistic to expect Pakistan to accumulate sufficient foreign reserves so quickly to repay IMF fully. A longer duration loan should have been negotiated.
Moreover, the IMF’s loan suspension midway due to Pakistan’s fiscal profligacy was inappropriate given that the external balance (the IMF’s main remit) was under control. The suspension actually increased external deficits too!
Fortunately, the new IMF loan negotiations reportedly envisage a longer repayment schedule. Pakistan must also ensure that loan conditions support growth through sensible stabilisation. Pakistan’s inflation and debt levels are problematic but have not crossed red lines yet, but investment/growth, fiscal deficit and foreign reserve levels have. Thus, the latter should constitute immediate targets.
Improving them will alleviate inflation and debt levels too in the medium-term. IMF funds will increase reserves immediately, leaving fiscal deficit and growth as the main immediate goals. Although mutually contradictory in the short-term, both goals can be pursued simultaneously by utilising the multi-dimensional tools mentioned earlier.
Fiscal deficits must be cut from current 7-8 to 4-5pc of GDP without hurting growth. Eliminating state-enterprise losses and non-productivity will save 1.5-2 per cent of GDP and help improve overall economic productivity, thus compensating for the associated (unproductive) job losses. Reducing tax evasion, corruption and government waste may reduce the fiscal deficit by 1.5-2pc.
Taxes targeting upper-class savings may fill the remaining fiscal gap without hurting growth, e.g., taxes on agricultural, larger-scale transport and retail incomes, capital gains and non-essential imports. Reducing subsidies and increasing sales taxes presently will hurt growth and the poor, despite IMF claims to the contrary. Such steps could be introduced 2-3 years later to fund increased social-sector expenditures once growth recovers.
Similarly, to ensure fiscal frugality, growth must be facilitated through non-fiscal tools, i.e., micro-economic and political interventions to overcome critical supply-side constraints such as energy shortages, insecurity and red-tape. Tightening money supply would hurt growth, as interest rates already exceed regional average rates. Money supply should actually be relaxed once fiscal deficits reduce.
To implement such policies, Pakistan must negotiate tenaciously to counter the IMF’s neo-liberal-oriented orthodoxy and its limited expertise in political and long-term growth issues.
The writer is a political economist at the University of California, Berkeley. firstname.lastname@example.org.