The new government will be in office in a few days. Nothing will be more important in its list of ‘things-to-do’ than putting the economy back on track. The finance minister (designate), Asad Umar, has categorically stated that all options are on the table. How bad is the economic situation? Well, it is pretty bad. But not as bad as what some not-so-responsible social media posts would have us believe.
There are two kinds of problems: immediate and short-to-medium term. Immediate problems will need instant attention, and those are what we will focus upon today. The one decision that has held up for more than seven months is whether the country should seek another programme from the Fund or should it continue on its own. There are many who believe that approaching the Fund will be disastrous as it will bring recession and hardship for the poor. Others, while acknowledging the need, warn that the Fund will place onerous conditions which will be politically unfeasible to implement, even for a popular government with a lot of political capital.
Before we discuss this question, let’s put out some facts that will help understand the extent of our problem. We have crossed all benchmarks that determine whether to seek outside help. Last fiscal year, we lost $6.1 billion in reserves and accumulated nearly $10 billion in net external debt. Clearly, this is unsustainable, for we are left with hardly any reserves to lose and borrowing options are narrowing both because of cost as well as limited sources, given the negative outlook that has been assigned to the country by the rating agencies. Therefore, we have no option but to stem this mess.
Suppose for a moment that we don’t want to go to the IMF. What would we do to clear the deck on our own? One approach that is frequently recommended is to directly control imports. To be sure, we have long abandoned crude instruments of import control through quotas, arbitrary tariffs or other non-tariff barriers. The only instrument available is regulatory duty or so-called ‘additional customs duty’, but these cannot be used indiscriminately, because the bulk of our imports are petroleum (24 percent), machinery (20 percent), industrial (textiles, transport and metal groups) raw materials (21 percent) agriculture inputs (15 percent) and food and edible oil (13 percent).
Raising the prices of these products, on top of depreciation effect, will lead to inflation as well as increased cost for exports. Some analysts have suggested that we stop providing foreign exchange for certain classes of imports. This is not possible given the current account convertibility that we adopted in the mid-90s, and it will be a retrogressive step. To sum up, controlling imports is not a viable option as a lead instrument, even if some of its elements are made part of a bigger strategy.
Another suggestion is to seek one-off support from Saudi Arabia and China to tide over immediate needs. Such support should be welcomed, and more the better. But this also does not address the malice that is afflicting our economy.
To address the malice, it should be understood that our external account deficit is the mirror image of what is wrong in our fiscal affairs. Last year witnessed an unprecedented fiscal indiscipline in the recent history of the country. Budget 2017-18 claimed the deficit would be 4.1 percent of GDP. When the budget was presented in April, it was claimed that the revised estimate is 5.5 percent. When the fiscal data for Jul-Mar was released, the data indicated a likely deficit of 5.8 percent. The interim FM indicated the fiscal deficit is likely to be 6.1 percent, whereas the latest reports place the deficit at 7.1 percent.
The nominal size of the budget overrun (beyond 4.1 percent) is around Rs1000 billion (about $8 billion). This is the excess amount of spending that was financed either from the SBP borrowing (printing notes) or by taking foreign loans. This excess demand has to be slashed, now. A fiscal adjustment of two percent during the year – either through new tax measures or credible expenditure cuts – is what is required to seriously address the problem. Both these actions will require heroic efforts, but there is no escape without them.
There are some more actions which will need to be taken to tame the excess demand, for example adjustment in the policy rate, constrained expansion in the domestic credit expansion and limit on government borrowings from the SBP. Surely, this is a painful prescription, but a festering wound heals faster after a painful surgery.
If we are ready to do what has been suggested above on our own, we will essentially be meeting the most onerous condition the Fund programme will stipulate. There will also be structural conditions, some of which are already part of the agenda of the new government, such as elimination of circular debt and power sector reforms, but these are open to negotiations. In such a case, it will be desirable to opt for the Fund programme and ease the financing gap. The IMF is a multilateral institution and Pakistan is one of its members. The IMF is supposed to help its members when they are facing a balance of payments problem. Of course, the Fund will ensure that its assistance is used alongside a policy mix that restores macroeconomic stability. The structural reforms will help create an investment environment needed to inspire investors’ confidence.
The Fund programme will be challenging, but not infeasible. In fact, the new government will elicit considerable goodwill with the Fund management – just as any other country poised to make a new beginning, and facing BOP problems. The programme will also enable the World Bank and ADB and many other development partners to assist the government in its economic plans. The assistance will obviously be needed not just for macroeconomic stability but for long-term growth and progress of social sectors. The earlier this decision is taken the easier it will be to deal with the multitude of problems.
Lest someone is misled by the recent happenings in the forex market, it is explained that the appreciation in the exchange rate is indeed spurred by the euphoria of fresh elections. However, the last two exchange rate actions under the interim government were misconceived and unwarranted. The interim government, so often appealing to its inability to do much because of the limits imposed on it under the Election Act, 2017, could have just waited for the new government to take such important decisions. Therefore, there is a required correction taking place in the market. This would also improve the incoming government’s negotiating position.
The writer is a former finance secretary. Email: email@example.com