Vagaries of Consciousness
- It’s not that bad
The social media is abuzz with outlandish predictions of economic melt-down. A post attributed to former World Bank/IMF officials is particularly vicious, which reads like an apocalyptic scene: “the external deficit is so big that exchange rate would go down to Rs200 even with an IMF program; the country would face a situation like that of Venezuela and Argentina – widespread shortages of reserves, expect fuel crisis and long lines for many other imported goods. To turn around would require scrapping of last NFC, shutting down of loss making SOEs, major increase in energy prices to cover losses in power sector, substantial increase in interest rate, substantial devaluation, major tax increases, major cut back in development expenditures and rapid privatisation. Basically to rapidly reduce fiscal deficit, slow down the economy, to reduce imports. Brace for a Venezuelan type of situation by December”.
Undoubtedly, there are elements of truth in this narrative but it is highly exaggerated. Surely, we have a difficult situation in hand. But we have faced such situations in the past and overcame the challenge once we did what was required to be done or refrained from policies responsible for the crisis. In the last three decades, we have faced a similar crisis for at least six times. This vulnerability started after liberalisation of Pakistan’s the external account. Prior to 1988, Pakistan was meeting its foreign exchange needs essentially from multilateral (World Bank-ADB) and bilateral (Aid-to-Pakistan Consortium) sources. The unipolar world spawned globalisation and international capital movements in the private sector. Markets and competition were the new rules of the game, and to be able to play, controls were to be removed.
While the country made major strides in opening trade, facilitating capital movement, removing forex controls and generally dismantling barriers to economic activities, we, however, failed to institute economic governance commensurate with the imperatives of new realities. In particular, fiscal discipline was the biggest casualty, which was frequently abandoned leading to excessive demand and external account deficit which the country was unable to fill. We face crises because we fail to exercise responsible care in fiscal affairs. We are neither interested in raising domestic resources (taxes and other revenues) nor in curtailing expenditures. Consequently, we borrow relentlessly. In doing so, we face no difficulty in rupee financing, because we can print local currency in any amount we want. But we overlook the fact that this excess demand inevitably leads to increased demand for imports, which means demand for foreign exchange. The availability of foreign exchange is limited by our exports and remittances – both significantly below the level of imports.
Under these circumstances, we rush for help from the IMF. Once under a program, things begin to improve, so long as we adhere to its conditions. However, we soon discover that these conditions are politically unpalatable and fling the program. That doesn’t last long, as the cycle of indiscipline is re-booted, following the above path, at the close of which the need for an IMF program is again felt.
The Fund program would also bring on board World Bank, ADB and other development partners to support the new government and to close the financing gap. The program would free the government from the constant worry about depleting reserves and fear of default
The present situation has emerged following the same pattern. The only surprise is that it has come on the heels of first ever successfully completed IMF program, and that too under a democratic government. All gains made under the program were lost. Fiscal and external deficits have risen to dangerous level, structural reforms abandoned, reserves declined rapidly and exchange rate is facing free fall.
Despite these challenges, the current phase offers highly promising opportunities. The last year saw the highest growth rate of 5.8pc in 13 years. Inflation is moderate, agriculture, manufacturing and services sectors are buoyant. Investments are also rising with robust consumer spending. Undoubtedly, some of this was aided by excess demand due to high fiscal deficit, but its primary nature remains firmly rooted in private sector confidence. Once the imbalances are removed, the economy would grow with a very healthy growth rate.
It is a foregone conclusion that the country has to approach IMF for a new program to restore economic stability. In fact, we have lost considerable time for the sake of political convenience. At the close of 2017, the economy had reached a point where a stand-by arrangement from IMF was critically needed, yet no such initiative was taken as it would have demanded economic discipline in the penultimate months of government’s term, which was not expedient.
We need a fund program to stem external account unsustainability, which means insufficient resources (reserves, FDI, loans) to meet the financing needs of the economy. The starting point of a Fund program is the so-called ‘financing-gap’. The current account deficit last year was $18 billion. Roughly, we had FDI of $2.7 billion, public investment (Sukuk and Euro Bond) of $2.3 billion and net borrowing of $6.8 billion from various sources. This adds up to $11.8 billion, which means there is still a shortfall of $6.2 billion relative to the deficit of $18 billion. Where was it made up from? The answer is by drawing down on our reserves by $6 billion, which declined from $16 billion in June ’17 to about $9.8 billion in June ‘18.
For this year, the option of repeating last year’s performance is simply not there. The level of reserves is dangerously low to lose any further. The exchange rate stability is critical for investors’ confidence. The Fund program would aim at stabilising the external account. To this effect the key is to reduce fiscal deficit, which was reportedly recorded at 7.1pc of GDP (Rs.2450 billion). The Fund program, e.g., would require a reduction in deficit of 2pc of GDP in the first year, which would mean either raising Rs750 billion in taxes or cutting equivalent expenditures or a combination of the two. This is surely a tall order, requiring severe austerity that the government would have to practice. But this is how the excess demand in imports would be curtailed and current account deficit contained.
Other requirements would be to further increase the SBP policy rate and a major reduction of deficit financing from the SBP, which would also put further pressure on the interest rate. Administered prices would have to be freed. These measures would spur inflation but it would be nothing like runaway inflation. Then there would be structural reforms, such as the revival of the privatisation program and fixing up of the circular debt and power sector inefficiencies, without which future investments would not be possible.
The Fund program would also bring on board World Bank, ADB and other development partners to support the new government and to close the financing gap. The program would free the government from the constant worry about depleting reserves and fear of default. It can then focus on its development and reforms agenda.
Let’s finally make comments on NFC, Venezuela and Argentina. The NFC challenge has no immediate solution. The government should seek a CCI resolution for provinces to give surplus in their budgets. Pakistan is simply not comparable to either of the two countries. Venezuelan economy is facing turmoil since it embraced socialist policies. Even in a non-socialist government, the ills created continue to this day. Argentina is recovering from nearly two decades of government controlled economy with prices frozen during this period. The required adjustment for balancing fiscal and external accounts is much more than what is needed in Pakistan. We have a very short period of about two years of economic mismanagement that can be cleaned up quickly. But the process of adjustment would be painful and government would do well to let people know, as the would-be prime minister has stated in his first national address, that the government would sacrifice equally if not more than what it would ask people to bear.