Can economy rise from the ashes?

The phoenix is a mythological bird that after living 100 years bursts into flames and turns to ashes. It is painful to witness but the Pakistani economy appears turning to ashes presently. FM Dar, through his obsession to peg the exchange rate, has achieved extraordinary outcomes: the steady erosion of SBP’s forex reserves, suffocation of business activities in the real sector, de-anchored inflation expectations, downgrading of sovereign ratings to junk status, and Pakistan’s probability of defaulting on sovereign debt servicing in the near-term.

The country has now reached a critical and existential stage. For decades, the country has relied on a combination of massive borrowings from a variety of domestic and external sources to underpin its economic growth strategy. Governments have avoided resource mobilization through equitable and just taxation arrangements and failed to provide leadership in productivity-led and export-led as the two fundamental pillars of economic growth strategy. Continuing with the failed economic growth model is no longer sustainable nor viable as both the access and limits to external borrowings as well as geopolitical rents are nearly exhausted.

Band-aid arrangements such as installing a longer-term “technocratic” caretaker government will not be able to implement credible reform program of state finances and deep structural economic transformation, which are likely to be reversed by political governments as they will be perceived as unpopular measures or under IMF diktat. Our own history, since 1988, is a testament to the reversal of various “technocratic” reforms by successive governments.

A resetting mind-set of policy elites across the entire power spectrum accompanied by honest assessment is required to truly understand the magnitude of the existential crisis facing the country. Zealously continuing with band-aid arrangements does not bode well in terms of building societal harmony and mobilizing resources on a sustainable basis to support peoples’ aspirations for social and economic advancement.

Essentially, the country is faced with a polycrisis that can be broadly clubbed into three categories: antiquated and low productivity production structure in the real sector, fiscal solvency crisis, and liquidity and solvency crises in the external sector. Without resolving these, the country is fated to remain forever mired in both fiscal and external sector insolvency crises.

The resolution of these crises will require a clear-headed recognition of the need to implement fundamental reforms by key domestic stakeholders across the power spectrum, which is also supported by longer-term understanding of external stakeholders. In other words, the dismantling of a dominant rent-seeking economy, which is predicated on failed growth strategy, will require explicit recognition by key stakeholders: the size of painful adjustment costs, its distribution burden across public and private sectors, and the implementation sequencing of various fundamental reform measures. Typically, external stakeholders provide debt restructuring support during the transition period that helps in easing the adjustment burden, especially on the most vulnerable segments.

On the domestic front, the key challenge is to turn both the milestablishment and judiciary into enablers and supporters of frontier governance reforms, which will entail the dismantling of elite capture rent-seekers and policymaking process as well as the break-up of cartelization in both the political and business spheres. As recent experience during 2018-22 amply demonstrated, key reform initiatives were hamstrung and attempts to improve governance standards were straitjacketed within the judicial system, which was then further undermined through behind-the-scene political machinations. Unfortunately, and ultimately, the laws of unintended consequences came into play and the decisive appetite and momentum for even piecemeal reform efforts were degraded.

On the external front, support for adjustment costs during the transition period is provided through debt restructuring framework agreements. Typically, the debt restructuring negotiation is an arduous process and its handling requires the finest diplomatic skills and, at the minimum requires one or two G20 countries to support and commit to constantly shepherding other creditor countries and private lenders. This means that such countries will also have to commit and earmark resources for the cause of Pakistan’s debt restructuring.

There are a number of other complicated restructuring terms & norms around different creditor groups that require negotiation and agreements. In our case, the most vexing issue will be to on-board Chinese, both official and their “private” commercial lenders, which other western countries see as state-owned financial institutions or part of official creditors. Another critical issue will be the treatment of multilateral debt. Typically, multilateral have two sets of balance sheets. Take the case of World Bank. It has IBRD & IDA balance sheets. IBRD debt is never directly restructured. But IDA compensates IBRD debt in NPV terms. This, in turn, requires support or agreement by IDA donors.

It appears that Pakistan has missed the window of opportunity for initiating the external debt restructuring negotiation process. Essentially, the present government has prioritized external debt servicing and, given the limited SBP forex reserves, suffocated real sector activities through the administrative rationing of imports. With friendly countries delaying the additional injection of fresh financial assistance, deadlock around implementing key IMF conditionalities, and SBP forex reserves at truly critical levels, the opportunity for protracted debt restructuring negotiations has been missed as the country doesn’t even have adequate forex reserves to see through a period of sub-par imports and clear unpaid LCs.

Furthermore, Pakistan has nearly exhausted normal access to IMF financing. Any augmented or exceptional access to IMF financing will require its Board approval and will be predicated on deep structural reforms across all sectors. In such a scenario, IMF monitoring implementation will be highly intrusive, the like of which Pakistan has never experienced.

Looking ahead, the country needs a political government with solid voters’ support, and most critically, which also commits itself to holistically overhauling currently unviable state finance arrangements; in fact, going much beyond what the IMF program typically entails. Across the political spectrum, only PTI (Pakistan Tehrik-e-Insaf) as a political party has a demonstrated record of “struggling” to implement piecemeal reforms, both at provincial and federal levels.

PTI needs to demonstrate a strong commitment to a holistic reforms agenda by presenting a “grand development bargain”, which should encompass judicial reforms, and state finances as well as a longer-term program of economic transformation that is built around three key pillars viz incentivizing productivity-led growth, supporting building of competitiveness and innovation ecosystem. Fundamental reform work in the Planning Commission, during 2018-22, was nearly completed and was ready for national roll-out by May 2022, which included an economic transformation strategy for sustainable and jobs-intensive growth, a national development framework aimed at fostering cooperative federalism, wide-ranging PSDP reforms, a medium-term program to re-capacitate and build competencies in the government to effectively perform public policy functions, and a well-articulated program of institutional strengthening, modernization, and autonomy of PBS.

Such a vision of a “grand development bargain” must be underpinned by a credible fiscal framework that will involve an immediate and orderly moratorium of debt servicing accompanied by negotiations to restructure both domestic and external debt as well as IPP contracts, review to develop a medium-term targeted reduction in defense expenditures, review of NFC award, immediate governance reforms leading to potential privatization of SOEs, and a medium-term program to reduce government footprint accompanied by wide-ranging regulatory guillotine.

Only with a sustainable and credible program to reduce the overall government expenditures will then garner voters’ support to embrace taxation reforms that will need to encompass broadening of the tax base in the agriculture and services sectors as well as to reduce the current unjust tax incidence on the industrial sector and the salaried class.

It is crucial that a vision of a “grand development bargain” along with a robust implementation mechanism, which is not only credible but also becomes embedded in various constitutional provisions. Fighting next election on such a vision will find strong support from the people as well as external stakeholders as it will allow Pakistan to move away from being a basket case to, instead, evolve and become a peaceful and just society in which the younger generation find opportunities for their social and economic advancement. By doing so, the Pakistani society and its economy can rise from the present catastrophe stronger, smarter, and more powerful.

Copyright Business Recorder, 2023