Divergent views on economy

Courtesy:- Dr Ashfaque H Khan
Tuesday, March 27, 2012

There appear to be divergent views on the current state of Pakistan’s economy. The government’s economic team would have us believe that the economy is moving in the right direction. According to the team, exports have touched an all time high at $25 billion and foreign exchange reserves have risen to $18 billion, they further contend that the tax collection has doubled, the current account shows a surplus, and economic growth is on a path of recovery. In addition, the new NFC Award is hailed as a great success.

On the other hand, four reports that appeared in the last two months on Pakistan’s economy have painted a rather dismal picture of the economy. These reports include the IMF Report under Article IV Consultation (February 2012), Moody’s and Standard and Poor’s (the two international rating agencies) reports (March 2012) and the Second Quarter Report of State Bank of Pakistan.

A number of well-known experts have been consistently highlighting the weaknesses of the economy and suggesting various policy measures to address them. Either these institutions and experts are wrong or the government’s economic team is misguiding not only their political leadership but also the people of Pakistan.

The above-listed institutions and experts have pointed out several weaknesses which include weak economic growth, higher inflation, high debt burden, re-emergence of balance of payments crisis, and most importantly, fiscal indiscipline which is believed to be fuelling macroeconomic instability. In addition, energy shortages continue to plague industrial and commercial activities in the country.

The economic performance of any country is often assessed by the degree to which national outputs are growing. Economic growth is therefore the most critical indicator of any country’s economic performance. Higher economic growth on a sustained basis can bring the country in the limelight of the comity of nation. India is a classic example. India has maintained its economic growth in the range of 7-10 percent per annum since the mid 1990s and has drawn the attention of global investors and leaders which finally helped the country to join the league of the ‘rich man’ club – the G-20.

Pakistan sustained an average economic growth of 7.0 percent per annum for five years in a row (2002/03-2006/07) and drew the attention of global investors and Goldman Sach which included Pakistan in the ‘Next-Eleven’ club. Whenever a country is consistently growing in the range of 2.5-3.5 percent per annum, it loses the interest of global investors and prestige in the comity of nation.

Pakistan’s economy has been growing at an average rate of 2.9 percent per annum since 2007-08. It needs to grow by 7.0 percent annually to absorb two million new entrants in the job market. A growth of less than three percent in four years in a row cannot have created enough jobs for the new entrants, hence giving rise to unemployment and poverty. Pakistan’s growth performance would remain disappointing as long as fiscal indiscipline persists.

On higher inflation, the IMF report writes “in the decade prior to 2008, Pakistan’s inflation performance was good. In 2008, however, inflation rose sharply with spillover of high international commodity prices and accommodating domestic policies”. A variety of factors appear to have contributed to the persistence of double digits inflation for over 50 months in a row. These factors include central bank financing of fiscal deficit, criminal increase in support price of wheat, the sharp depreciation of exchange rate, frequent upward revision in government administered prices of electricity and POL products, and erosion of state authority reflecting weak governance.

Moody’s report has linked the high debt burden with “low” government financial strength. A highly indebted country would see the persistence of macroeconomic instability, low economic growth, rising unemployment and poverty, low prestige in the comity of nations, and hence risk being overlooked by global investors and “friends”.

All the reports have termed financial indiscipline as the ‘mother’ of economic crisis. Persistence of large fiscal deficit is one of the critical sources of high and rising debt burden. Reducing fiscal deficit is central to addressing debt burden, safeguarding macroeconomic stability and laying the foundation for higher economic growth. A substantial increase in revenue is necessary to reduce fiscal deficit for which the implementation of RGST, improvement in withholding tax regime, bringing income originating from agriculture and services under a direct tax net, and improvement in tax administration and tax compliance are absolute necessary.

On the expenditure side, the resolution of the power sector ‘subsidy’ and rotten PSEs are a must to remove large drains of budgetary resources. Improvement in current NFC Award is sine quo non for a meaningful fiscal policy. The government should not make it a point of prestige. A mistake has been committed because the NFC Award was finalised in extraordinary haste. A simple adjustment would make the award functional.

With reference to the re-emergence of balance of payments crisis, all the reports argue that the current account gap is expected to widen on account of rising oil prices and slowing export growth. Although the current account deficit would be in a modest range, the financing of this gap has already emerged as a serious challenge for the government. Pakistan may overcome these difficulties by drawing down its foreign exchange reserves during the current fiscal year. It will, however, face serious difficulties during the next two years when trade balance is likely to worsen on account of the surge in oil prices and slower exports growth on the one hand, and heavy debt repayments to the tune of $9 billion on the other.