The economy continues to 
be under pressure and the 
situation likely to  persist for some time

Independent analysts are of the view that these ‘feel good’ economic indicators are not the appropriate answer to the real issues that the economy is facing, particularly with respect to the external account

By M. Sharif

The SBP in its latest monetary policy statement expressed partial satisfaction over the foreign exchange reserves of $14.0 bn, sufficient enough for imports of around five months. Forex reserves have more than doubled from $6.1 bn in October 08, which a year earlier were at a record level of more than $16.0 bn.

The IMF laid great emphasis on building the forex reserves to stabilize the parity of rupee with international currencies and to relieve pressure on the rupee to avoid its further depreciation. The rupee has shed more than 2.5 per cent of its value against USD during the current fiscal year. Political volatility, structural imbalances in the economy, ever increasing cost of electricity and gas that stoke inflation and high interest rates prevailing in the country are likely to make the economic conditions even more susceptible to risks, despite some positive developments that have taken place recently.

One of such risks is to the country’s external account. The external account’s strength lies upon remittances sent by expatriates, $11.3 bn loan provided by the IMF in addition to credit given by the WB and ADB under various development schemes and financial assistance provided by the US for Pakistan’s major role in the war against terrorism. What would happen if the present regional security environment changes with the exit strategy of the US from Afghanistan, which is most likely to happen as announced by the US president?

The exit strategy includes withdrawal of the US forces from 2011. Incase this happens, it would decrease the inflow of USD to Pakistan, notwithstanding the commitment of annual financial assistance of $1.5 bn made by the US administration under the Kerry-Lugar law. Keeping in view all these factors, it is typical that the government should chalk out a comprehensive strategy to counter the risks to economy that it is likely to face due to squeeze in inflow of capital in the not too distant future. This would lead to financial hardships particularly with respect to servicing foreign debt that now stands at $55 bn and meeting with other commitments, which cannot be ruled out.

The most important issue is about the economy’s ability to absorb any external or domestic shocks that might come from an unexpected quarter. A case under consideration is the decision of SBP to shift 100.0 per cent (against existing 60.0 per cent) burden of arranging foreign currency payments worth $10.0 bn a year from inter-bank money market for oil imports by the private sector with effect from 14 December, 09. It is a heavy amount and is likely to put rupee under pressure repeatedly because of fragility of economy and forex reserves.

Even one year after implementation of IMF’S stabilization package, it is being assumed that rupee would be saved from quick depreciation through IMF’s third tranche of $1.2 bn likely to be released shortly. With an inflow of $1.2 bn, forex reserves would be sufficient for seven-month imports. But, should it be considered enough on account of the source and nature of inflows that are hardly sustainable? 

Despite these fears, there is quite a bit of optimism about the economy heading in the right direction. The optimism is based on the following factors, the reduction in inflation to a single digit of 9.0 per cent, inflation likely to continue to decline at a slow pace, and despite the reduction being a result of base effect because it is being measured from a high inflation base of 25.3 per cent in October 08.

LSM has shown a slight improvement of 0.17 per cent during first two months of current fiscal year, compared to the worst-ever decline of 8.2 per cent during the last fiscal year. Discount rate has reduced by 150 bps during current fiscal year and supply of electricity has also improved. Exports could improve during H2 of current fiscal year and enable exporters to meet the export target for current financial year.

There has been a drastic reduction in current account deficit. It has reduced to $448 million during first quarter of current fiscal year against current account deficit of $4.3 bn for corresponding period of last fiscal year. Imports and exports have declined by 27.7 per cent and 18.8 per cent respectively. There is substantial improvement in remittances during the current year. It is being projected that by the end of this financial year, remittances would increase to more than $9.0 bn as compared to $8.7 bn of last fiscal year. Furthermore, IMF, multilateral institutions and the US are on board to assist Pakistan to overcome its economic crisis.

But, many independent analysts are of the view that these ‘feel good’ economic indicators are not the appropriate answers to the real issues that the economy faces, particularly with respect to the external account. In fact, they argue that a similar situation of external inflows through privatization proceeds, financial assistance by the US and its western allies, remittances and to some extent increase in exports had created the illusion of a strong and sustainable external account. Forex reserves of more than $16.0 billion were considered an assurance against any domestic or external shocks. But, political uncertainty and steep increase in the prices of oil and agricultural commodities in 2008 whose imports were essential consumed forex reserves within ten months. By the end of fiscal year 2008, current account deficit had increased to 5.8 per cent of GDP. Insurance through forex reserves and dependence on external financial resources has proved to be more than illusive and it seems that the same scenario is being repeated once again.

Any strategy that is to reduce risks to external account has to be comprehensive with three fundamental factors to achieve.

Firstly, the government must visibly strive for political stability, good governance and minimizing corruption. These are essential requirements for boosting economic activity and there is enough scope for improving them.

Secondly, efforts must be expedited for fiscal consolidation and revival of economic growth. The bench marks fixed for current fiscal year for tax revenue collection, exports, fiscal deficit etc must be met, no matter what. There is a general public concern that the government and other political forces in the country have spent more time on political infighting than making any joint efforts to resolve socio-economic problems faced by the people. The concern needs to be addressed on priority basis.

Thirdly, adding value addition to agriculture and industrial products is imperative to give a boost to exports and to reduce the cost of production. Hardly any measures have been taken either for value addition or diversification of exports and reaching out to new markets to make exports more competitive. Even if the government succeeds to complete IMF’s macroeconomic stabilization package, the economy would still remain vulnerable because of over dependence on external account that itself is highly unsustainable.

Time to reap economic benefits from war on terrorism is perhaps over and now the countdown to the harsh reality of bearing the economic burden of the war along with countless human sacrifices has started. It is prudent that the government should plug in all those holes that are negatively impacting the national economy. Priority should be given to improving domestic savings, capital formation, investment, human resource development and infrastructure along with other measures suggested above.