ECONOMIC management in Pakistan has for a long time been based on ad hoc decisions and temporary patchwork neglecting the fundamentals of the economy. It has given birth to two interrelated structural deficits of the budget and the balance of payment.

These deficits have for a long time been ‘financed’ by borrowing, landing the country in the existing state of ‘stagflation’ which combines a low rate of economic growth with a high rate of inflation.

The shortsighted solution of depending on borrowing to ‘finance’ the two structural deficits, rather than being addressed through basic policy reforms, has by now itself become a major contributory factor to their deepening and widening. Debt servicing and debt repayment have become structural in nature making it more difficult and painful to tackle these deficits.

The increasingly daunting task of the needed reforms to reduce the two deficits prompted successive governments to continue to opt for expediency and easy solutions rather than take the political risk of implementing difficult economic policies. Moreover, widespread corruption, vested interest groups and a flourishing underground economy have stood in the way of structural reforms.

It was hoped that the present government would read the writing on the wall and try to initiate basic policy reforms to address the fundamental structural problems. Unfortunately, it failed to understand the gravity of the situation and made no serious effort in that direction. It appears that with the coming elections, the government would continue to subordinate economic policy decisions to short-term political considerations.

The most likely scenario is that the government will continue to follow the existing approach in the remaining part of the current fiscal year, and public expenditure is likely to exceed the budgeted amount by a wide margin. The losses of the public enterprises will remain large, which in fact is a hidden component of the budget deficit.

The massive line losses and theft of electricity will not be addressed which, in combination with increasing average cost of electricity per unit, will leave a substantial ‘deficit’ in energy-sector operations necessitating its filling through bank borrowing. The provinces are also likely to continue their spending spree and bank borrowing The fiscal year 2012-13 being an election year, the status quo would most likely be maintained and the budgetary trend of 2011-12 will accentuate.

Neither the federal nor provincial governments will take steps to reduce their wasteful expenditure and may in fact increase it in the election period. No new tax initiatives are likely to be taken to raise revenue.

At the same time, with the termination of the standby arrangement with the IMF, and a decline in the net external funding of the budget, the gap between uncovered public-sector expenditure and its revenue will widen considerably in 2012-13. This deficit will be met mostly by borrowing from the commercial banks.

No structural reforms will be implemented to stop the bleeding of public-sector enterprises and their borrowing needs will increase. The circular debt of public-sector enterprises will continue to be financed from the banking system rather than through their restructuring or privatisation.

In order to avoid crowding out of the private sector, the State Bank of Pakistan (SBP) will be obliged to provide liquidity to the commercial banks. The recent reduction in policy rate by the SBP will only add fuel to the fire.

The cumulative outcome of fiscal and monetary policies will be a sharp rise in net domestic assets of the banking system and in the next year and a half.

Consequently, by the latter part of 2012-13, more intensive inflationary pressures will be felt by the people and the economy, even if not captured by the new consumer price index due to a revision in its base and weights.

In an inflationary environment, and with the fiscal policy in disarray and monetary policy subservient to the financing requirements of the government, saving rate, public and private investment and the rate of economic growth will remain low.

The balance of payments, which is already showing a deteriorating trend, will get worse in the remainder of the current and the next fiscal year. Exports will record very little growth due to the fall in international prices of export commodities and with the production disruption continuing due to loadshedding and worsening law and order and political situation.

The domestic demand pressure and a rising oil import bill will contribute to a deficit in the trade account. A slowdown in remittance inflows has already started which, in combination with a rising level of foreign interest payments and profit remittances, will widen the deficit in the current account of the balance of payment.

The wide current account deficit, combined with substantial repayments to the IMF and other capital outflow, will take its toll on foreign exchange reserves. The sharply declining reserves will create panic in the foreign exchange market.

By the latter half of 2012-13, the government will stand on the verge of an actual or potential external debt default. At that point, the country will either have to knock at the doors of the IMF and accept its harsh conditionality for a new bailout package or face the grave consequences of a potential debt default.

If this bleak outcome is to be averted, the government should give serious consideration to immediately adopting a homegrown programme of economic reforms in consultation with all stakeholders and begin to implement it no later than at the time of launching the 2012-13 budget. The political risks of difficult economic reforms in an election year will be much less than those emerging out of an economic collapse due to no action.

It should be understood that the choice for the government is not whether or not to take difficult economic policy decisions in the foreseeable future, but whether to take them voluntarily in an orderly, or involuntarily in a disorderly, manner.

The writer is a former governor of the State Bank of Pakistan.