Dr. Meekal Aziz Ahmed worked in the Planning Commission, Government of Pakistan and was later Senior Advisor to Executive Director in the IMF. He holds a D.Phil in Economics from Oxford University. Dr. Ahmed has very kindly written this article for LUBP. We will be archiving this article and other articles about the economy on our new economics page. The purpose of this page is to encourage a rational discussion on the economic policy options available to the government at the present time.
No Room for Complacency
There have been pronouncements by the leadership that the economy has stabilized and the worst is behind us. There is much that one can concur with but lest complacency set in we must remember we are not out of the woods.
When the present government took over, the economy was racing headlong towards another balance of payments crisis largely due to the lagged effects which by that time had become evident of the previous government’s flawed and self-destructive economic policies. To be sure, the surge in world prices of oil and other commodities made the situation much worse swelling our domestic and external deficits beyond our capacity to finance them. But these exogenous price shocks were not the cause of the economy’s difficulties. They exacerbated it but did not precipitate or cause it.
With our domestic and external deficits at an unprecedented 8% of GDP each and inflation running at 26% per annum, a rate of inflation never before seen in Pakistan’s 62 year economic history, there ensued a loss of confidence which was manifest in massive capital flight at a rate approaching almost a billion dollars a week, a rupee in free-fall, the popping of speculative bubbles in real estate and the stock market, and an alarming loss of our foreign exchange reserves. True, the new government should have quickly taken stock of the rapidly unfolding chaotic economic scenario and taken policy action to forestall it or at least check its virulence. This they did not do. Hoping against hope for help from a new contraption called “Friends of Democratic Pakistan”, maybe China or Saudi Arabia, they waited for another free lunch. Only when it dawned upon them, slowly and painfully, that Pakistan had no other recourse did they turn to the Lender of Last Resort, the IMF.
The IMF program, or as one should preferably call it, the GOP-IMF jointly-negotiated program has restored a measure of macroeconomic stability, reduced our domestic and external imbalances and brought inflation down. Foreign exchange reserves are up to more comfortable levels, the stock market has recovered (notwithstanding the recent drop due to the crisis in Greece), and asset prices in real estate and commodities have stabilized. That this much has been accomplished against the sharp headwinds of crippling power outages, a volatile political and security situation and a deep global recession is a matter of satisfaction. To be sure, the economy’s growth rate has dropped to well below potential and inflation has turned up again. But despite the brief contraction in the large-scale manufacturing sector, overall GDP growth has remained in positive territory. This is not to make light of the immense suffering the Pakistani people have been put through (like many times before) for no fault of their own in terms of lost jobs and deepening poverty.
Provided we stay steadfast, there is no reason not to expect the economy to revert, albeit slowly and painfully (unless the drag imposed on it by power outages is quickly and convincingly alleviated), to its potential growth rate of around 6.5% per annum on the back of new investment which will create employment opportunities and boost exports by around 2011-2012. The new budget for 2010-2011 which is just around the corner needs to set the economic tone for the period ahead. The budget will tell us whether the government is serious about policy continuity that is prudent and responsible or whether it will fall prey to the seductive appeal of macroeconomic populism. The budget in broad terms needs to be credible and financeable without taking on too much additional debt or bank borrowing. The budget must ensure that the fiscal impulse that emanates from it is aimed at reducing inflation and safeguarding the external accounts. This task cannot be left to monetary policy alone. Both fiscal and monetary policies must work in tandem and complement each other in getting inflation down to the low to mid- single digits. This should be the government’s highest policy priority for 2010-2011 since inflation is the cruelest tax of all and hits those most unable to cope with it – the poor.
There is much debate, spontaneous and contrived, about the VAT. The government has been slow to educate the stakeholders about what the VAT means, how it will work, and whether it is the magic bullet that it is being made out to be in terms of raising tax revenue. All this should have been done 18 months ago as in other countries which have changed over from a GST tax regime to a VAT. That there is fierce resistance from the business community should not come as a surprise. They are well-versed in the fine art of abusing and evading the GST. They fear that the VAT may tighten up the supply chain of value addition and make evasion and fake refund claims more difficult. The government should use the IMF as its economic flak jacket and pin it all on their intransigence to get the VAT through if they want to. Most government do.
On the spending side, the government needs to be watchful. Spending on security has grown rapidly and has caused breaches of the budget deficit before. While such spending is arguably necessary in the present difficult circumstances and not amenable to sharp cuts, other spending on the running of the government is. The people of Pakistan have been infinitely patient for the day when a government comes along with demonstrated commitment to their welfare. They are willing to sacrifice more if they see the burden of sacrifice is being shared equitably whether this relates to paying taxes or conserving energy. The Prime Minister’s recently-announced Austerity Drive seems to have gone up in smoke. There are too many multi-million rupee bullet-proof cars and executive jets and foreign tours. There is too much waste and too many un-monetized perks. They are too many Ministers, Ministers of State, Advisors and Roving Ambassadors. There is too much graft and corruption. If the people see all this waste cut by a half they will be prepared to undergo further economic hardship and sacrifice.
The practice of meeting budget deficit targets by cutting development spending needs to stop. While not all development spending is making a contribution to development and there is waste and mis-allocation here as well, cutting spending on vital projects in physical infrastructure such as irrigation and roads, or education, health, water supply and sanitation grievously undermines the economy’s long-term growth potential. It causes irreparable harm.
With a budget that is tight and has credible numbers, half the battle for continued macroeconomic stability would have been won. The rest will be up to the policy stance that the State Bank of Pakistan adopts to controlling inflation, safeguarding the external accounts and further building up its cushion of foreign exchange reserves to guard against future shocks. Macroeconomic stability is always and everywhere pro-growth and pro-poor and there are no counterfactuals that prove otherwise. I hope the government keeps this fact in mind.