PAKISTAN is again facing a severe economic crisis, with the usual debate about which government is to blame. The question is, how should we compare the performance of various governments if we are looking for a fair and non-partisan assessment? The purpose of this piece is to offer a framework.
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The underlying causes of our repeated crises relate to our poor productivity and low investment level. From examples of high growth countries, we need investment/GDP to be somewhere close to 30 per cent to grow around 7pc. With our investment/GDP of around 15pc and dismal productivity, it is no wonder that we cannot grow faster than 4pc or so without developing deficits that result in a crisis.
The only way we can have sustainable growth is through reforms that improve productivity, reduce rent-seeking, and reorient our economy from excessive consumption towards higher saving and productive investment. But reforms are harder, and it is easier for governments to use ad hoc measures to pursue growth.
When the economy grows, the rise in consumption also increases our imports. As our foreign exchange earnings fail to keep up, we run into a balance-of-payments crisis.
Such a crisis is marked by a rapid fall in the currency which is inflationary, and the shock brings down the growth rate sharply. To prevent the currency from tanking further, the interest rate must be increased, which is also contractionary. The government is also forced to take austerity measures as an external deficit goes hand-in-hand with the budget deficit. Last but not least, the money borrowed to stabilise the economy means more external debt.
Had PML-N been re-elected in 2018, it would have more or less done what the PTI government did.
Some people often blame governments and the IMF for devaluing the currency. The reality, however, is that devaluation is a misnomer. The exchange rate is determined by the supply and demand for dollars; if we are not earning enough dollars to cover our imports, the rupee is bound to fall. The only way to keep the exchange rate fixed, despite a large external deficit, is for the State Bank to sell dollars in the market to make up for their shortage, assuming that it has the dollars to sell. However, this is only a recipe for depleting reserves and worsening the external deficit by effectively subsidising and encouraging imports. Consequently, when the reserves run out, the currency has a bigger fall. Such a policy is therefore like the proverbial ‘hundred onions and hundred chitters,’ since it does not save the currency and only drains the forex reserves.
Every dollar sold off in this senseless pursuit, eventually has to be re-borrowed, worsening foreign debt. It is better to let the currency float freely, or better still, keep it even slightly undervalued by purchasing dollars, thus building forex reserves and also maintaining competitiveness while disincentivising imports.
In short, a large external deficit causes a full-blown crisis with a sharp currency crash, high inflation and low growth, and necessitates measures like an interest rate hike, austerity and borrowing. A government that creates a large external deficit sets up the economy for a big fall. Whether that fall occurs under its watch or lands in the lap of the next government, the real blame lies on the government that is responsible for the external deficit.
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A government that inherits a massive external deficit from the previous one inevitably ends up being unfairly blamed for the sins of its predecessor, even from many analysts who should know better.
In contrast, a government that does not inherit an external account mess is a fortunate one as it does not have to receive an incessant barrage of brickbats. For these reasons, when we evaluate our governments, we must avoid being deceived by symptoms. Any government giving us a high growth, low inflation and stable rupee story without reforms, and without earning enough dollars to cover our imports, is selling us snake oil which will inevitably end in pain.
It is against this backdrop that we should assess the performance of our governments. Of our four post-Musharraf governments, PPP (2008), PTI (2018) and PDM (2022) inherited severe external crises. We can argue about which of these crises was more serious, but the one lucky government that did not inherit a large current account deficit was the PML-N (2013). So naturally, the currency and growth did not suddenly crash after the PML-N took charge as it did not have to spent its first two years cleaning up after its predecessor’s external deficit.
Yet it gave us just the kind of low inflation, stable exchange rate and high growth package that should immediately trigger our snake oil detector. Like the other governments, it too did not carry out any structural reforms. And it maintained the exchange rate not by earning enough exports or attracting foreign investment to cover our imports, but by selling State Bank dollars in the market. This gave us low inflation and consumption-fuelled growth with rising imports, creating a $19 billion current account deficit for which the next government would take the brickbats for the inevitable, painful unravelling.
After leaving the economy with a massive external deficit in 2018, the PML-N and its supporters had fun bashing the PTI and being completely illogical about the real origins of the crisis they left for the latter. Today, the roles are reversed, and it is now the PML-N’s turn to get bashed, with the PTI gloating and scoring cheap points.
The reality, however, is that had PML-N been re-elected in 2018, it would have more or less done what the PTI did on coming to power, and the economic indicators would have fallen roughly the same way. And had PTI not been toppled now, it would be doing more or less what the PDM will be doing in the next year and a half, with nearly similar results. Tweedledum and Tweedledee are not that different, notwithstanding what partisans say.
The underlying problems are cumulative and require deeper structural reforms, without which the economy cannot grow sustainably. Instead of drawing simplistic conclusions based on symptoms, we need to clamour for reforms and call out our governments whenever they give us any growth story without reforms, and especially when they leave the economy with a massive external deficit. Only when our discourse moves in such a direction can there be a momentum for reforms and some hope for our economy to be fixed.
The writer is a physicist and also has a business administration degree.
Published in Dawn, June 30th, 2022