IN an article titled ‘Boom or bust’ published in Dawn two years ago, I had posed the question whether the then government would behave any differently from its predecessors and, while hoping it would, answered that, “as in the past, we will fill up the tank with borrowed money for fuel, press down hard on the accelerator and enjoy the ride. After all, the IMF is always ready to tow us back to town when the fuel runs out and make us pay through our nose to carry out the repairs!”
How things have come to pass! The burden of setting the economy right and negotiating with the IMF to carry out the repairs fell on a new government, which had never been in office and whose performance must now be judged on what success it has had in turning the economy around. These efforts should not, however, distract attention from the fact that the previous government’s gross macroeconomic mismanagement is primarily responsible for the current state of the economy. Mending an economy that suffers from extremely high and unsustainable fiscal and current account deficits, a mountain of debt needing repayment (especially short-term borrowings), and an overall foreign exchange financing gap of almost $30 billion, can hardly be put right in 10 months even in the best of circumstances and under stellar economic management.
Yet, after partially plugging the financial gap and avoiding an impending debt default, thanks to loans from friendly countries, on balance, the new government could have performed better in 2018-19. The main reason for this was its failure to devise a consistent set of policies linked to a well-thought-through home-grown stabilisation programme, once it had decided not to resort to the IMF (which it has now done). Its only important step was to undertake a long overdue devaluation which helped reduce pressure on the current account deficit and dwindling reserves, due mostly to a reduction in imports while exports stagnated. Overall, its actions were piecemeal. As a result, Pakistan got the worst of all worlds — low growth (3.3 pc), high inflation (9.5 pc) and, in the end, a very high fiscal deficit, now estimated at over 7 pc.
The targets and pace of economic reforms the government has set are formidable.
The new economic team has spelled out a comprehensive stabilisation strategy, even though the full details of the IMF programme have not yet been made public. Each component of this strategy faces major challenges in terms of both implementation and targets set.
The first is the target set for GDP growth at four per cent next year. Given the drastic compression in aggregate demand envisaged, this will only be possible if development expenditure — which is being maintained to some extent — is concentrated on low-gestation employment-intensive projects. Here, the government’s commitment to providing housing for the poor — for which a significant amount is allocated — could play a key role, given its strong backward and forward linkages with other labour-intensive sectors. The projected rise in unemployment and poverty could be dampened through a change in the capital intensity of the development programme.
The second is the planned drastic reduction in current expenditures to meet the targeted primary deficit in the federal budget of near 0.6pc next year (from 2.5pc expected in the current year) and the overall deficit from well over 7pc to near 5pc (but adjustable to higher interest rates and exchange rate). This will require right-sizing existing government department and rationalising current defence expenditures. In the past, attempts at the former have met with little success and in the latter, current conditions make this even more difficult. Another impediment here could be getting the provinces to adhere to the reduction targets set, given their large share in total revenues after the 18th Amendment.
The third — and this may be a near impossible task — is raising revenues by almost 35pc in a year of low economic growth. This is to be achieved by withdrawing tax concessions (against the strong protests of affected industries) and expanding the tax net which has been promised for long, but never borne fruit. The challenge here will be the right mixture of the ‘carrot and stick’, one that avoids dampening business sentiments while bringing into circulation their hidden wealth, the withdrawal of which has primarily led to the current sharp slowdown.
The fourth is protecting low-income groups from expected higher double-digit inflation in the face of higher energy and fuel prices and its pass-on effect, which — IMF or not — are necessary to reduce the extremely high circular debt. The key here will be to use resources efficiently by targeting the poorest of the poor and lowering the administrative delivery costs of the larger allocations made to the Ehsas and BISP income support programmes. Here, the new Ministry of Social Safety Nets and Poverty Reduction could play an important overall supervisory role.
The fifth is a rise in exports to take advantage of devaluation, with the new current exchange rate, which should hold with some fluctuations, reflecting the real effective exchange rate. Overcoming Pakistan’s historically low export price elasticity of demand, the high domestic profitability of many exports, and placid global markets will remain a major challenge. A determined effort is required to improve quality, find new niche markets and take advantage of the new FTA with China.
Finally, there is the need to respect the autonomy of the State Bank, which the government has promised to uphold. Old habits die hard and it will take a lot from the doyens in finance to accept this reality. It will also test the resolve of the new State Bank governor in strictly following the agreed IMF conditionalities, especially in restricting government borrowing only from commercial banks.
The targets and pace of reforms the government has set are not just challenging, but also formidable. In the end, success will depend on ownership by the implementing agencies and strict adherence to the IMF agreement. Most importantly, the government needs to demonstrate that the poor will be protected, vested interests will be restrained from reaping rents and monopoly profits and that it is sincere in its goal of moving the economy out of the current economic mess.
The writer is a professor at the Lahore School of Economics and former vice-chancellor of the Pakistan Institute of Development Economics.
Published in Dawn, June 1st, 2019