Precarious state of economy

During an interview with a Turkish TV, the Prime Minister remarked that his government faced multiple challenges but the economic challenge was the foremost and that he was pleased that in the last four months, the economy was stabilised, and now the government was moving to increase exports, remittances and, above all, investments for job creation and foreign exchange reserves.
While the Prime Minister made this claim confidently, the facts were speaking otherwise. Before we argue this proposition, it is important to define what economic stability really means? There is a very simple definition of economic stability. At the national level, there are two accounts, fiscal (budget) and external (balance of payments) whose balances determine whether or not an economy is stable. In both cases, it is not required that these are balanced, which, in an accounting sense, are always balanced. Rather, the imbalances (deficits), if any, should be sustainable; converging to a steady state where they pose no threat to the rest of the economy.
Let us examine where the imbalances are standing. The external (current account) data for six months is yet to be released. However, the shipment-based data on imports and exports from Bureau of Statistics is out. It is not so encouraging as exports are up barely 2.2 percent and imports are down merely 2.3 percent and the trade account improving by 5.1 percent. Compare this small positive change relative to what is needed to have meaningful Last year, the current account deficit (CAD) was $19 billion, which has to be brought to less than half to stabilize the economy. The six-month trade account performance is way short of the desired adjustment in the overall external account.
It is curious to note that since July 2017, rupee has depreciated by more than 30 percent and yet the external account has virtually remained invariant. One can understand if the exports supply has not responded immediately but for the imports to remain largely unaltered is somewhat surprising. But it is understood when the structure of imports is examined. A quick review of the composition of imports in economic categories shows that petroleum (27.3 percent), machinery (16 percent), fertilizer, agriculture inputs and chemicals (16.4), food (10.6), metal (8.9), textile and transport (10.4) capture more than 80 percent of imports. These are all essential imports, badly needed for economic growth. Even the food group (edible oil) cannot be cut back in the short run as it would require considerable efforts to achieve required level of import substitution.
The real reason behind the stubbornly high import demand is the fiscal account. All indications point to an unusually high fiscal deficit that is all set to surpass even the Q1 deficit of 1.4 percent. On revenue side the six months (Jul-Dec) revenue shortfall is reportedly around Rs 172 billion. At this pace, there would be a shortfall of nearly Rs 350 billion (or nearly one percent of GDP). The target for the year is Rs 4.3 trillion. Based on six months performance, it looks difficult to achieve even Rs 4.0 trillion. The tax-to-GDP ratio is likely to fall significantly, continuing the declining trend for the third consecutive year.
On the expenditure side, the rising debt servicing costs would neutralize any austerity measures or cutting of development spending. The policy rate increase of 350 basis points (BPS)will cost Rs.847 billion in additional debt servicing not fully accounted for in the current budget estimates. The growth in public debt during Jul-Nov at Rs 2.2 trillion is about 10%, which is unprecedented. This comprises Rs 1.2 trillion in exchange rate loss on existing external debt and Rs 1 trillion in deficit financing. At this level of deficit in five months, year-end deficit would be Rs 2.4 trillion or 6.0 percent of GDP. Chances are it would be significantly higher as no corrective measures are in sight.
Then there are other pressures on the budget not fully recognized. The IMF was asking the government to either pass on the prices of utilities as determined by the regulators or put them in the budget. Those are still missing. Then there are unbudgeted subsidies on fertilizer imports, LNG and electricity use by textiles sector and export rebates. Taken together, these items could easily add up to one percent of GDP.
With such precarious position of the two accounts, it is untenable to claim economic stability. What is more amusing is to note that mutated voices are sounded in some sections of public opinion, lauding government's decision for not going into an IMF programme for stabilization.
There is a fundamental misunderstanding about the nature and history of IMF programmes. An IMF programme is not the result of a marketing effort whereby IMF reaches out to member countries for doing a programme. It's a medical facility where those afflicted by economic disorder are treated. This medical facility is a cooperative effort founded by all member countries for the purpose of preventing an outbreak of international payments disorder since it could have repercussions for regional and global contagion. The state of the Pakistan economy, as depicted above, is a clear case of medical emergency requiring immediate attention.
Those in need of medical help could make any of the two choices: either submit to professional advice or decide against taking the prescription. A fund programme is definitely a negotiated arrangement but its basic features are based on a very sound economic logic. The macro imbalances are a result of excess aggregate demand relative to supply. Demand compression in the short-run is the only viable option essentially by cutting fiscal and external account deficits. To this effect, revenue mobilization, austerity, policy rate and foreign exchange reserves or exchange rate are the corrective instruments. All these have to be done in a coordinated fashion within the framework of a comprehensive programme.
Apparently, Pakistan authorities have decided not to seek IMF facility and focused instead on seeking friendly help to tide over the persisting imbalances. Unilateral adjustments in instruments have so far made no perceptible impact on these imbalances. Has this been helpful to economy? Clearly, the answer is in the negative as the friendly help was good for a short while and afterward we are back to the same place. The uncertainty surrounding the markets and economic activities is seriously undermining the health of the economy. It cannot go on like this. The longer it takes to correct the course, the greater would be pain for doing the requisite adjustment.
Those who may have felt that the Fund programme on the table was too harsh and that they needed the breathing space through friendly support to negotiate a better deal would soon discover that this was not the correct strategy. Precious time has been lost in the process and imbalances have worsened. Consequently, the cost of adjustment would be higher and perhaps more painful decisions would be required to stabilize the economy.
The failed IMF programmes have invariably been the result of governments succumbing to political pressures and expediencies at the cost of neglecting economic imperatives. Precious reforms were abandoned mid-way and when done they were half-hearted and without convictions. The IMF is not an epitome of reforms which others cannot match; it has money to support those reforms and it acts as an external lever to induce discipline. If a country doesn't need money, it may well choose to work without the IMF. However, if you are in need, you cannot then set your own conditions. The concessional facility, the cooperative arrangement has decided, is for economic correction and not for indulgence and indiscipline.
(The writer is former finance secretary)
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