There seems a dangerous disconnect between the economic challenges confronting Pakistan and its response to it. The leadership’s inability to anticipate their gravity and the inadequacy of its response could prove disastrous.
Last week, Finance Minister Ishaq Dar presented the ‘balance sheet’ inherited from the previous government as of March 31, 2008 in the presence of the top bureaucrats who had been closely associated with the past regime. He rightly pointed out that the budget deficit has hit unsustainable and highly inflationary level and cut the real GDP growth estimate for the current fiscal year to six per cent from 7.2 per cent and revised the inflation estimate from 6.5 to 10 per cent.
These growth and inflation estimates do not fit in with the overall picture nor are they supported by the government’s own data. But he perhaps did not have sufficient time to examine the growth and inflation data prepared by the finance ministry officials to question their validity. If the growth is indeed six per cent, it contradicts his own view that the economic growth under the previous regime was unsustainable because it is a respectable number. This is a crucial question. If we do not have the full appreciation of the seriousness of the economic issues and right picture of the economic growth and trends, the fiscal and monetary policy responses to the issues will prove to be inadequate and run the risk of failure.
The rot is far greater than just the budgetary overruns and current account deficit. Pakistan faces the looming threat of a sharp economic down turn in the backdrop of high inflation, global financial, oil and food crises, energy shortages, capital flight, stagnant exports, falling foreign exchange reserves, a depreciating currency, and slowdown in investment activity.
The reason that the real economic growth cannot be six per cent during FY2008 is simple. The forecast real GDP growth rate was 7.2 per cent with the target inflation rate of 6.5 per cent. During the nine months from July 2007 to March 2008, the cumulative rise in the consumer price index (CPI) was 13.30 per cent and 15.75 per cent in the wholesale price index (WPI). Obviously, these numbers will be higher for the entire 12-month period.
Based on the ninth months’ rise, the annualised inflation rate works out to be 18.11 per cent for the CPI and 21.53 per cent for the WPI. It is important to note that much of the real GDP data is calculated using the wholesale price index (WPI). In any case, pick any inflation index, the real GDP growth cannot be more than three per cent in FY 2008 unless the (previous) government’s economic managers can provide a convincing explanation of the glaring inconsistencies in what are the some of the most important macro economic indicators.
To say that the economic position is worse than what has been previously acknowledged is an understatement. It is a ticking time bomb which together with a historically weak commitment to reforms can cause far more damage than the unfortunate violence seen in Lahore and Karachi during the past week. The establishment must not give in to the temptation to play the familiar power games to put pressure on the ruling coalition because the failure to stabilise the economy would have serious repercussions and no future administration would be able to fix it without a prolonged period of severe economic stress. Precious time has been lost in the formation of the governments since the February 18 elections whilst the economic managers had already been paralysed by the political developments since March 2007. While the media’s attention has been riveted on the judiciary issue and more recently on the violence in Lahore and Karachi, it would do the country a huge favour by also focusing on the economy teetering on the verge of a sharp slowdown compounded by a global economic crisis.
Rising food prices could spark worldwide unrest and threaten political stability, the UN’s top humanitarian official warned last Tuesday after two days of rioting in Egypt over the doubling of prices of basic foods in a year and protests in other parts of the world. Sir John Holmes, undersecretary general for humanitarian affairs and the UN’s emergency relief coordinator, told a conference in Dubai that escalating prices would trigger protests and riots in vulnerable nations. He said food scarcity and soaring fuel prices would compound the damaging effects of global warming. Prices have risen 40 per cent on average globally since last summer.
According to the officials of the World Food Programme (WFP), nearly half of Pakistan’s 160 million people are at risk of going short of food due to a surge in prices. The WFP survey covering the year to March showed the number of people deemed “food insecure” had risen to 77 million from 60 million in the previous year. The WFP estimates that anyone consuming less than 2,350 calories per day is below the food security line.
Sahib Haq, an official with the WFP’s Vulnerability Analysis & Mapping Unit in Pakistan, says food prices rose at least 35 per cent in the past year compared with an 18 per cent rise in minimum wages. “There is a very big gap between the increase in prices and increase in wages ... the purchasing power of the poor has gone down by almost 50 per cent,” Haq said.
Given the ground realities, the policy options are difficult and demand a full reappraisal of the fundamental issues and formulation of a comprehensive reforms programme. While there is a broad consensus that we need to control inflation, cut fiscal and current account deficits, and increase investments, the challenge is to come up with a comprehensive response because the time for piecemeal solutions is up. Although there is no choice except to borrow to finance the current deficits, this is not a sustainable option. The government is trying to raise about $2.5 billion in foreign exchange funds by the end of June.
It is an established fact that a democratically elected government’s best time to introduce difficult economic reforms is around the beginning of its tenure, especially during a crisis period. It takes time to formulate and implement a programme. Under the current circumstances, the government faces the seemingly contradictory challenge of raising tax revenues and stimulating investments. It must cut the deficit but it also needs the fiscal space to allow for subsidies and development expenditure or face popular backlash.
In the wake of past fiscal crises in other developing countries, introducing tax reform that can provide incentives for growth, can meet needs of the poor and can increase revenue collection proved central to state viability and effectiveness.
Pakistan’s problems are no different from many other developing countries and they have been able to implement tax reforms. Because taxation affects incentives and distribution of resources simultaneously, tax reform requires either a degree of social consensus that such policies are in the collective interest and/or it requires a state with the ability to coerce those who challenge its allocations. Since the purely coercive approach has not worked due to the general absence of the rule of law, its rulers need to write a new social contract with the upper income classes and convince them that without an adequate revenue base, the system itself is in great danger. This would necessitate a radical restructuring of the tax system including reduction in the number of different types of taxes, reduction in the maximum rates of taxes, and removal of incentives to evade provided there is clear road map to raise the tax revenue base to Rs2,000 billion.
However, expanding the revenue base and tax net alone will not be sufficient to mobilise the resources required for boosting investment spending. Investments cannot grow at the required pace without a high rate of domestic savings. Hence, the government needs to introduce special schemes to enable commercial banks to mobilise long-term funds. For example, it should allow the banks to operate tax and zakat free long-term deposit accounts on the pattern of the retirement savings accounts in other countries where contributions to such accounts are tax-exempt provided the funds are kept for the specified period. Similarly, special schemes should be launched to attract funds from overseas Pakistanis into longer term investment products on the pattern of non-resident Indians (NRI) schemes in India.
These are just some examples of the type of reforms needed and point to the need for the government to start a dialogue with the business and other elites to write a new social contract with the objective of introducing a comprehensive package of imaginative reforms because tax reform at the end of the day is essentially a national and political policy issue and not just an economic problem.
The writer is the author of “The Gathering Storm. Pakistan: Political Economy of a Security State” to be launched shortly.
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