Macro blues- By DR FAISAL BARI

Macroeconomic issues have, in a relatively short period, become quite binding for the economy: to the extent that today people are talking about Pakistan defaulting on its international obligations, its banking system becoming unstable, while there have been mini runs on some of the banks and people have tried to move out of Pakistani rupee and into dollars, at the same time trying to get the dollars out of lockers and money out of the banking system at large. The stock market continues to be in doldrums. So, the entire situation looks pretty bleak, unstable and quite unpredictable.
It is interesting to note that it was only a year or less ago that the last government had been celebrating the many years of high growth that had been achieved in Pakistan. They had been declaring that Pakistan’s foreign debt, as a percentage of GDP, had come down substantially, local demand and production and hence growth were healthy and due to significant inflows, Pakistan was, according to them, doing quite well. More than that, they also claimed that since our ‘fundamentals’ had become much more sound and since the economic growth had become more robust, Pakistan was on a sustainable growth path and was on the verge of ‘takeoff’ and so on.
Clearly the speed with which the entire growth structure has unravelled and the way Pakistani economy has been brought on to its knees gives a lie to the claim that the growth was robust and the fundamentals were sound. But of course, there had been growth in those years. So, why did the growth not become robust and why did the fundamentals not get better? These actually might be the key questions for researchers to answer if they want to address the issue of sustainability of growth in Pakistan.
The answers to these questions will, most likely, come from a variety of areas. Though there had been growth it was not broad based, it was not based on sectors (agriculture, livestock, textile) where we seem to have lots of potential and lots of competitive advantages, it was based on high domestic consumer demand and with a hefty component for imported consumer items, it was not export led, and it did not have a high employment elasticity. Furthermore, though the growth was accompanied by significant foreign direct investment (FDI) inflows, they were mostly restricted to consumer related industries and for catering to domestic demand rather than for creating exports from Pakistan.
Another main failing of the last government occurred in a different area: at the time when the government had fiscal space due to increased remittance flows, FDI as well as increased foreign aid flows, while our loans had been rescheduled to give us more breathing space, the government failed to address the issue of institutional reforms almost completely. Banking was probably the only sector that had some serious reforms implemented. But other sectors and areas, equally important if not more so, were more or less ignored. There were no reforms, to speak of, in areas like judiciary, property rights regime, contract enforcement, police, regulatory environment, government administration and so on. And where reforms were introduced, like in local government, they were not sufficiently entrenched in the larger set-up to allow for smoother functioning.
Given the above and other weaknesses it is not surprising that the growth was not robust and the unravelling happened so fast. We did not have a solid base and our fundamentals were clearly not right. We were not getting growth from areas that were/are our strength, we had entrenched structures that did not and could not support modern industry and commerce, and we did not have the pre-requisites in place for markets to work efficiently and on their own.
The growth was there, but it was based on exuberance of ‘animal spirits’ caused by the large amounts of money that were coming in due to the fiscal space that had been created in the wake of 9/11 and due to the creation of various bubbles that, once created, had the power to feed off themselves and one another. Consumer demand and lower interests allowed local industry to expand and do well, which in turn gave more money to the local professionals and other richer groups and this created subsequent demand. Similarly money availability created the initial land boom and later the two fed each other. The same sort of thing happened in stock markets as well where initial injections created upward and rising trends and coupled with rising trends elsewhere it allowed more people to have the confidence to invest in stock and capital markets and that, in turn, encouraged even more people to enter and to make profits while the going was good and so on and so forth.
The main problem with this sort of growth is that when a downturn comes the bottom can vanish from most markets. This is indeed what we saw in the case of our stock markets, and this is exactly what we are trying to avoid in other markets and sectors. It is interesting to contrast Pakistan and the Indian experience in the current scenario. Both countries have been hit by the oil and food shocks, both countries are now being hit by the international crisis, but where India is still hoping to post 7 percent GDP growth this current fiscal, we are expecting Pakistan’s GDP growth to be around 3.5-4 percent this year and probably the next year is going to be tough as well. This is an indication of how weak was our economy, how the crisis we are facing, though worsened by international crisis, is more a domestic crisis than an international one, and how it is based on the basic weaknesses in some of the fundamental structures in our economy.
The situation is surely grave. We have to not only deal with the short-term crisis, we have to plan for the medium and long-term too. We cannot think of stabilisation alone or growth will not come back. This makes the managing act a lot more trickier: the State Bank of Pakistan (SBP) and the government have to maintain a fine balance between reigning in the economy to squeeze demand a little to handle issues related to the fiscal deficit, the large import bill and the high inflation, it has to, at the same time allow for domestic industry to produce and invest to gear for higher growth in the medium term.
This is not an easy thing to manage. If SBP raises interest rates to squeeze demand and bolster the rupee, it takes the risk of stalling investment, forcing a lot of existing borrowers into default and putting additional pressure of Non-Performing Loans (NPLs) on to banks that are already reeling from the effects of the financial crisis. But if it does not raise interest rates, how do we bring inflation in some check or limit local demand and even make real interest rates positive?

There are a number of domestic options that the government should definitely explore. It has to cut down development and non-development expenditures and raise more money through additional taxes, but we know that the scope for these activities in rather limited in the short run. So despite these measures we might not be able to manage the crisis. One way that could really help Pakistan out of the mess is to find money from outside of the country. If we could raise $10 billion odd for the moment, the exchange rate crisis would vanish, for the time being, and with it a lot of the woes of the domestic financial sector will go away as well and so will the problems that government finances are facing.
But this would be a short-term solution only. We need to increase domestic production, increase exports and we need to initiate and implement the institutional reforms that we have been avoiding for decades now. If that is not done even if the government is able to manage the short term issues, they will come back to haunt us in a few years, as they have done many times in the past as well.
You cannot build a tall building on weak foundations. This should be obvious to all, why is it so hard for successive governments to comprehend? It is time for us to, while weathering the storm, build stronger foundations. The best time to do this is of course when the sun is shining (when we had fiscal space) but the worst outcome would be if we once again choose to delay it and try to get by as in the past.
The writer is an associate professor and Head of Department of Economics, LUMS and senior economic analyst


Source: The Nation, 20/10/2008

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