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Pakistan's economy races to a tipping point

Updated October 30, 2017

Pakistan is on the cusp of progress. The country has a window of opportunity in which to initiate key economic reforms that shall ensure it continues walking down the path to progress.

Over the last three years, according to the IMF, “policy implementation has weakened and macroeconomic vulnerabilities have begun to re-emerge: fiscal consolidation slowed, the current account deficit widened, and foreign exchange reserves declined.

“On the structural front, the accumulation of arrears in the power sector has resumed, financial losses of ailing public-sector enterprises continue to weigh on scarce fiscal resources, and exports remain low. Despite progress, poverty and inequality are still significant, and growth needs to become more inclusive.”

Pakistan’s annual current account deficit widened to record $12.1bn in 2016-17 as compared with deficit of $4.86bn in the preceding year.

With $8.98bn imports and $3.93bn exports, the country’s goods deficit surged to $5.05bn during July-August compared to $3.69bn in the same period of a year ago. The tipping point is fast approaching.

This has happened at a time when reduced oil prices have been providing a cushion of about $4bn every year since 2014, though there has been an increase of about 13 per cent in demand due to low prices.

Remittances have been at a record high too. In the outgoing fiscal year overseas Pakistani workers sent home $19.3bn, a year-on-year rise of three per cent.

We need to go back to the drawing board and figure out how and where our competitive advantage lies and what will work best for our country

But this bonanza seems to be coming to an end this year. The IMF has warned Pakistan and other oil importers that because of an increase in global prices, their oil bills for 2017 will be almost 30pc higher than the last year On the domestic front, the FBR is failing in policy implementation. As a last resort, it has imposed additional taxes in lieu of regulatory duties, hoping to collect Rs25bn.

At 11pc, our tax-to-GDP ratio is below regional countries. At the very least the tax-to-GDP ratio needs to rise to 15pc in five years and to 20pc in 10 years. If we are able to achieve this, our reliance on domestic and foreign borrowings will fall substantially.

At approximately 15pc, our savings rates fares very poorly with regional peers where rates range from 25pc – 30pc plus. This in turn has limited our investment rates to similar levels.

With low levels of investment we cannot achieve the high single digit GDP growth necessary for sustainable development. This is because GDP growth requires a certain plough back into productive capacity each year to generate growth in subsequent years.

One of the major events of the last couple of years has been a fall in international commodity prices — most notably oil. This has been a boon for Pakistan and has substantially eased the burden on imports where oil is a major component.

Not only have low oil prices lifted the pressure off vital foreign reserves, they have lowered the cost of production and transportation for manufacturers and service providers.

Our competitors in export markets have been devaluing their currencies in light of a strengthening dollar. We on the other hand have kept the currency overvalued. Our current real effective exchange rate is north of Rs120 while our official exchange rate is Rs105 per dollar. This has played havoc with our exports which are commodity based and low value added in nature.

Moreover, imports have become cheaper, thus widening the Balance of Payments and frittering away the advantage of low oil and commodity prices and leading to capacity closure and rise in sector unemployment.

Right now our trade gap is being filled through inward remittances — not the best way to manage trade. We need to go back to the drawing board and figure out how and where our competitive advantage lies and what kind of an export policy will work best for our country.

Allowing phased devaluation of the Rupee is the first step in turning the tide. As growth picks up, Pakistan needs to further invest in generating capital, which in turn will improve the external account by promoting exports.

The country needs an equitable broad based efficient tax regime. Poor tax collection has contributed to a low saving rate, which have in turn limited investment rates. As a result, the plough back into productivity that a sustained GDP growth needs every year, is not taking place.

This is the best way to reduce inequality, and make policy inclusive. A formalised study and corresponding reforms on the basis of zakat and usher can bring in the large informal sector to the tax regime.

Above all, investment needs to be made in the social sector to harness the youth bulge. Presently an estimated 119 million Pakistanis, or 63pc of the population, fall under the age of 25 years. If neglected they can fuel social disruption and cause major upheaval.

Next in line is agriculture. This needs a progressive government policy framework coupled with strong private sector participation to improve performance. Investments need to be made in water storage / modern irrigation, seed, warehousing, value added products and marketing.

Similarly funds allocated to health remain abysmally low. Allocations of more than the present three per cent of GDP must be made on health and education; the amount must be increased by an additional one per cent each year to reach eight per cent in the next five years.

Last but not the least governance needs to improve, not by only by improving policy options, but by ensuring better management and nipping corruption. The situation must be handled through balanced intervention without disturbing the investment sentiment on a mid-to-long term basis.

The writer is a senior financial management professional and runs a community welfare initiative called Al-Nasr Foundation.

jawwad_majid@hotmail.com

Published in Dawn, The Business and Finance Weekly, October 30th, 2017