May 052008

By Ahmad Faruqui 

LIKE a mirage, Pervez Musharraf’s much-vaunted economic miracle has come and gone. Shaukat Aziz’s claim that he doubled per capita income from $400 to $800 in four years may go down as one of history’s shortest-lived boasts.

For that statement to be credible, per capita income would have to grow at roughly 25 per cent per year and national income would have to grow at that rate plus the rate of growth of population of some two per cent. A growth rate of 27 per cent per year in national income would be hard to visualise, even allowing for the significant inflow of foreign remittances that took place after 9/11.

For a moment, let us assume that Aziz’s comparison was meant to be in nominal dollars. Subtracting an average inflation rate of seven per cent per year still leaves us with a growth rate of 20 per cent per year, much too high a number since it is double what China achieved during the past two decades.

Even if we throw in the one-time mysterious upward adjustment in GDP of 30 per cent that reportedly took place during the Musharraf administration, we come up short.

The economic and financial advisors in the new government will have to work hard to unravel these and other myths of the period.

It is true that million-dollar homes and Porsche cars first appeared on the scene during that period. But such vapid developments simply conveyed to the world that some people had become very rich. They did nothing to enhance the wellbeing of the common man.

The biggest disappointment is that the structure of the economy did not change much during the past eight years. The problems that plagued the economy in October 1999 are still very much there in May 2008.

Thus, the new government has to tackle multiple economic crises, not just one. First and foremost, there are the near-term crises related to the twin deficits in the fiscal and trade accounts and to the accelerating inflation rate.

Secondly, there are the medium-term crises related to the chronically low domestic savings rates, an undiversified source of foreign direct investment which largely consists of money from expatriates (and the US government) and a chronically low income tax base.

Finally, there are the long-term crises related to rising income inequalities, a stubborn poverty rate and a rate of population growth that ranks among the world’s highest for well-populated nations like Pakistan.

A few of these stand out and are worthy of comment. The budget deficit is expected to come in higher than six per cent during the current fiscal year, 50 per cent higher than the threshold deemed safe by international lending institutions. Subsidies for food and energy products account for a good portion of the deficit but chronically high spending on defence, some of which is published in the budget and some of which is hidden under other categories, continues to exacerbate the problem.

The trade deficit during the first nine-months of the current fiscal year has come in at $14.5bn, up 44 per cent over the corresponding year-ago period. At this pace, the deficit will hit $19bn by the end of the fiscal year, setting an all-time record. The deficit is being driven by rising imports of consumer goods, such as mobile phones, luxury vehicles including bullet-proof cars, perfumes and cosmetics.

Not one of these purchases is going to enhance the productive capacity of the economy. In fact, by their conspicuous nature, they will heighten the tensions between the proverbial ‘haves and have-nots’ and further inflame inter-class tensions.

The Economist Intelligence Unit (EIU) estimates that trade deficit will continue to be about eight per cent of GDP during the next five years, up from six per cent in 2007. This will put further pressure on the value of the rupee and deplete foreign exchange reserves.

Inflation is making serious inroads into consumer pocketbooks. While some of it is undoubtedly due to the rising world price of oil, much of it is due to a lax domestic monetary policy which has financed the budget deficits.

According to the State Bank, inflation may reach nine per cent during the fiscal year ending in June, almost a third higher than the target rate of 6.5 per cent. And it is the inflation trend that is even more disconcerting. In February, inflation crossed over into double-digit territory, coming in at 11.3 per cent. Shortages of key food items, such as flour, have affected the population in both urban and rural areas.

It is clear that a strategy of economic growth premised largely on American military and economic aid has failed. The domestic savings rates remain low, leading to an investment rate of about 18 per cent. To achieve growth in the seven to eight per cent range, this rate would have to rise by 10 percentage points.

The Musharraf government had predicted an annual growth rate of seven per cent for the current fiscal year but the actual number may come in below six per cent. EIU estimates that the annual economic growth through 2012 will average around five per cent, attributing the slowdown in growth to tepid investment rates.

The international credit rating agency, Standard & Poor’s, downgraded the outlook on Pakistan last November when Musharraf suspended the Constitution and imposed emergency rule. It has given a B+ foreign currency rating on Pakistani debt, four levels below investment grade. This makes it very expensive to borrow money on world markets and further worsens the budget deficit.

The population of Pakistan continues to grow much faster than that of any other country in South Asia. In 1971, East Pakistan accounted for some 55 per cent of the population of Pakistan. Today, Bangladesh accounts for only 45 per cent of the combined population of Pakistan and Bangladesh.

If current trends continue, by the year 2050, Pakistan will become the fourth most populous nation in the world. This is not a cause for celebration but alarm, since it will slow the growth in per capita income, raise poverty rates and heighten income inequalities. This ‘demographic bomb’ poses a bigger threat to regional security than the nuclear bomb.

Finance Minister Ishaq Dar needs to come through with a new approach that will stop the economy from melting down, an event that will have horrible political consequences.

The writer specialises in defence analysis and energy economics.
Daily Dawn, 5/5/2008

 Posted by at 8:34 pm

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