Economic cost of uncertainty

Published August 22, 2022
The writer is a former ambassador to the US, UK & UN.
The writer is a former ambassador to the US, UK & UN.

ANTICIPATION of the resumption of an IMF bailout package has helped improve market sentiment. But given the turbulent state of politics, there is little reason to be sanguine about the country’s political and economic future.

Confirmation that the Fund’s executive board will meet next week to approve the loan programme has helped to strengthen the rupee and revive market confidence. It also resulted in a largely buoyant week at the stock market.

Prime Minister Shehbaz Sharif has, in an essay written for The Economist, called the IMF programme the “path to safety”. But political turmoil continues to cast a shadow over the economy. The nexus between economic recovery and political uncertainty is not to be underestimated.

Under attack by both his own party and his government’s principal coalition partner, Finance Minister Miftah Ismail has stood his ground by taking painful but necessary decisions to close the deal with the IMF and thus avert the possibility of default by the country. The acting governor of the State Bank, Murtaza Syed, also played a key role by skillfully managing a difficult situation. Under his stewardship, the central bank issued thoughtful statements, ensured the exchange rate remained market-driven and made the right, though politically unpopular, decisions on interest rate policy.

The finance minister continues to face criticism from his party colleagues. But he has been straightforward about the austerity measures the government has had to take to prevent a meltdown of a precarious economy.

The political situation, however, is not proving to be an ally of the government’s goal to stabilise the economy.

The confrontation between the coalition government and opposition leader Imran Khan has assumed an ominous shape after PTI secured control of Punjab. The centre and the provincial government are now locked in a stand-off and tit-for-tat actions that are creating more political disarray. The tussle between the two over the custody of Shahbaz Gill is a case in point. As are the arrest orders issued by the Punjab government and police raids on the homes of PML-N leaders, who then fled the province.

The federal government, for its part, has been stepping up its drive against Khan over the foreign funding case, ordering the FIA to launch an investigation into PTI’s ‘prohibited funds’. Discord continues over the transfer of civil servants. The centre-province wrangle and the politics of settling scores has plunged the country into a vortex of turmoil and uncertainty.

More seems to be in the offing. Encouraged by the large crowds he has drawn, and his support base remaining unaffected by allegations of malfeasance by his opponents, Khan is in no mood to dial down political tensions. Neither is the Sharif government.

Editorial: Charter of the economy

Even though the prime minister has stressed the need for a “national dialogue” to evolve consensus on an economic charter, his government has done little to further this objective, perhaps because it sees this as an exercise in futility in the present fraught environment.

There is a close nexus between economic recovery and political certainty.

This means tempestuous politics will continue to heighten economic risk, keep markets edgy and investors in a hesitant state. Moreover, rifts within the PML-N and divisions on economic policy among coalition partners have raised doubts about whether the government will stay the policy course agreed with the IMF.

The burden of history rests heavy in this regard, given Pakistan’s stop-start record of previous Fund programmes, which earned it the reputation of being a one-tranche country. Therefore, questions continue to be raised about the longevity of the IMF programme.

The IMF deal in any case is a necessary but not sufficient guarantor of economic stabilisation, much less of durable economic recovery. The programme itself is not just about fulfilling prior actions but staying on track, implementing measures over time and rebuilding trust with international financial institutions. The Fund has already cautioned the government it might have to take additional measures “given the elevated uncertainty in the global economy and financial markets”.

Read: Prioritising economy over politics

Pakistan has faced many balance-of-payments and liquidity crises in the past. But never before has it confronted a financial crisis in such an adverse external environment, in which the aftershocks of the Covid pandemic and the fallout of the Ukraine conflict have left supply chains and global commodity and financial markets in such a volatile state. Energy and food prices have soared and fuelled worldwide inflation, exacerbating Pakistan’s economic difficulties. This at a time when global interest rates are rising, leaving indebted countries particularly vulnerable.

Political uncertainty has many damaging effects on a struggling economy. The exchange rate in particular is a barometer of such uncertainty as it is determined both by economic fundamentals and sentiment. Uncertainty affects the exchange rate as both inflows (foreign investment, remittances, export earnings) and outflows (imports and portfolio flows) are impacted by sentiment. This leads to weakening of the rupee, as the experience of recent months testifies. Depreciation of the rupee in turn fuels higher debt-financing costs and inflation.

Moreover, the most important indicator of the country’s growth path — and of sustained recovery — is the level of private investment. Even with the most robust policy actions, political uncertainty can vitiate the investment climate and dampen investor sentiment.

Political polarisation has another deleterious economic impact in Pakistan’s federal system. The central and provincial governments regulate different aspects of the investment environment. The federal government provides tax stability, the central bank external stability, while provinces have to foster a secure and conducive climate for investment to take place. But when politics is so divided and the centre and provinces at loggerheads, this acts as a disincentive for the private sector, which then prefers to sit it out. This diminishes chances of a sustainable economic rebound that clearly depends on new investment.

The irony is that all major political parties actually agree on the fundamental elements of economic policy — export-driven growth, curbing the fiscal deficit, instituting an equitable and simplified tax system, ensuring tax compliance, creating a business-friendly environment, adhering to a market-determined exchange rate, privatising bankrupt state-owned enterprises, bringing down inflation, reducing the debt level and restraining government expenditure. Despite this convergence, their efforts to seek political mileage drives them in the opposite direction, which puts the accent on their divergences at the cost of the country’s economic stability.

The writer is a former ambassador to the US, UK & UN.

Published in Dawn, August 22nd, 2022

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