DAWN IN its editorial of July 29, 2002 entitled, “Not the Right Indicator”, commented on various key economic indicators of the country. Regrettably, the editorial under review is based on pre-conceived opinion that is not supported by facts. The editorial has touched almost all the key indicators but for the sake of brevity, I shall discuss three, namely, foreign exchange reserves, shrinking economic growth, and recession-ridden state of the economy.

The reason why I have selected three indicators is that many commentators in the past have written on these issues from time to time. An understanding of these indicators and their mechanics require considerable knowledge of macroeconomics. Else, there is a danger of committing errors. The purpose of this article is to clarify the issues raised in the editorial and educate readers and commentators who would wish to write on these issues. Let me begin with recession-hidden state of the economy first.

It has been observed that many commentators as well as general public use the word ‘recession’ quite liberally without actually knowing its meaning. How do we define recession-hidden economy? Technically speaking, when an economy registers negative growth for two consecutive quarters it is said to be in recession. In an individual economy, recession involves a fall in GDP. Has Pakistan’s GDP fallen ever? The answer is ‘No’. Pakistan has never registered a negative growth in real GDP. Then why talk about recession? Slower economic growth is different from falling GDP. Pakistan’s economic growth has slowed over the years for a variety of reasons, for which, I shall turn momentarily, but this does not mean that the economy is in recession. I hope, future writers would be careful in using the word ‘recession’.

Let me turn to shrinking economic growth as mentioned in the editorial. It has become a fashion to talk about declining investment rate and declining real GDP growth rate. But seldom has any body provided economic reasons for deceleration in these two key economic aggregates. During the last two decades, Pakistan has witnessed decline in investment and real GDP growth rates. Investment as percentage of GDP averaged 19 per cent in the 1980s, gradually declined to 15.6 percent by 1998-99, and remained at 15.9 per cent in 2000-01. With declining investment rate, The economic growth also witnessed a significant deceleration. The real GDP grew at an average rate of 6.1 percent in the 1980s but slowed to 5 percent in the first half and further to 4 percent in the second half of the 1990s. As a result of declining economic growth, the employment generation capacity of the economy also shrank. The ultimate outcome of declining investment and real GDP growth rates has been the doubling of poverty in Pakistan - rising from 17 to 32 per cent during this period.

Why investment and growth slowed over the years? The root cause has been the persistence of large fiscal and current account deficits over the last two decades. Fiscal deficit averaged almost 7 per cent of GDP during the last 20 years. The size of the deficit has been twice as high as of average of Asian developing countries. The current account deficit, on the other hand, averaged 4 percent of the GDP in the 1980s and 4.5 percent in the 1990s. The gaps in internal (fiscal) and external (current account) accounts have been responsible for the deceleration in investment and growth. The larger the gaps in internal and external accounts, the more we needed to borrow to fill these gaps. Large borrowings resulted in the accumulation of public debt at an astronomical rate during the last two decade. Pakistan’s public debt was Rs155 billion or 60 per cent of GDP or 317 per cent of revenue in 1980-81. It rose to Rs 800 billion or 92 per cent of GDP or 505 per cent of revenue by 1989-90. It further increased to Rs 3243 billion or 103 per cent of GDP or 606 percent of revenue by 1999-2000. Public debt which was a tiny trickle in 1980-81, quickly graduated to an avalanche by the end of the 1990s. What have been the consequences of astronomical increase in public debt?

The natural outcome of the massive increase in public debt has been the rise in debt servicing liability. Debt service was only Rs9 billion or 19 per cent of total revenue in 1980-81; it rose to Rs 74 billion or 43 per cent of total revenue in 1989-90; and by 1998-99 it rose to Rs343 billion or 73 per cent of total revenue. During the 1980s, debt service grew at an average rate of 23.5 per cent per annum and during the first nine years of the 1990s it grew at an average rate of 16.6 per cent per annum.

