A currency dealer counts US Dollars | Fahim Siddiqui, White Star
A currency dealer counts US Dollars | Fahim Siddiqui, White Star

The ruling Pakistan Tehreek-e-Insaf (PTI) inherited an economy that had been showcased as a success story by its predecessor government of the Pakistan Muslim League-Nawaz (PMLN). The previous government would claim that the national economy had been revived and economic activity had been put on the path for a higher and sustainable growth.

The reality was different. The PMLN’s economic edifice was built on very weak macroeconomic foundations. Heavy dependence on foreign loans and short-term borrowing as well as stagnant exports had caused a foreign exchange financing gap of near 30 billion US dollars, almost 10 per cent of the Gross Domestic Product (GDP).

This gap stared in the face of PTI’s economic team whose immediate primary task after coming into power became to raise foreign funding in order to save the economy from financial collapse and bankruptcy. Thanks to help from friendly countries such as Saudi Arabia, United Arab Emirates (UAE) and, most recently, China, the team was able to raise sizeable foreign exchange. It similarly managed to obtain concessions on payments for oil imports — also from Saudi Arabia. This helped Pakistan ward off an imminent economic crisis and provided some cushion to our fast declining foreign exchange reserves.

While the government was seeking help from friendly countries, many analysts worried that it was taking too much time to go to the International Monetary Fund (IMF) for a financial-assistance package. Prime Minister Imran Khan, indeed, was not keen, at least initially, on approaching the IMF because he had pledged to reduce Pakistan’s dependence on external financing and the conditionalities that came with such financing. The government, nevertheless, decided to bite the bullet despite strong divisions on the issue among its team of economic advisers.

In the first few months of being in office, the government tried to negotiate with the IMF on a three-year assistance programme worth 8-9 billion US dollars. During these negotiations, the Pakistani team faced an IMF that was upset because all the previous governments – starting in the 1990s – had gone back on their promises to carry out economic reforms in return for aid packages.

The government negotiators found that the IMF wanted to put in very harsh terms and conditions for a new assistance programme. These included further devaluation of Pakistani currency, an end to the practice of using the State Bank of Pakistan’s foreign exchange reserves – built mainly through foreign borrowing – to support the rupee’s value, drastic decrease in energy and fuel subsidies to reduce the mounting circular debt, sharp tightening of monetary policy (that is, increase in interest rates), a significant decline in Public Sector Development Programme to reduce fiscal deficit and the privatisation of major loss-making state-owned enterprises. The IMF wanted the government to commit to – and initiate – all these measures at the very outset.

Pakistan’s economic managers, led by finance minister Asad Umar, decided that taking these measures immediately was too high a cost to pay as these would “subject the people of Pakistan to unbearable hardship”.

They, therefore, sought a relatively gradual process of economic reforms — something that the IMF did not agree to. The government, however, did not close its parleys with the IMF. A process of discussion has continued for the last few months and has now reached a stage where the two sides are again talking about the possibility of the approval of a financial package sooner rather than later.

The decision to not succumb to the IMF’s harsh conditionalities was certainly a bold one but it needed to be complemented by some other important steps. Prime Minister Imran Khan’s economic team, on the contrary, did not realise the importance of undertaking a quick and decisive, but also well-thought-through, short-term programme for the stabilisation of the economy in order to restore business confidence and ensure that economic growth did not stumble downwards. After displaying an understanding of the economy’s underlying ailments, his team appears to have come up with somewhat simplistic solutions to deep-rooted problems. At times, it has made even conflicting economic decisions.

This was most clearly displayed in the government’s approach towards the private sector. At one stage, its economic managers made it clear that private businesses will be the major engine of capital accumulation and job generation, and will be fully encouraged to undertake this task by freeing them from unnecessary controls and bureaucratic interference.

Yet, at the same time, the government set in motion a strong and overzealous drive by revenue authorities to not just bring habitual tax evaders into the tax net but also to pressurise the existing taxpayers — at times unfairly. Resultantly, it has failed on both fronts. Neither did the private sector respond positively to its friendly overtures nor were its policies successful in bolstering tax revenues significantly.

Similar is the case with the mini-budget presented by finance minister Umar at the end of January 2019. Here we see a classic case of a government trying to please everyone but ending up in pleasing no one. The move to withdraw some of the tax concessions on salary income given by the previous government was perhaps justified given Pakistan’s current fiscal position (where the gap between income and expenditure has been increasing consistently).

Similarly, the removal of high tariffs on the import of industrial raw materials was an important and much-needed step to increase the international competitiveness of local manufacturers. The revenue measures proposed in the mini-budget – and now approved by the National Assembly – were, however, certainly not sufficient to meet the revenue needs. Similarly, the planned cuts in government expenditure to decrease the burgeoning fiscal deficit were also not clearly spelt out. The IMF, for one, was not impressed.

