With around two dozen IMF programs in history, Pakistan is considered as a habitual borrower of “the lender of the last resort”. Dr. Reza Baqir is repeatedly pointing out that the fall in SBP gross reserves is the main reason for knocking down the Fund door. Every program comes up with the cost of stabilization and an array of stipulated reforms. Some of the instructed polices repeat, such as tightening the fiscal and monetary policies and making sharp adjustment in currency value. On structural reforms, there are some alteration in every program as per the need of time and the desire of the government in charge.
The one-line answer to stop going to the IMF very now and then, or to come out of balance of payment constrained growth of 3-4 percent (ADB computed it at 3.8%): sustainably build forex reserves. Take the reserves to a level so that the country can withstand a crisis or two without having to make an SOS call. But it’s easier said than done.
The way forward is to have central bank focus on its singular mandate of inflation targeting. That is, deviate from growth-focused policies. Historically, expansionary fiscal and monetary policies to spur growth (when not in IMF program) have led to balance of payment crises. Inflation targets were never followed religiously while short-term growth was the agenda of every other government to win votes.
With economy not having inherent strength to absorb such upward growth spurts, crisis used to be a logical consequence. This is the first time in the history that there is so much deliberation on the issue and everyone is talking about this boom-bust cycle. There seems to be a broad-based understanding to tackle the issue, and the political will is yet to be tested.
Stabilization is definitely in sight, but the economy is nowhere close to affording expansionary fiscal and monetary policies any time soon. The Fund thinks that mandating central bank with sole inflation-targeting can help in achieving long-lasting stability. For that to happen, the much-needed growth of 5 percent plus for a prolonged period (to absorb millions coming into work force) has to be put on back burner. SBP is said to target medium-term inflation at 5-7 percent. For that, interest rates have to be kept high till the time that targeted inflation levels are in sight.
Higher current account deficit (CAD) is one reason for the run down on reserves. The saving-investment gap is resulting in higher CAD. In the 1980s, Pakistan’s saving to GDP ratio was low but the difference with other regional and emerging economies was marginal. The other economies saved more in the last three decades while Pakistan focused on consumption. The saving to GDP ratio of others moved up north while we went south. The gap, thus, widened.
One reason for low savings is persistently high fiscal deficit. The government deficit is hard to control. The central bank might not allow expansionary fiscal policies to be adopted any time soon. Till the time Pakistan is in the IMF program, primary fiscal deficit target will keep growth of government debt in check. Since interest rates are kept high, in absolute terms the ability to spend on development is to remain low.
The other important reason for low savings and higher CAD is falling exports. In late 80s and early 90s, the country’s exports peaked in terms of GDP. The exports remained at reasonable levels till early 2000s before nosediving. Today, Pakistan is in the club of the five worst exporting economies. This trend has to be reversed. Otherwise, the consumption of government and household have to be curtailed substantially.
The point is that for the economy to move up the ladder in the medium to long term and to come out of the rut of boom-bust cycle, the stability has to be prolonged. The savings have to be higher. The fiscal deficit has to be curtailed. The exports have to move up.
The SBP’s policy is seemingly to redirect the economy and shift the credit towards productive sectors. The production has to move towards manufacturing and exporting sectors. The growth formula has to move from government-run PSDP to privately-run industries. In days of high interest rates, the SBP is extending and expanding its subsidy-oriented export-refinancing schemes. The market-based exchange rate is favoring exporters. The other benefit of a market-based exchange rate is to attract FDI in efficiency-seeking (including exporting) sectors. The market-based exchange rate amid aggressive medium-term inflation targeting is attracting global capital market investors to Pakistan. That will help in building reserves and in giving time to reset the economic priorities.