Imagine a country spending almost three-fourths of its total revenue to finance one budgetary item, i.e. debt servicing, leaving about one-fourth of revenue to be spent on social and physical infrastructure, running civil administration, maintaining a credible defence, allocate resources for development projects, and other activities. If this has been the state of the affair, should any sensible person/commentator expect investment and growth to rise? Since one-half to three-fourth of the revenue were consumed by debt servicing alone the successive governments had little choice but to cut development spending to keep budget deficit at around 7.0 per cent of GDP. Pakistan’s Public Sector Development Programme (PSDP) was 9.3 per cent of GDP in 1980-81. It declined to 6.4 per cent in 1990-91 and further to 2.8 per cent in 1999-2000.

When a country spends three-fourths of its revenue to pay for debt servicing and continue to slash development budget for such a long period of time, its investment and growth are bound to decelerate. When the government is in the borrowing mode to finance such a large fiscal deficit for such a long period of time, interest rate is bound to remain high, adversely affecting private sector investment. Public sector investment continued to decline for budgetary reasons as stated above. Therefore, overall investment decelerated over the years and consequently economic growth slowed.

I hope, I have made my points clear. The root cause of shrinking economic growth is the persistence of large fiscal and current account deficits for over two decades. It is for this reason that the government is making all-out efforts to reduce fiscal and current account deficits. Over the last two-and-a- half years, the government has succeeded in reducing both the deficits. Its beneficial effects are quite visible in terms of decline in both domestic and external debts in absolute term as well as in per cent of GDP. Much more is still required to bring the issue of public debt to a sustainable level. With the reduction in public debt and consequent decline in debt servicing, more resources will be freed from debt servicing and will be available for development spending. A beginning has already been made in fiscal year 2002-03. The PSDP for the current fiscal year is estimated at Rs 134 billion or 3.3 per cent of GDP with a possibility of raising it further to Rs 144 billion. A reduction of Rs40 billion in debt servicing in 2002-03 was made possible because of the reduction in public debt. This has enabled the government to raise the allocation for development budget. Simply passing a judgment about shrinking economic growth and declining investment rate is not enough. We must know the reasons for such a decline.

Let me turn to another indicator, i.e. foreign exchange reserves. It has been argued in the editorial that the accumulation of reserves was on account of reduction in imports, sudden jump in remittances, and official transfers. Furthermore, it argues that the issue of “purchase from the market is controversial” and that reserves should be built up by increasing exports.

It appears that despite sincere efforts by the governor of the SBP and myself to clarify the issue of foreign exchange reserves build up through print and electronic media, various commentators continue to create confusion and hence misguide the general public. As stated at the outset, the understanding of the changes in exchange rate regime and the role of the central bank in the new regime require considerable knowledge of macroeconomics. Failure to understand the regime does not imply that “the issue of purchasing dollars from the market remains a highly controversial matter.”. Let me make yet another attempt to explain as to how the foreign exchange reserves accumulated and why the State Bank intervenes in the market to mop up excess supply of dollars.

It is well known that a country builds up its reserves through a combination of measures. Most important are the improvements in the trade balance, increase in private flows which include remittances and foreign investment, assistance from donor agencies, grants from friendly countries, and purchases from the inter-bank and open markets. Pakistan’s trade balance has improved by $315 million in 2001-02. Improvement in trade balance is due mainly to decline in imports by 3.7 per cent or by $ 393 million. Let us analyse the decline in imports. Sugar imports have declined by 91 per cent or by $ 228 million because the country has produced enough sugar to meet its domestic requirement. Is it a bad thing to happen? Pakistan’s oil bill was lowered by 16.6 per cent or by $559 million during 2001-02.

The decline in oil bill is on two accounts. First, the price of oil in international market was low compared with last year by 13 per cent. Second, the imports of petroleum product are down by 9.0 per cent because Pakistan has emerged as an exporter of petroleum products. It has exported $ 112.4 million worth of petroleum products in 2001-02. When a country is exporting petroleum product why do we need to import. Is it bad to become an exporter of petroleum products? Only on these two items that the country has saved $ 787 million on import bill. Does this reflect recessionary trend in the economy? The answer is No. Because non-food non-oil imports are up by 5.3 per cent. Imports of machinery are up by 6 per cent. Imports of metal group (Iron & Steel) and textile group are up by 19 per cent and 16 per cent, respectively. Could we still say that the economy is in recession because imports have declined?

