No one can dispute the fact that the economy today is caught perilously in a situation of low growth and high inflation. What brought the country to this pass is also uncontested – governments, both at the federal and provincial level, that over decades lived beyond their means.
The country’s economic managers do a good job of explaining the challenges this poses to the country’s financial stability. They are well aware of the root causes of Pakistan’s compounding economic problems. They also know what needs to be done and why prompt remedial action is necessary to deal with the fiscal deficit crisis. The remedy lies in sharply cutting down public sector expenditure and raising resources through comprehensive and equitable tax reforms. Left unaddressed, the fiscal problem will push the economy towards a train wreck, whose consequences for Pakistan’s stability are not hard to guess.
Why then has the budget for 2011-2012 fallen so short of the corrective measures warranted by the febrile state of the economy? The short answer is a weak will to reform – increasingly driven by electoral considerations, as political leaders set their eyes on the 2013 general elections. A capable economic team has obviously been unable to convince its political principals of the need to take admittedly difficult but necessary decisions.
With 2013 as the defining prism, the budget has been reduced to a patchwork, risk-averse document. It takes minimal action to contain the runaway budget deficit. It also avoids structural measures, including meaningful expansion of the tax base, that can help the country break out of the cycle of high inflation and low growth – stagflation – that it is mired in.
The key question for budget-makers was how to finance the deficit of Rs1 trillion: mobilise domestic revenue or resort to the usual dysfunctional way of continuing to borrow from the central bank? With official spokesmen proudly proclaiming that no new taxes had been levied in the budget, the answer is no surprise. And the consequence is equally clear. More borrowing.
While the finance minister described reducing the fiscal deficit as a government priority, it is hard to see how this will be achieved. The taxation measures are simply not there to produce significant reduction. Implementation of a broad-based VAT-type General Sales Tax (GST) has been shelved. Removal of more exemptions from the sales tax has been resisted.
No asset tax has been levied and no wealth tax re-introduced. Despite the recent political debate on an agricultural income tax, the authorities have used the provincial jurisdiction of the tax as an alibi not to move in this direction. There was nothing to stop the PPP-led coalition – except its own constituency – to show its commitment to reform and implement this in Sindh thus challenging the Punjab and Khyber Pakhtunkhwa to follow its lead. But this was trumped by the electoral considerations that weighed on the minds of its leaders.
The aversion to taking tough political decisions was evident not only from the absence of significant tax measures in the budget but also on the expenditure side by the lack of credible action to contain wasteful expenditures, reform loss-making Public Sector Enterprises (PSEs) and prune price subsidies. Only such actions can restrict borrowing from the central bank and from abroad. In the absence of significant expenditure restraint and additional real resource mobilisation the only way of plugging the budget’s financing gap will be by more bank borrowing. Printing more currency notes by the State Bank of Pakistan will only push inflation up further. An environment of rising inflation and low growth will confront the country with the specter of being stuck in a low equilibrium trap at a time when poverty levels are rising. More reliance on external borrowing will add to balance of payments vulnerabilities.
When the average official rate of inflation has been around 15 percent for the past four years and the economy has only been growing at 3 percent, the population growth of between 2-3 percent means that per capita growth has been stagnant. With food inflation outpacing other price increases, the indicators suggest that poverty has been rising. This also means that the economy is failing to create jobs for the approximately two million people entering the labour force each year. Continuance of these trends heightens risks for the country.
The positive optics of higher exports, higher overseas workers’ remittances, and a comfortable level of foreign exchange reserves, have given the government a sense of confidence that it can coast along on these factors to the 2013 polls. The official calculation is that a replay of the 2008 situation (when the twin fiscal and balance of payments deficits soared to record levels forcing Pakistan to turn to the IMF) is for now ruled out by this relatively strong external position, reflected in the rare surplus on the country’s current account.
This position however is the result not of policy but of windfall factors that may not hold. A sharp rise in world commodity especially cotton prices, is mainly responsible for the export ‘surge’ and not an increase in its volume. The rise in remittances is due to fears of surveillance of such transfers by ‘unofficial means’ in countries where overseas Pakistanis reside, as well as channeling of a growing part of export proceeds in the form of remittances. There are limits to this upward trend. Moreover this transient, exogenous factor cannot offset the need for sound budget management.
There are in any case trends moving in the opposite direction. This rise in international oil prices will begin to exert pressure on the balance of payments. So will external debt repayments especially to the IMF in the next four years. As a result the country’s reserves will begin to erode, as no offsetting financing is available at a time when the oil import bill is rising.
Continued reliance on borrowing to finance the budget deficit will also start depleting foreign exchange reserves, put pressure on the exchange rate and erode confidence in the country’s currency.
In fact excessive borrowing both at home and abroad over the years has saddled the country with a debt problem that everyone agrees is unsustainable but that those in authority do little to remedy or curtail. The long standing practice of showing external and internal borrowing as ‘external and internal resources’ in the budget and other economic documents shows an official mindset that pretends that public finances can continue to be managed by this pain-free, smoke-and mirrors approach.
This is untenable. Not only are external ‘resources’ dwindling but internal ‘resources’ mobilized by bank borrowing are now pushing the country into an intensely inflationary environment in which the cruelest tax on the poor – inflation – is eroding people’s incomes, crowding out private investment, and can over time threaten social stability. If the budget was a missed opportunity and signified an effort to kick the can of structural adjustment down the electoral road, the question this raises is what will stop the slide of the economy, stuck in the vortex of escalating inflation, sagging growth and shrinking investment? The lack of a credible road map and corrective measures to deal with widening macroeconomic imbalances means that the danger of an economic breakdown is far from over, even if electoral politics rather than sound economics remain the priority of the country’s rulers.
The writer is special adviser to the Jang Group/Geo and a former envoy to the US and the UK
Copyright “The News International”
If not for your writing this topic could be very convluoetd and oblique.