Political expediency vs economic necessity
Dr Muhammad Yaqub
April 18, 2015

An average citizen must be totally confused about the state of the economy after hearing, on the one hand, the official/IMF pronouncements that economic stabilisation has been achieved and, on the other hand, reading views of independent economists that point to the failure of the government and the IMF to focus on real policy reforms to address structural imbalances that remain very much entrenched in the economy and pose a threat to the long-term economic stability of the country and welfare of the people.

The official line of arguments, supported by the IMF, is that a lower budget deficit-to-GDP ratio, falling rate of inflation and rising level of foreign exchange reserves are indicators of economic stabilisation and a result of sound economic management. Leaving aside the fact that to some extent these improving trends represent manipulation of statistics to make them look good, an examination of all the factors for changes in these variables reveals that temporary improvements hide behind them a worsening underlying economic situation from a long-term perspective.

A professional analysis of the factors contributing to a lower budget deficit-to-GDP ratio indicates that it is all due to a patchwork of nonrecurring and extraordinary measures that will not repeat themselves and, if resorted to for a long time, will plunge the fiscal situation in a deeper hole.

First of all, the government has made extensive use of external begging and borrowing that generated rupee counterparts to finance fiscal operations. But foreign borrowing has added to the public debt, and foreign begging has compromised national self-respect and sovereignty. If the government continues to borrow and beg from abroad, economic vulnerability will increase and, if it stops without structural tax reforms, the budget deficit will balloon back to previous levels again.

Another step taken by the government is sale of national assets and recording of privatisation proceeds as a revenue item below the line to show a lower budget deficit. This source of containment of budget deficit will soon come to an end with no more profitable national assets available to sell leaving a wider budgetary gap, and at the same time the future of the country having been mortgaged to foreigners.

The third method used to curtail budget deficit is a slow release of development expenditure than budgeted but it carries with it a heavy developmental cost in the form of lowering of the potential of economic growth. The federal government has also put pressure on provincial governments to generate surpluses in their budgets to keep the consolidated budget deficit within the target set by the IMF, but that means inadequate spending by provincial governments on health, education and other social sectors with all its adverse implications.

The fourth trick used to show a lower budget deficit is deferment of release of tax refunds and advance collection of taxes due for payment in the future. Fifth, there is a large amount of circular debt and losses of public sector enterprises that the government does not include in calculating the budget deficit to keep it low. But accumulating circular debt and rising losses of public sector enterprises are contingent liabilities which would have to be discharged by the government in one way or the other and at one time or the other. These various methods used to show a relatively better short-term budgetary picture cannot conceal the gravity of the underlying budgetary situation.

Long-term fiscal stability will only come about through structural tax reforms and by bringing in the tax net the untaxed sectors and under-taxed people, dismantling the flourishing underground economy, improving tax administration, reducing corruption and tax evasion, and imparting elasticity to the tax system in relation to changes in income, consumption and prices – and thereby steadily increasing the tax-to-GDP ratio. But these economically sound measures are politically unacceptable to the government that politically depends on tax dodgers, smugglers, black marketers, land grabbers, underground operators and others falling in the category of ‘rentiers’.

The inflationary situation is equally precarious from a long-term perspective even when the official price indices show a sharp decline in the rate of inflation in the recent past. The government changed the base year and weights of commodities in the construction of price indices in a way that the current rate of inflation stands reduced and is not comparable with that in the past. The use of price data collected to construct price indices is also biased towards underreporting of the rate of inflation.

In addition, the fall in world commodity prices and maintenance of an appreciated real effective exchange rate have lowered the rate of inflation in the short run. But the underlying disequilibrium between the growth of the economy and that of money supply remains high. The government continues to rely on indirect taxes, which are highly inflationary in their impact. The fiscal, monetary and exchange rate policies continue to promote income disparity and encourage conspicuous consumption – and consumption-driven growth adds to demand pressures.

When the one-time impact of exogenous developments on the price situation wears out, public sector expenditure financed by excessive internal and external borrowing and money creation will push back the rate of inflation to a higher level. Inflation can only be tamed on a sustained basis if the rate of domestic savings rises significantly and the rate of growth of money supply is scaled back considerably. That would require a complete restructuring of fiscal, monetary and exchange rate policies and abandonment by the government of its recklessness in using the SBP and commercial banks to finance fiscal operations.

The conclusions drawn by the government and the IMF from a rise in foreign exchange reserves are also ridiculous. The reserves have increased not because of a fundamental improvement in the balance of payments but due to massive foreign borrowing and sale of profitable national assets to foreigners. An increase in foreign exchange reserves made possible by the build-up of massive foreign debt is not sustainable in the long term. Additionally, the sale of profitable national assets to foreigners also has had adverse side effects. With declining exports and rising imports, increase in remittance of profits abroad will become an additional burden on the balance of payments over the long term.

The real solution of the balance of payments vulnerability lies in adoption of the exchange rate and other policies that promote exports and restrain imports and impart fundamental improvement in the current account of the balance of payments.

The most bizarre statement of the government relates to the prospects of higher economic growth. The rate of economic growth will rise on a sustained basis only when foreign direct investment begins to increase, the government allows commercial banks to finance private sector, measures are put in place to increase domestic rate of savings and investment and bottlenecks that impede the fuller utilisation of the installed capacity are removed. The government – and the IMF – need to explain the basis on which they forecast a rising rate of economic growth in an environment of stagnation in direct foreign investment, low rate of domestic capital formation and energy shortages standing in the way of fuller utilisation of installed industrial capacity.

The only way the economy can be pulled out of its quagmire is for the government to abandon politicking and gimmickry and undertake major structural economic reforms that are needed to put it on a solid path of long-term growth with price stability and balance of payments viability.

The writer is a former governor of the State Bank of Pakistan.

Email: doctoryaqub@hotmail.com

Published in The News