Workers’ remittances more than doubled during 2001-02. As against an inflow of $1.086 billion in 2000-01, workers’ remittances stood at around 2.4 billion in 2001 - 02 - an increase of almost $1.4 billion. Foreign investment totalled $475 million as against $182 million- an increase of $ 293 million 2001-02. Besides, Pakistan has received substantial assistance from donor agencies because of its credible macroeconomic policies. Pakistan has also received grant assistance amounting to $ 660 million from friendly countries.

Let me turn to explain purchases that the editorial still believe as “highly controversial”. The market-based unified exchange rate system that was introduced on May 19, 1999 was replaced by the free floating exchange rate regime on July 21, 2000. Under the new regime the exchange rates are determined in the inter-bank market on the basis of supply and demand of foreign exchange. All supplies of foreign exchange (export receipts, remittances, foreign investment) are sold in the inter-bank market and all demands (imports and other payments) are met by this market as well. The SBP has the prime responsibility to maintain stable exchange rate consistent with the country’s overall macroeconomic objectives.

The SBP mops up foreign exchange that is in excess to the requirements of the private sector. That is, the job of the SBP is to maintain equilibrium in inter-bank market. If there is excess supply of foreign exchange and SBP does not intervene then the price of dollar will fall and consequently the price of Pakistani rupee will increase. In other word, Pakistani rupee will gain strength or will appreciate viz. US dollar that will hurt Pakistani exports. Thus, SBP makes effort every day to maintain exchange rate that keeps Pakistani exporters competitive in international market. If SBP is not mopping up excess supplies of foreign exchange and allowing exchange rate to appreciate beyond threshold level then it is not doing its job properly. It is for this reason that SBP intervenes in the inter-bank on daily basis to mop up excess supply of foreign exchange and in the process builds the country’s foreign exchange reserves. Everywhere in the world where the country is in free float regime the respective Central Bank intervenes in the market to maintain stable exchange rate. Therefore, there is nothing “controversial” here. What is required is to change our mindset from the managed float exchange rate regime to a free float system and try to learn the role of the SBP. Things are changing at a rapid pace, both at home and abroad. We the commentators have to learn at the equal pace the new developments taking place in national and international scene.

Let me turn to another issue. It is generally argued by many commentators including the editorial under review that the country’s reserves should be built by increasing exports. A developing country whose economy has not yet reached to a mature level cannot build its reserves by simply increasing exports because its import will always be higher than its exports. In other words, its exports will not be sufficient to finance its imports, not to mention of building reserves. Let me give you some examples. India’s foreign exchange reserves were as low as $ 1.1 billion at the time of serious balance of payments crisis in 1991. Its reserves now stand at $ 54 billion. Has India built its reserves by increasing exports alone? The answer is No. India’s exports have fallen short to its imports in the range of $ 14 - 15 billion every year since then.

There are other countries like Argentina, Brazil, Chile, Mexico, Philippines etc. that have built their foreign exchange reserves but at the same time maintained trade deficit (i.e. their exports were not sufficient to finance their imports). Therefore, what is required is that the country minimizes its trade gap, encourages private flows, get assistance from donor agencies, and make efforts to get grant assistance from friendly countries to build its reserves. This is what Pakistan has done to build its reserves from as low as $ 400 - 500 million to more than $ 7.0 billion.

The build up of reserves have provided much needed stability to our exchange rate, strengthened the country’s external balance of payments position and significantly reduced the country’s vulnerability to external shocks. The stability of exchange rate has shielded the poor and common man of this country from the vagaries of imported inflation, particularly the rise in oil prices in international market. It has helped the country to reduce its public debt burden and released resources from debt servicing to spending on education, health and physical infrastructure. We must avoid passing pre-conceived opinion on economic issues without understanding their mechanics. The build up in foreign exchange reserves is one indicator. There are many indicators, such as domestic and external debt, inflation, exports, remittances, foreign investment etc. that have improved considerably over the last two and a half years.

The writer is Economic Adviser and the spokesman of the ministry of finance