Understanding the problem is half the solution. This article spells out the top three problems that constitute the present crisis: an urgent (“dollar”), an immediate (“fiscal”), and an underlying longer-term (“economic”) problem.
The first two are financial and contrary to popular belief are unrelated. Both arise from a deeper, third problem, which is economic. The economic, in turn, reflects still deeper political and social problems, beyond the scope of this article.
The urgent, dollar problem is the chronic shortage of (and currently, dwindling) foreign exchange reserves held by the State Bank of Pakistan (SBP) and the banking system, which is choking off foreign trade.
The immediate, fiscal problem is the federal government’s inability to pay for essential expenditures after paying interest on its debt (85pc of net federal revenues in FY22, and on an explosive upward trend).
Even though only 10 percent of interest expenditure (and 35 percent of debt stock) was in dollars in FY22, the shortage of dollars in the banking system is so severe that government finds it difficult to convert rupee revenues into dollars, to service external debt. Consequently, the dollar problem is often mistaken as a fiscal problem.
But — and this is critical to understand—the dollar problem isn’t caused by fiscal stress: taxes being low, expenditures being high, or not enough financing being available at reasonable rates (the last, naturally, being the only problem that bankers focus on and try to solve).
The dollar problem arises because the structure of the economy — which, beside the government, includes private consumers, investors, exporters, and importers—and the direction in which it is changing in response to existing risks and incentives, are such that collectively we import far more (and increasingly far more) than we export.
This arises from the third, the economy problem, which underlies both the dollar and the fiscal problems: by adversely affecting export capacity and the tax base, respectively, among its other ill effects. The market can’t fix this. The government must.
Probably the biggest hurdle in fully understanding that the dollar and fiscal problems require separate attention is the widely believed “twin deficits” fallacy. In trying to simplify things for the general public, some very respectable experts have explained for decades now that the balance of payments (i.e., dollar) deficit is a mirror image of our fiscal deficit. Solve one and you’ll solve the other. This is compound ignorance (believing the false to be true, jahl-e murakkab) that has led to policy neglect of the economy, and economic planning and development policy, since the IMF-inspired turn to markets in late 1988. True, there are two deficits, but the drivers of the dollar and fiscal problems are different: the dollar, more economic; the fiscal, more political.
To summarise, there are financial problems (dollar and fiscal), which arise from deeper economic problems (of structural changes in investment and production), which are embedded in still deeper political and social problems (that constrain good governance, which underpins social prosperity, on which government revenues depend).
In this situation, policy intervention should aim first for short-term palliative solutions to the financial crisis, outlined in this article, which create the room needed for medium-term remedial solutions to the economic crisis, while working on long-term transformation of politics and society.
The dollar crisis is now suffocating foreign trade, the life breath of the economy, and the economy is gasping for breath. Policy is often a choice between the awful and the terrible. Rationing does lead to black markets and unethical practices. But when things are scarce (whether due to war, recession, trade restrictions, or crop failure), governments must and do ration the scarce commodity, because inaction would be catastrophic.
It is high time, therefore, that government controls, budgets, and rations foreign exchange, and takes ad hoc measures to enhance export receipts and curtail import expenditures, temporarily, until the severity of the crisis is alleviated.
For details of such a programme, which led among others to the bonus voucher scheme and was implemented successfully under similar conditions, the government can refer if necessary to the February 1959 (Wilhelm Vocke) report submitted to government.
This should be supplemented by tightening the trade and payments regime (especially on the capital account), whose premature liberalisation caused and sustains the present crisis. (The weighted average tariff rate, currently around 12pc, fell from 65pc in 1988 to 19pc in 2000, significantly eroding our industrial and export capacity.)
Finally, trust in the rupee must be restored by strengthening and stabilising it at an exchange rate that can be defended. A suitable committee should be able to prepare actionable recommendations in two to four weeks.
By contrast, a palliative solution to the immediate fiscal crisis is conceptually easier, although its execution would require domestic bankers to agree to arrangements that are far less lucrative than at present. The immediate problem is the explosive past and future path of interest payments to banks, as government, cut off from SBP (this must change), borrows at increasingly higher rates to meet its interest obligations.
The government should restructure its domestic law, rupee debt, taking care not to trigger a banking and financial crisis and to protect pensioners and other vulnerable groups, in a process that should take about four months (for details, see How to solve the debt crisis, BR, 22 Apr 2022).
The IMF has issued guidelines in 2021 on how to do this and would be supportive if approached. Finally, there is a need for a radical reform of the domestic financial sector — now mostly a cartel of sovereign debt brokers, rather than institutions of genuine financial intermediation that mobilise savings.
This is, of course, just the tip of the iceberg. The longer-term remedy lies in instituting a continuous cyclical process of formulating, implementing, and monitoring a comprehensive, macroeconomic and sectoral, medium-term plan for economic revival, making and correcting mistakes in the process.
This will also restore much needed consistency in economic strategy and policies, which have become compartmentalised into insulated silos: SBP, finance, commerce, planning, etc.
Naturally, timing, sequencing, and secrecy are everything in policymaking, as in war. The winning strategy, executed at the wrong time, in an improper sequence, disclosed prematurely, leads to failure, not success, defeat, not victory.
Our ultimate aim must be a competitive market-based mixed economy, overseen by a lean strong government, both functioning under effective laws and courts — the last, an essential precondition. But this will take time to build. At this point, therefore, when the infrastructure of governance lies in shambles, the state must be strengthened to regulate rigged markets, in the public interest, and to better protect and manage public assets.
This work must be carried out under political leadership. Because to resolve the present debt crisis and prevent future ones, coalitions must be built to try and redistribute power and opportunities, strategically and incrementally, toward the people, away from domestic and global capital.
This can only be done by a genuinely democratic government, culturally rooted in the people, that governs not by force and patronage but by the authority derived from providing justice, under law, to all. Only a cohesive, prosperous, civilised society can support a financially sustainable government. Economic revival must therefore be based ultimately on a programme of political and social transformation.
Copyright Business Recorder, 2023