Combating fears about economic meltdown
By M. Sharif
National economy is passing through difficult times. It is feared that unless drastic measures are not taken to overcome food insecurity and high inflation, the situation is going to get worse for the low-income group and poor people. There is also a need to look into essential macroeconomic indicators to stop the slide and consolidate economic gains made between 2003 and 2006. Things should not be left for too long otherwise it could create serious problems of fiscal and monetary management that would be difficult to address without seeking help of the IMF whose prescription might not be palatable to the stakeholders in the economy.

Fears about economic meltdown

The shaky economic condition was largely created by the political uncertainty that has lingered on for the last two years. It has shaken investor’s confidence, compromised quality of governance and economic management in quite subtle and negative ways. It was being hoped that there will be change for the better after the general elections, and the new government will move swiftly to address serious issues facing the economy but the experience of past one month has clearly indicated that slide down in the economy has kept its momentum going and has badly affected rupee-dollar parity, rising inflation, downslide in stock markets and flight of capital to Dubai.

There were a few subtle strengths that the economy had gained between FYs 2003 and 2006. Conspicuous among them were high economic growth rate that averaged to around 7.5 per cent, a sound forex reserve, investor’s confidence and a manageable current account deficit. The weak points of economy include high cost of inputs that had started scuttling exports around two years earlier, higher M2 growth despite tight monetary policy pursued by the SBP when inflation started increasing in 2004, and dwindling current account surplus that has registered negative growth during past three years. There is much dependence on external sector supported by remittances of expatriates, US aid, liberal loans by the WB and ADB and proceeds of privatisation. Equally weak point was fuelling of consumption through consumer financing that put a lot of pressure on supply side of economy that could hardly keep pace with the demand and this helped further fuel inflation. In case one were to look at consumption and external sector based recipe of economic development and growth, it would not be difficult to conclude that it was a misplaced strategy that left many crucial areas of economy un-addressed over the past few years. With mounting pressure of political uncertainty since March 2007 coupled with changes in global economy and increase in prices of fuel, food and non-food commodities, the economic outlook started to change. It did not take much time to expose the flaws in the policy that some of the domestic analysts and multilateral organisation had been pointing out for rectification for quite some time from now.

The focal point of policy pursued by the government were macro-economic stability and improving economic indicators. The government succeeded to achieve its targets and in a limited sense they sounded good and credible. Issues such as income inequality among different segments of society and different regions of the country, poverty alleviation, and good governance at grass roots level, education and health care got relegated. It was stressed that these issues would be addressed by the trickle down effect that many analysts believed hardly took place notwithstanding claim by the government that poverty was reduced by around 10.0 per cent and per capita income had increased from $450 to $925.

Referring to a few macroeconomic indicators would be instructive at this stage. Forex reserves have decreased to around $12.0 billion from $16.0 billion, as it stood around seven months earlier in October 2007. SBP holds around $10.368 billion at present and remaining $2.244 billion are held by the commercial banks. It is their money. Latest figures about imports and exports indicate that trade deficit of $14 billion during first nine months of current fiscal year is the highest ever recorded in economic history of the country. Likewise, current account deficit of $10.0 billion during first nine months of current fiscal year is the highest too. It is difficult to sustain the latter in view of pressure on supply side of the economy, stagnated exports and likely crunch in external sector.

It was a positive achievement of the previous government to reduce public debt that was more than 100.0 per cent of GDP in 2000 to around 62.0 per cent within four years because of prudent fiscal and monetary policies that the government pursued in accordance with the commitment made to the IMF. But it is somewhat ironic that it did not adhere to its own good fiscal act. It had added $10.0 billion to foreign debt within around four years that raised it to $42 billion from earlier $32 billion. Domestic debt also shot up to around Rs3.0 trillion. During the last fiscal year, debt servicing had cost Rs316 billion. It will be on the higher side for current fiscal year. Will it be possible for economy to take such a huge burden? Certainly, it will be difficult. The govt will have to look out ward for financial assistance and to seek more loans for economic development and may be even for meeting fiscal needs. The finance minister is already running pillar to post to arrange $2.5 billion to beef up forex reserves before June 2008. It might give some strength to a depreciating rupee.

The government plans to issue convertible bonds by offering OGDCL shares in international capital market for generating around $1.0 billion but a pertinent question about this entire exercise could be about response of the market that could be comparatively mute because of uncertainty that prevails at home. ADB is expected to provide around $650million before end of current fiscal year. The government may also get a few millions from other inflows such as MCB transactions and small financial assistance from friendly Gulf and other states.

Poverty alleviation has been a great issue in the country. The official figures on poverty and figures given by the WB and independent analysts are at variance by around 5.0 per cent taking 33.0 per cent figure as the base line of poverty existing in the country. It is obvious that upward trend in inflation particularly food inflation has added poverty to the existing level at least during past more than one year.

According to latest ADB report titled “Soaring Food Prices: Response to the Crisis,” Pakistan being a low income country where poor people spend more than 60.0 per cent of their income to meet family food requirements, incidence of poverty is likely to increase because of 18.3 per cent increase in food prices during first quarter of 2008. According to the Bank’s estimate, 10.0 per cent increase in food prices will add another 7.05 million people to the number of existing poor people estimated to be more than 40.0million according to a very conservative estimate. Their number will increase by multiple of two and three of 7.05 million in case food prices increased by 20.0 per cent and 30.0 per cent respectively. It is feared that increase in food prices that have international dimension is likely to persist. It will keep pushing food inflation upward because Pakistan is a net importer of food items. It simply means that poverty level in the country is likely to increase during next one or two years unless there was visible decline in food prices on one hand and increase in purchasing power of poor segments of the society on other hand. It is unlikely to happen in a big way in short term perspective.

Measures to combat meltdown

The government has the responsibility to take corrective measures to combat fears about economic meltdown that to some extent is reflected by slide in macroeconomic indicators and difficult time that lie ahead for the economy. These measures have to be short, medium and long term. The prime objective of short and immediate measures should be to regain the lost ground mainly because of slow reaction shown by the government in tackling the problems faced by the people and economy. Following suggestions are made in this respect:-

The judges issue is sapping energy of the government whereas it could have been utilised more fruitfully in resolving problems of supply side of the economy to gain confidence of the public and domestic and international investors.

On the forth coming budget

(a) One of the focal points of forthcoming budget should be to reduce non-development expenditure. This is essential to reduce fiscal deficit that is likely to increase to more than 6.0 per cent of GDP despite reduction of Rs70.0 billion in PSDP expenditure meant for current fiscal year and increase in the oil prices.

(b) The government should take concrete measures to document the economy that has been repeatedly emphasised by the donor organisations. It is essential to have a sound base for revenue collection, expand tax net and collect authentic data for better economic planning.

(c) Capital gain tax may be imposed on real estate and stocks. Agriculture income be brought in to tax net.

(d) Cost of inputs for industrial and agriculture sector and for doing business should be reduced as far as could be possible.

(e) Loans should be contracted only for development of such projects that can help to increase employment, industrial and agricultural out put. Fiscal management should be done with in the revenue collected.

Conclusion

National economy is in dire straits for reasons that are partially domestic and partially external. There are reasons to believe that it is passing through a short lived transitory phase. Its woes can be addressed effectively despite existence of some structural imbalances that might take slightly longer to address. The most important point for winning public and investor’s confidence is that the government should be visibly in action in resolving issues one after the other. This can allay the fears of many about the soundness of economy.