PAKISTAN has been struggling with low economic growth for three decades. Since 1990, real GDP growth has averaged 4.2 per cent. By comparison, South Asia has averaged economic growth of 6pc over the same period. In the past three years, Pakistan’s annual GDP growth rate has fallen even further, to an average of 1.9pc, due to the combined effects of the 2018 balance of payments crisis and the Covid-19 pandemic.
Hence, there is a dire need to put the economy on a high growth path that is sustainable over the long run. Growth is a necessary condition for many good things to happen not just for the economy, but politically for the PTI as well before the 2023 elections. For the first time in years, a budget has been presented that is loaded with incentives for industry, agriculture and SMEs along with potentially game-changing documentation measures. Even its underlying fiscal stance is fairly realistic, with the revenue target not completely implausible, and the fiscal deficit target broadly achievable given available cushions on the expenditure side.
Not surprisingly, the federal budget has been well received. Yet, it has a potentially fatal flaw. The problem is that budget strategy, however apt on its own, cannot operate in isolation. Entrenched constraints in the economic environment cannot be ignored or wished away, none more so than the impact of economic growth on the balance of payments.
Pakistan has a low export base and a relatively high income elasticity of imports. While various published estimates for the latter range from 0.5 to 3.2, it is relevant to note that since 2005, while real GDP growth has averaged 4.5pc, annual import growth in terms of value has averaged over 11pc. This yields an imports to GDP growth ratio of 2.5x.
The budget strategy will deliver growth but raises the risk of external account stress.
Using this ratio implies that for the projected 5pc growth rate for the next fiscal year, import growth could be around 12.5pc. Hence, imports next year could well be in the vicinity of $63-65 billion. Exports are not as responsive to domestic growth, and are likely to be around $27bn in 2021-22. With worker remittances expected to plateau at around current levels, the gap between projected imports and exports for next year yields a current account deficit of around $7bn.
Factoring in the projected external debt repayments, Pakistan’s gross external financing requirement for 2021-22 thus stands at an estimated $25bn. With an expected oil facility on deferred payments from Saudi Arabia of around $2bn, and other sources of external financing, the next year will not pose a problem. The problem could arise on current trends, however, in 2022-23 — the election year.
With GDP growth projected to accelerate to close to 6pc in 2022-23, imports could rise a further 15-18pc — on an elevated base. Of course, international energy prices, among other factors, will have a large bearing on the actual increase in import value. Nonetheless, with external debt repayments expected to remain elevated, a sharp spike in the current account deficit could produce a difficult-to-manage situation.
The risks to Pakistan’s external account from the global economy over this timeframe are not insignificant, and are probably rising. A super-cycle in commodities is already playing out, which is expected to lead to sharp spikes in the prices of commodities that Pakistan imports such as petroleum products, RLNG, coal, palm oil etc. The second risk emanates from a potential tightening bias by the US Federal Reserve. With muscular spending plans by the Democrats increasing the risk of overheating in the US economy, even a change of language by the US Fed could lead to a repeat of the ‘taper tantrum’ the markets experienced in 2013, and a flight-to-safety of global capital that could starve external financing for countries such as Pakistan.
The government is absolutely on the right track by focusing on removing the constraints to economic growth imposed by the balance of payments. The finance minister has rightly identified exports, agriculture, ICT as the drivers of growth going forward, adding to the prime minister’s focus on tourism.
The problem is that these sectors have suffered policy neglect for years, or active anti-growth policies such as in the case of exports. The reforms required to make these sectors growth drivers are not just structural in nature, but also involve very substantial institutional and governance elements. By definition, these reforms take several years of consistent and coherent implementation before they deliver results.
The process cannot be short-circuited, no matter how pressing the economic or political need for growth in the economy. The extent to which the growth versus imports trade-off has been ignored in the budget is evident from the incentives given to small cars — an industry that relies on billions of dollars of imports annually. (There is also a completely unnecessary sop to a small band of stock market speculators).
A second potential issue with the budget strategy is the instrument used for stimulus. While a slew of incentives and some business-friendly changes to the tax code could have been enough to solidify the economic momentum, the federal budget incorporates a 43pc increase in development spending. Despite the conventional wisdom, both the economic as well as political benefits of muscular development spending are questionable.
First, the spending under PSDP/ADPs suffers from large ‘inside’ as well as ‘outside’ lags. Second, the efficiency of spending under PSDP has fallen drastically since the 1990s, as measured by the IMF’s Public Investment Efficiency Index, and its boost to growth as well as distribution of benefits is moot. Even politically, the strategy has been seen to be ineffective, as both the PML-Q and PML-N governments discovered to their chagrin in 2008 and 2018 respectively.
All in all, the federal budget lays an excellent foundation for growth in the short run, but ignores very real risks on the external account front.
The writer is a former member of the prime minister’s economic advisory council, and heads a macro-economic consultancy based in Islamabad.
Published in Dawn, June 18th, 2021