Economy of pk

PAKISTAN`S economy is failing rapidly on many fronts: the growth rate stagnates, inflation persists and public debt has ballooned due to macroeconomic imbalances; the infrastructure cannot meet requirements of power, transport and water resources; roads and port facilities are rapidly deteriorating and are further burdened by the transit use of Isaf forces in Afghanistan. Human development indicators are low, the social infrastructure needed to address the needs of a growing population inadequate; poverty is growing; local government which is critical to providing health and education services is dysfunctional; the environment for doing business is neither cost-efficient nor corruption-free; the rule of law so essential to nurture private enterprise is challenged by a democratically elected government in the Supreme Court daily. And law and order is hostage to the destabilising effect of the US war in Afghanistan. This piece is about stabilisation of macroeconomic imbalances which is the first step required to save Pakistan from a total collapse. Growth in GDP after peaking at 6.8 per cent in FY07 averaged just 2.5 per cent during the last four years officially, but was actually lower when glaring exaggerations are excluded. For instance, in FY11 GDP grew by 2.4 per cent officially on the basis of implausible growth in small-scale manufacturing (exactly 7.5 per cent for the fifth year in a row, despite long hours of loadshedding), buoyant livestock sector (3.7 per cent growth despite 1.2 million cattle lost in floods) and over 13 per cent expansion in value added by public administration and defence services. The latter reflects ballooning war expenditures, salary increases, rising debt service, politically targeted subsidies and transfers to public corporations to cover losses due to corruption. None of these are meaningful contributions to GDP. Excluding these, GDP growth is unlikely to exceed one per cent in FY11. Sectoral details of GDP reveal a more dismal reality. Production of major crops declined three years out of the last four; growth in industrial production was negative twice during the period, while finance and insurance services, which are pivotal to growth in a modern economy, shrank three years in a row for a cumulative decline of nearly 30 per cent since 2007. These numbers point to an alarming decline in private-sector activity and shrinking productive sectors of the economy during the last three years. With population growing at 2.1 per cent annually, unemployment is rising. Over 50 million people have now slipped below the poverty line especially due to erosion of purchasing power by inflation. Reminiscent of Musharraf`s regime, economic managers claim mockingly that per capita income now exceeds $1250, another sleight of pen by converting the inflation-based GDP into dollars at an overvalued exchange rate. The result is nothing more than an illusion. The last four years have also seen acceleration in inflation, with year-on-year inflation peaking at over 25 per cent during late 2008, but persisting subsequently, fluctuating around 15 per cent until recently. This is the longest spell of inflation Pakistan`s economy has suffered, threatening the social order. Economic managers blame dismal conditions on factors outside their control: war on terror, global financial crisis, the subsequent economic recession and the floods of 2010. Only some are relevant and their impact is overstated, while policy-controlled factors have been more important: the floods of 2010 caused a loss of over Rs800bn but policy- and mismanagement-induced losses in the public sector exceeded Rs400bn last year as well; the war on terror was only one factor that impacted investment, other rectifiable factors that discouraged investment were macroeconomic mismanagement, the rising cost of doing business, energy crisis and corruption. The contagion from the global financial crisis never reached Pakistan because we are not integrated in markets globally; and the world economic recession has mostly ended without impacting our exports significantly. On the inflation front, factors like the impact of floods on food supplies in 2010, adjustments in the prices of electricity and gas and surging international food and commodity prices have periodically affected inflation, but the main reason for the persistence of inflation has been the inability to control monetary expansion. Contrary to official claims, the main reasons for the undeniable economic slowdown and persistent inflation in Pakistan are domestic, a mix of wrong fiscal and monetary policies and an inappropriate exchange-rate response, carried out by three successive economic teams. While the economy was growing rapidly pre-2007, the initial spurt of inflation was triggered by the State Bank of Pakistan`s inability to control monetary expansion in the face of large foreign exchange inflows. While still coping with this monetary policy failure, the election year and every year subsequently, saw irresponsible fiscal expenditures financed by borrowings from the SBP that further expanded liquidity and fuelled inflation.

The budget deficit and the way it is financed has now become the root cause of economic imbalances and persistent inflation. The SBP responded to the runaway growth in monetary aggregates by raising interest rates, an instrument used to control private-sector credit expansion, despite the fact that it was public-sector credit that was expanding and not private. This was yet another policy mistake and continues today with the discount rate at 14 per cent. Naturally, increases in the discount rate have not reduced inflation but further stifled private-sector activity, dampening supply responses which fuels inflation. High discount rates have also contributed to the rising cost of government borrowing from the commercial banks, thus increasing the deficit and perversely encouraging the government to continue borrowing from the SBP instead of commercial banks. Consequently, the vicious cycle of large deficits, more borrowing and high interest rates have again placed Pakistan in a debt trap as in the late 1990s. In the process, commercial banks have practically given up on financial intermediation to support private-sector activity and are making billions just lending to government in risk-free treasury paper. Private-sector activity has also been adversely affected by policy failure to maintain Pakistan`s competitiveness in the face of foreign currency inflows, which caused the real effective exchange rate of the rupee to appreciate, a predicament called the Dutch disease. In the period since September 2008, measures of competitiveness indicate that the rupee is now overvalued 15 per cent despite the gradual erosion of the exchange rate of the rupee against the dollar. The erosion of competitiveness is unmistakable; the recent surge in exports is due to higher export prices, and would have been greater in the absence of loss of competitiveness. The importance of the FY12 budget for correcting macroeconomic imbalances cannot be overstated. Achieving a budget deficit target of four per cent of GDP would be the minimum to curtail inflationary pressures but which must be achieved through quarterly monitored fiscal discipline, while protecting development expenditures. The deficit should be financed mainly with non-bank borrowing to prevent `crowding out` of the private sector. Subsidies are poorly targeted in Pakistan and help only a few thousands, but the resultant budget deficit fuels inflation which erodes the meagre purchasing power of 50 million poor Pakistanis. To revive growth in incomes and employment, the new growth strategy is irrelevant; what we need is a reversal of policies that are stifling private-sector activity. Lower interest rates, restore competitiveness by devaluing, unleash the comparative advantage of agriculture sector, lower the cost of doing business. And most importantly address the energy crisis economically and efficiently. The world is witnessing currency wars through competitive devaluations to gain market shares and stimulate economies; in contrast, Pakistani policymakers are rejoicing in maintaining an overvalued rupee. The writer is a former commerce minister and has worked for the IMF.