The other flaw in the economic management has been a continuing uncertainty about currency exchange rate and foreign exchange reserves. Though the State Bank of Pakistan has been able to stabilise the exchange rate at around 140 rupees to a US dollar, many potential investors fear that the value of rupee will drop further – perhaps quite significantly – once an agreement is signed with the IMF. Such an agreement will preferably seek a free-floating exchange rate system. Short of that, the IMF will want to put a drastic limit on the State Bank of Pakistan’s ability to intervene in the currency market. Many potential investors have, therefore, decided to wait till an agreement materialises.

As far as foreign reserves are concerned, dollar deposits given by Saudi Arabia, UAE and China have, indeed, given them a semblance of stability but these deposits have limited utility because these cannot be used for loan repayments or for foreign trade. Similarly, a rising dependence on imported natural gas for electricity generation has reduced oil imports and blunted the impact of concessions given by Saudi Arabia through deferred oil payments.

The reserves, in the meanwhile, continue to bleed by an amount ranging between 750 million and 1 billion US dollars every month. This haemorrhage is resulting from not just a high import bill but is also caused by payments being made to service foreign debts. What we have borrowed from our friends will certainly do nothing significant to ward off the twin impact of these two factors.

The overall economic situation reflects how the government has handled – or mishandled – various challenges. That the GDP growth rate is expected to drop – from 5.2 per cent recorded in 2017-18 to 3.5-4 per cent in 2018-19 – suggests there has been some break in the growth momentum achieved earlier.

The fiscal deficit, on the contrary, is expected to rise higher — to over 6 per cent of the federal budget at the end of 2018-19. And, though the current account deficit has narrowed in recent weeks – more due to a lull in imports than because of any significant increase in exports – considerable pressure still exists on foreign exchange reserves for bridging the gap between low export earnings and high foreign exchange requirements for imports and debt servicing.

Most worryingly, there has been a spurt in inflation primarily because of rupee devaluation which has raised prices of imported goods, significantly increased natural gas prices and, to a lesser extent, pushed up electricity rates (which have also risen due to reduction in subsidies).

Because businesses are setting prices for their products through a ‘cost-plus’ formula (due to uncertainty over foreign exchange rates), the knock-on effect of this pricing formula on non-tradable goods – such as construction and transportation, etc – means that the overall annual rate of inflation could be 8-10 per cent at the end of the current financial year on June 30, 2019. This will put pressure on the low income groups and those already living below the poverty line will immediately need a government-provided safety net.

The first major test of the government’s economic team in the coming months will be the upcoming round of negotiations with the IMF. Given that this team has been in office for more than half a year now, it is expected to be better prepared for this round of negotiations. Its task has been made somewhat easier because the government has already implemented some of the reforms demanded by the IMF in order to soften their blow on the economy and poor segments of the society — although the IMF will clearly ask for more. These mainly include adjustments in fuel and energy prices through reduction in subsidies.

That the foreign exchange rate is already well near where it should be also makes life easy for the economic team during its negotiations with the IMF. Now it must try to ensure that the rate is not subjected to any significant decline.

It must also convince the IMF that fiscal deficit is brought down gradually so that sharp cuts in development expenditure and steep increases in taxes do not completely break the momentum for economic growth. It should, similarly, agree on achievable revenue generation targets rather than the ones which it cannot attain. Above all, the government must seek an increase in the amount of money allocated for the Benazir Income Support Programme and other social welfare initiatives, including housing for the poor — and keep this money outside the fiscal deficit targets.

The economic managers should, however, accept the IMF’s contention that a greater autonomy is given to the State Bank of Pakistan in setting currency exchange rates and managing the monetary policy. As long as the bank’s own monetary policy committee has an autonomous status and as long as there are frequent meetings of the committees that coordinate between the bank and the government, this autonomy should not hurt the economy. There, though, is a need to make this consultative process more inclusive by enabling the participation of provincial governments in it.

The biggest challenge for our economic policymakers is to ensure that the stabilisation phase following the introduction of economic reforms is not prolonged (even if its sharp impact cannot be avoided in the immediate term). The other part of this challenge consists of the need to take the economy to a growth rate of 5.5-6 per cent in the next three years.

With China-Pakistan Economic Corridor entering a phase where new economic zones will be set up and with electricity shortages having been drastically reduced, Pakistan is well placed to attract private investment. Simultaneously, foreign and domestic investors are showing a high interest in the country’s large and growing market and a fast rising middle class. Together these factors should help Pakistan achieve an even higher growth rate.

We must, in the end, realise that recurring foreign exchange constraints are the reason why Pakistan’s GDP growth rate does not reach the level it has the potential to reach and why we continue to have start-stop cycles of economic development. To overcome these constraints, exports should be placed at the centre of a new growth strategy. Rather than trying an arbitrary slowdown in imports, economic managers should make policies that encourage exports. Finally, we should realise that Pakistan is required to aim for a sustained growth rate of 7.5-8 per cent if it is to meet all its security needs as well as the needs of its people.

The writer is a professor of economics at the Lahore School of Economics.

This article was originally published in the Herald's March 2019 issue. To read more subscribe to the Herald in print.