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Economy in troubled times

October 02, 2012

THESE are abnormal times. How else should one describe the confluence of several crises reinforcing each other and generating an acute crisis of state and society?

The insurgency in the country (which is costing the economy more than $5bn a year), lack of political consensus on many issues, Baloch disaffection, unprecedented recession-like global conditions, massive power shortages, a budget deficit running wild, the ‘poor country’ image, the state’s inability to protect life and property affecting investment, and the annual increase of more than a million youth in the unemployed category are all contributing to social discontent and worsening law and order.

And to top it all there is a fragile government that will not get rave reviews on its competence to handle crises which even capable leaderships elsewhere would struggle to tackle. It would be a miracle for any economy to demonstrate even a semblance of resilience under these circumstances.

So how will 2012-13 pan out and what outcomes should one expect?

Well, GDP should grow by four per cent, although this will, among other factors, depend on how the weather behaves, with floods already ravaging some areas of the country. Obtaining a good agricultural output under these circumstances will not be easy, as we await the official assessment of crop damage caused by the untimely monsoon.

Both the small- and large-scale industrial sectors could do better this year, despite the scourge of power shortages — owing to a low base last year, lower interest rates and increased government and private spending in the domestic economy in an election year.

We should expect industrial output to improve partially also because of increased demand for goods from the rural sector as crop prices begin to climb owing to international developments (e.g. the drought in the US), and as a result of reduced supplies owing to crop losses from rains and floods. With excess capacity, the manufacturing sector (facing stagnation in production and sales volumes) should be able to respond fairly quickly to the increased demand without being inflationary.

However, it will be next to impossible to achieve a fiscal deficit of less than eight per cent of GDP this year. This is partly because a) tax revenues will be lower than the ambitious budgetary estimates; b) we are fighting a battle for the country’s survival; c) this is an election year; d) the subsidy for the power sector is now touching Rs10 lakhs a minute (Rs140 crore a day); and e) Islamabad is not seen to be losing sleep over the worsening situation.

The resulting heavy borrowing by the government will deny the private sector adequate volumes of credit at a time when uncertainty in our traditional export markets shows no sign of ending.

Moreover, contrary to official projections, inflation will continue to be double-digit. This is because international commodity prices are firming up (although the saving grace could be oil if its price settles at around $100 a barrel); b) administered prices of utilities — electricity and gas — are being raised steadily; c) expectations regarding inflation will reinforce inflationary trends; and d) the pressure on the rupee will not abate in the foreseeable future (given our higher rate of inflation than that of our competitors) even if the Americans give us the $400m we are hoping they will part with before their presidential election.

It will be difficult to achieve macro-economic stability under these circumstances (all self-inflicted). Trying to do so may well result in the death of a junkie addicted to bailouts by the international community which has tended to be too eager to loosen its purse strings for fear of chaos.

Our Achilles’ heel is our external account. We will need $ 3.5bn to $4bn to finance the current account and that too provided Etisalat coughs up the overdue $800m and our export earnings remain flat at last year’s levels (assuming we sell low-value products whose demand is not likely to be affected too badly despite the global gloom). Also there will have to be enough interest in acquiring 3-G licences (with budgeted receipts of Rs79bn) and the dream of a Euro bond float of $500m needs to be realised.

Flows from the World Bank, ADB, the US and UK cannot fill a hole of this size. Thus, certain actions may result as default measures, like regulatory duties, higher import tariffs, 100 per cent LC margins on imports of ‘luxury items’ and the inevitable depreciation in the value of the rupee.

We may have to request the Saudis (and maybe the Kuwaitis) to accept deferred payments for their oil, initiate privatisation of some assets to foreigners and perhaps resort to ‘bad policies’ like import bans/controls on some items (with all its implications under the WTO).

Moreover, even after taking these steps a significant proportion of this gap might have to be financed by depleting foreign exchange reserves, already down to $10bn, equivalent to three months of imports. How the market reacts to such an outcome would be anyone’s guess, apart from piling additional pressure on the rupee.

Indications of market views on these developments should start becoming visible by the end of this calendar year, testing our management capabilities on this front much more seriously by March 2013; a parting ‘gift’ from the caretakers to the next coalition government.

To conclude, the Pakistan economy can now only be fixed and growth restored, if not enhanced, by painful structural reforms. This will be a long haul, requiring better quality governance and management if growth prospects are not to be unduly compromised and some trust in government is to be repaired.

The ‘more-of-the-same’ approach is no longer an option and the actions required will test the limits of what is politically feasible. But is there a leadership on the horizon well prepared and determined to embark on this arduous journey, and capable of taking on powerful interest groups protecting the status quo?

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