The balance of payment and inflation worries have started surfacing again. However, the important point to note is that the economy is not overheated – unlike 2017-18. In some sectors the demand is yet to peak at 2017-18 levels. The better growth in 2020-21 was due to a bounce- back from a low base in the preceding year and due to flurry of foreign net inflows. One can say economy is at a lukewarm stage; and there might be a case of slowdown in activities due to spiking commodity prices in the next quarter or two.
Things are getting tougher for businesses with the increase in cost of production due to escalating raw materials prices. Sooner or later, price may increase in various products such as cement, automobile, and others. The worry is the slippage in the current account deficit and inflationary impact of both higher commodity prices in dollars and rupee depreciation. Seeing both the elements, it is prudent to check the demand till the time international prices cool down.
The question is what kind of policy reform is warranted. Some are trying to draw parallels to 2016-18. Well, it would be unfair with the current economic managers to compare them with Ishaq Dar. The foremost policy flaw Dar had was to let the current account slip while keeping currency artificially fixed.
Between November 2016 and December 2017, the current account deficit monthly average stood at $1.2 billion, and the policymakers were numb. The international oil prices averaged at $53/ barrel at that time versus at $72/barrel in the last three months. Similarly, many other commodities prices like palm oil, coal, fertilizer (DAP), steel, etc., were at steep discount to current prices.
There was no price pressure on the imports; but due to persistent expansionary fiscal and monetary policies at the same time dragged the economy to a deep crisis. After Dar, when Miftah Ismail of PML-N took charge, the government had started slowly adjusting the currency and interest rates. But that one year was enough to let the deficit to keep on rising for the next eighteen months before the tightening and adjustment started to yield results.
The case of 2021-22 could be like 2007-8 when the government did not pay heed to rising oil and other commodity prices. The government at that time was of the view that prices would come down and things would get better. The prices eventually came down; but that few quarters were enough to cause a massive current account deficit. And it took years before the economy bounced back to normalcy.
In both cases of 2016-18 and 2007-08, one thing was common. Both the respective governments were in election modes and were in political turmoil, and to avoid public bashing and to show better economic performance in their last years, they let the crisis to brew. And the inertia of these expansionary policies was enough to let the economy to operate on clutches for the next few years.
The message to incumbents is to not repeat the mistake. Irrespective of the reasons, the current account is slipping, and that needs to be addressed promptly before it becomes too late. Unlike 2007-8, election is not round the corner. Unlike both the previous times, the federal government is relatively in a comfortable position. It’s time to introspect and revisit, the ambitious plans of the new finance team, and to take it easy on the growth paddle.
The foremost important message is to not fiddle with the international prices. The government is thinking for the past few months that international commodity prices to revert to mean and till that time it is fine to keep prices low by compromising on revenues and let the growth momentum to remain unabated. That is a dangerous ploy. It’s near impossible to predict oil and other prices. A cautious and safe approach could be to pass on the impact to consumer so that demand can be rationed and let the momentum regain when international prices come down.
One marked difference today is flexible exchange rate and relative independence of the central bank. This could be due to the reason Pakistan is in the IMF programme and desperately need this to be out of freezing mode. In both cases in the past crises, there was no IMF programme, and there was no check on the policymakers’ exuberance. The presence of the IMF is giving comfort that a full-blown crisis might be averted.
There is other way to look at the situation today in the light of economic volatility due to Covid-19. After the tightening in 2018-19, it was anticipated that economy to be back on growth momentum in 2021-22 or 2022-23. However, the pandemic flipped the equation. Like rest of the world, monetary and fiscal stimulus were offered.
Interest rates were down to half. TERF, wage support, and loan deferment are to name a few concessions by the SBP. Then construction package (amnesty and low fixed tax rates), and other support came from the federal government. Then smart lockdowns in Pakistan paid dividends in terms of higher exports order. Lower international commodity prices tamed the import bill. Less travel was a blessing for remittances growth. The current account was in surplus; construction and agriculture (due to better wheat support price) boom spurred the economy.
But the Covid19-related cycle is now moving the other way. The international commodity prices are at multiyear high. Supply chain disruption is adding to the cost of imports and delaying export shipments. The opening of travel is challenging the remittances growth. Then the Afghanistan situation is adding concerns in relation to external accounts.
The point is that part of what the government gained in 2020-21 it needs to give some back in 2021-22. The message for Islamabad is to not get greedy, as you are not needy. The message for SBP is that it is the time to unwind the stimulus. The policy of accommodating monetary policy needs to be revisited.
However, running too many interest rates (due to numerous concessionary policies) and too high currency in circulation may dilute the impact of monetary tightening, and the fiscal borrowing is insulated to rates. SBP should think of reducing the dual interest rate policy by lowering the loans in schemes like LTTF and ERF – as TERF has already expired. The big seths are rational economic agents, when they see cheap credit, they invest their own capital in real estate (or other asset classes) and invest on cheap credit in businesses having on average 20 percent plus return on equity. SBP must think of ending such distortions – especially for big businesses.
Islamabad should think of having higher duties on non-essential items. The question is what constitutes non-essentials and how much impact these would have on curtailing import bill. A more effective policy could be to pass on the impact of oil and gas prices to consumers. Let the prices do rationing. The finance minister must let the reality to sync in it that the growth acceleration plans need to be put on the back burner. The bottom line is that it’s time to balance out the tailwind the government (and SBP) got last year to tackle the headwind right now – it’s time to balance the act.
Copyright Business Recorder, 2021