State of the Pakistan economy: on the edge of precipice

Government’s real challenges are reducing fiscal and current account
deficit and increasing tax-to-GDP ratio
By M. Sharif

The year 2008 has passed into history leaving behind visible scars on the national economy, and the economies of the developed and emerging world. A cursory look at macroeconomic indicators of the country clearly indicates that gains made during the past seven years were lost during the year under reference. How, and why, all this happened and what will be its spill-over effects during 2009? These are some of the important questions that economists, financial analysts and managers of national economy will have to live with for taking corrective measures. The global financial crisis also took place during 2008 and has raised many questions about blindly emulating the American Capitalist Model of economic growth and development based on the free market economy exclusively and in vogue in many developing countries including Pakistan. Do they need to follow it any further or should they modify it radically to meet domestic needs? This question also needs to be addressed by policy makers in Pakistan and across the world.

 

Challenges during 2008

The country faced economic and political challenges during 2008 starting from general elections and the spill over effects of maintaining status quo in economic decision making, by the interim government. General elections which were held on 18 February, 2008 resulted in acquiring political power by a coalition government of two largest political parties of the country and the expectations of steering the country through economic crises.

The new government took sometime to grasp intensity of economic challenges and for this very reason did not react promptly at least during first 3-4 months of assuming power. Some of the measures it took to address economic issues through budgetary proposals 2008-09 and otherwise were considered adequate. These measures included withdrawal of subsidies, focus on agriculture sector to boost productivity, increase in price of electricity and gas and directly targeting poor segments of the society through the Benazir Income Support Programme at an estimated cost of Rs33 billion. This is still to commence. The government later realised that the malice was much deeper and needed a surgical operation that it won’t be in a position to do all by itself through what was hyped home grown stabilisation programme. It looked up to eagerly towards “the friends” with a lot of expectations but they did not deliver according to its expectations. It found that it had no option except going back to IMF. The government after substantial hectic activity of a few weeks succeeded to get a package of $7.6 billion from IMF in November 2008 after accepting tough conditionalities of reducing fiscal deficit, reigning in inflation and current account deficit and providing some sort of social security to vulnerable segments of society that had suffered quite a bit during 2008. It has received first tranche of $3.1 billion that boosted the depleted forex reserves from around $6.3 billion to more than $9.6 billion.

Most of the economic and social sector challenges such as inflation, fiscal, trade and current account deficits, income inequality and poverty alleviation that pre-existed worsened during 2008. They continue to persist despite some difficult decisions taken by the government to resolve them. Inflation started deepening from 2005 despite tightening of monetary policy by the SBP to contain it by increasing interest rates to reduce aggregate demand. It increased from 14.4 per cent by mid-2008 (end of FY2008) to around 22.0 per cent by end-December 2008. Primarily because of increase in prices of oil, food group items in international market and inflationary pressure built by indiscrete borrowing by the government from the SBP. It borrowed Rs688 billion from the SBP during last fiscal year most of which was borrowed during its last eight months (November 2007 to June 2008). The interim government did not pass on increase in oil prices till March 2008 to the consumers for reasons that were partially politically expedient. Inflation was also fuelled because of increase in food group items in international market during first half of 2008.

The present government withdrew subsidy on oil and electricity that added to public misery but would help to reduce fiscal deficit. Apart from inflation, energy, stock exchange, fiscal and current account deficit issues and crises of good governance and winning confidence of investors are some of the serious challenges that could not be tackled during the outgoing year and are waiting for prompt solutions. IMF package has put a number of constraints on fiscal management by the government such as reducing fiscal deficit to 4.3 per cent, inflation to around 14.0 per cent and borrowing from the central bank to zero level by the end current fiscal year. The government took some measures but to come out successful with IMF conditionalities, it will have to execute well calculated fiscal and monetary policies to measure up to the expectations of IMF and general public. The latter are likely to suffer because economic growth is likely to slowdown to around 3.5 per cent according to IMF and SBP estimate.

 

Government strategy

Government strategy to meet the challenges of 2008 has remained ambiguous till now. For example, it withheld functioning of stock market from August till mid-December 2008 for around four months out of the fear of collapsing it, could not keep its word of providing a bailout package of Rs50.0 billion (later changed to Rs20.0 billion) and could not finish circular debt of more than Rs200 billion in for electricity generation that has presently landed in the worst ever crises during winter season in history of the country.

Government’s real challenges are reducing fiscal and current account deficit and increasing tax-to-GDP ratio that was registered only 9.6 per cent by the end of last fiscal year. Ironically it was 0.1 per cent lower than the ratio registered by the end of FY2007and around 1.0 per cent lower than the average of 10.5 per cent of decade of 90s.This has happened despite higher economic growth of around 7.0 per cent during five years from FY2002-07. The government so far has not taken any concrete measures to boost tax revenue collection except expressing strong desire to increase it to around 15.0 per cent during next five years.

 In order to reduce fiscal deficit the government has already started curtailing development budget, a measure against the common thinking seeking higher expenditure to boost growth and employment. It has avoided taking the hard step of curtailing non-development expenditure, something least appreciable. This measure along with high commercial interest rate of around 20.0 per cent is unlikely to boost economic growth and put economy on sound footing for higher and sustainable economic growth. Ongoing energy crises that have literally crippled industrial, commercial and family life in the country are to affect productivity adversely in LSM, SMEs and agriculture sector. Export target of around $21.0 billion is unlikely to be met. It is doubtful if the government would really succeed to bring down fiscal deficit on one hand and reduce borrowing from the central bank to zero-level. The measure in all earnest would be untimely because nearly all sectors of economy need fiscal relaxation rather compaction.

Current account was positive four years earlier till FY2003-4. It ended up with highest fiscal deficit of around $14.0 billion, 8.0 per cent of GDP and needs to be curtailed. Inflow of foreign capital including remittances had given previous government illusive hope that inflows would continue endlessly.

Trade deficit during first six months of current fiscal year has not bridged to the desired extent but it is hoped that because of reduction in oil prices from November 2008, food prices and higher duty imposed on luxury items, there might be a little reduction in the trade deficit. Equally important is the point that because of global recession in developed countries, the destination of our exports, substantial reduction in trade deficit might not take place.

 

Global challenge

Global financial crises that started from the US have made free market economic system less trustworthy and reliable in the eyes of many analysts and economists. Free market can’t be allowed to operate at its own to correct itself and take care of itself as its protagonists had wished the world to believe. There is a strong realisation among Western countries that effective regulatory measures will have to be implemented for smooth functioning of free market economies to avoid “boom and bust” cycles after every 10 years that have become a norm rather than an exception in Western economies. Pakistan perforce has adopted free market economic regime but recent outflow of billions of USD and manipulation of markets to earn higher profits on tradable commodities is a grim reminder that all can’t be well in a free market of a developing country. Banking sector did not plunge into serious crises thanks to the vigil kept by the SBP. Managers of national economy therefore, need to keep an eye on the behaviour of the market and its various role players who are prone to deviating from the normal business practices and norms for making quick money.

 

Conclusion

Year 2008 pushed the domestic and global economy to the edge of precipice for reasons that are yet to be understood fully. In Pakistan, the reasons for economic meltdown are well understood but taking prudent and timely measures is one of the great challenges that the government has not met enviably during outgoing year.

http://jang.com.pk/thenews/jan2009-weekly/busrev-05-01-2009/p2.htm

 

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