Dear Muzammil, I hope you are well. It has been a while since we last saw, met or spoke. Judging from your article on Saturday, I have been on your mind. I found some of what you said unfair and wish you had called me first.
But there is a silver lining in you airing your views on my article in the open. It provides a rare, teachable moment for the Pakistani public. We must not waste it. I am hoping it will also help improve the understanding of Pakistan’s political leaders and others that call the shots (that is, if they pay any attention to this sort of stuff).
I am glad that you agreed with a lot of what I said. Perhaps because you were in a rush, however, you did not accurately present some of my ideas. In particular, you claim that I had said on previous occasions that all was well on the economic front before the change in government in early 2022 — with two years of near 6 percent growth, government debt having fallen post-Covid, and no problems in servicing our external debt.
If that is what you think I have been saying, you have misheard. While major improvements did occur during the first three years of your government, FY22 featured some unfortunate deviations. Perhaps these deviations were because of the intense pressures your government came under from the opposition and others after three years of difficult but necessary stabilization, but they contributed to the predicaments that we face today.
You also disagreed with me on two fronts: you feel that the FY22 budget was not overly expansionary and that the fiscal stimulus that was provided was crucial to our post-Covid recovery. I wish you were right.
Muzammil, here is my sincere response. None of this will be news to as accomplished an economist as you, but it is meant for our audience—the Pakistani public and our masters—so I will try to speak as plainly as possible. I have organized my points into four general principles that they should always keep in mind when assessing any government’s economic record.
Principle 1. If a government inherits scarce foreign exchange reserves, its options will be extremely limited and it will take at least 2-3 years before things better. It means you have no choice but to go to the IMF and tighten your belt. It also means you have to let your currency move since you cannot defend it by throwing reserves into the market. Your government faced this in mid-2108 and did commendably during its first three years, even as the necessary depreciation of the currency contributed to debt mushrooming from 65 percent of GDP in FY18 to 80 percent of GDP in FY20.
There was not much you could have done about this. You did not create much new debt, you just valued what the previous government had accumulated correctly. But by the end of FY21, you reduced it to 75 percent of GDP through fiscal restraint despite the once in a lifetime Covid shock, which you handled in a highly commendable way, drawing high praise internationally. Moreover, you also reduced the current account deficit and raised foreign exchange reserves to over $17 billion. The stabilisation was now complete.
Principle 2. A government that manages its affairs well leaves behind a healthy level of foreign exchange reserves. On this count, too, you did reasonably well. You left around $12 billion and halved the negative forward book, although with an important footnote.
The IMF review was left in abeyance because of the energy subsidies you announced in February 2022 and extreme political uncertainty, putting the reserves outlook at risk at a time when we faced a wall of debt repayments. This was not a good outcome. By the time the new government was able to complete the pending review, reserves were down to $9 billion.
Today, the government’s renewed impasse with the IMF has brought reserves further down to only $3billion. All told, then the damage of delaying the IMF program has been a $9 billion reserve drain, of which two-thirds of it on the new government’ shoulders.
Principle 3. High growth is not always good and in Pakistan above 4-5 percent for a sustained period does not end well. Growth is usually desirable because it creates jobs and boosts incomes. But if it is fueled by fiscal stimulus it adds to our already high debt burden and puts pressure on inflation and the current account.
Given the consumption and import heavy structure of our economy, this overheating can occur at growth rates above 4-5 percent. This was what happened during the 2013-18 period, whose pieces you had to pick up when you came into power.
However, with credit to you, it was not the story of the strong post-Covid recovery in FY21. Growth rebounded even though fiscal policy was appropriately contractionary given already high public debt. Fiscal spending was re-allocated to the most vulnerable but a tight lid kept on overall spending. On the other hand, monetary policy provided generous support. This tight fiscal-loose monetary was a good policy mix.
The result was high-quality growth, with low inflation, a low current account deficit, and falling government debt. By the end of FY21, Ehsaas was celebrated as a global success and the SBP’s temporary support schemes (TERF, Rozgar, debt service relief) were appropriately ended.
We stood at an important cross-roads. We now needed tough structural reforms to boost investment, exports and productivity like slashing regulations, lowering entry barriers and improving access to finance. This was the hard road we needed to take. Instead, we reverted to the lazy old playbook. The fiscal floodgates were opened and subsidies doled out to the same old sectors. We did not need this stimulus.
The economy had already recovered from Covid. By March 2022, this ill-advised stimulus and the concurrent commodity super cycle saw inflation rise to almost 13 percent and the current account deficit balloon from zero to $13 billion. Much of the hard work of your previous 3 years was undone. On the macroeconomic front, we were back to square one. It was time to stabilise yet again.
Principle 4. To assess whether fiscal policy is expansionary, it is the change in the primary balance that counts, not the headline deficit. Since interest payments are determined by past borrowing and past interest rates, they are not in the control of the government. Therefore, they should be deducted from the fiscal deficit to arrive at a true measure of the government’s fiscal stance.
This is well-known and is called the primary balance. During both FY20 and FY21, the primary balance narrowed so fiscal policy was contractionary, despite the COVID shock, a very creditable outcome. When you left the government, the primary deficit for July-March FY22 was Rs 447 billion compared to a primary surplus of Rs194 billion in the same period of the previous year. That is a significant fiscal expansion of more than 1 percent of GDP.
Regrettably, the new government was not able to rein in spending either, and damagingly ended up injecting a further 1 percent of GDP in stimulus in the last three months of FY22. By the end of the year, government debt also rose by 3 percentage points to 78 percent of GDP.
In closing, Muzammil, let me assure you that my intention is simply to diagnose where we went wrong in order to help prevent it from happening again. Mistakes were made all around, some graver and more unforgivable than others. We have had so many boom-busts in our history. Our people deserve better and they deserve the truth, you will agree. It is not about political affiliations. It is about Pakistan.
We are where we are now. In explaining what will happen going forward and what policy options are available, all parties have to be sober and recognize the tight spot that we are in. We cannot pretend that there is an easy way out. Whoever takes charge of Pakistan will have to contend with a very difficult 2-3 years, featuring austerity, high inflation and the need to impose higher taxes and energy prices to balance our books. They will have to negotiate another tough IMF programme. With foreign exchange reserves as low as they are, they will have little room for maneuver for at least another 2-3 years.
Hard-nosed and imaginative structural reforms will be needed to change our growth model towards investment and exports. Ehsaas provides the playbook for how to protect the most vulnerable during this tough period. Unfunded and untargeted subsidies like the energy package do not.
These are the harsh realities that we need to communicate to our unsuspecting public to prepare them for what is coming. For this, professionals in all major parties like you will first need to get your bosses to listen.
You know better than anyone how hard that is, given the strong personalities involved. It is made harder by our current state of political civil war, which rewards bluster and a take-no-prisoners attitude even to subjects as serious as the economy. But we must all do better in our collective fight for a better Pakistan. In fact, this letter is not just for you but for all the fine professionals in our major political parties. It is time to stand up.
Respectfully yours.
Copyright Business Recorder, 2023