Political instability, delay in reforms key reasons behind economic downturn

ISLAMABAD: The Policy Research Institute of Market Economy (PRIME) has linked the dismal performance of Pakistan’s economy with deteriorating political stability and the reluctance of the governments to carry out reforms.

In its quarterly report released here on Wednesday “Prime Plus”, which tracks the progress on the pillars of economic prosperity along with the analysis of macroeconomic trends and outlook, highlighted excessive government footprint in the economy and public spending which continues to fuel economic crisis.

The pillars of economic prosperity are limited government footprint, spending restraints, low tax rates, reduction of trade barriers, establish sound money and privatise loss-making state-owned enterprises.

The fiscal deficit clocked at Rs1.87 trillion or 2.3 percent of GDP in Jul-Feb 2023 where expenditures stood at Rs5 trillion and revenues were Rs3 trillion; therefore, the government borrowed Rs1.39 trillion in the first two months of third quarter of FY 2023, out of which, Rs239 billion were from the State Bank and Rs1.15 trillion from commercial banks. Resultantly, the borrowing for budgetary needs led to build-up of public debt of more than Rs54.9 trillion.

The report highlights that the government’s restrictions on imports to stem the burgeoning current account deficit though succeeded in bringing down the deficit from $12 billion to $3.8 billion in July-Feb 2023 from last year; it also contributed to a halt in manufacturing sector where the output of the sector declined by 5.56 percent in eight months compared to last year. This slowdown contributed to inflation and prospects of further hikes in the coming months.

The slowdown in manufacturing sector also resulted from a decline in the borrowing of private sector by Rs219 billion in first two months of third quarter of FY 2023 and total borrowing stood at Rs7.4 trillion.

The borrowing of the private sector under export processing scheme also declined by Rs7 billion. The decline in borrowing can be attributed to 300 basis points increase in the policy rate and halt in operations due to the unavailability of raw materials.

The report argues that the taxation system of Pakistan is regressive in nature with more reliance on indirect taxes because the government has remained unsuccessful to broaden the tax base and people are reluctant due to exorbitant rates of taxes.

The distortions emanating from high taxes can be represented by the fact the sale of smuggled cigarettes in March 2023 increased by more than 30 percent and sale of legitimate cigarettes fell by more than 60 percent after the increase of federal excise duty in supplementary finance bill 2023.

The adoption of a market-based exchange rate has promoted some stability in the foreign exchange market, but the weak economic fundamentals continue to keep the currency precarious.

However, the debt servicing obligations and import payments kept the pressure on the local currency and exchange rate in the third quarter of FY 2023 depreciated by 25 percent from Rs225 at the end of December 2022 to Rs281 at the end of March 2023. Moreover, the foreign exchange reserves declined from $5.6 billion to $4.2 billion at the end of March.

The governments remained unsuccessful to carry out reforms due to political instability and reluctance due to potential fall in the political capital. However, the current political divide has deeply fragmented the masses and any consensus on key policy reforms remains elusive.

The government’s continuous deviation from the agreed path with the IMF has resulted in the cessation of the program and a significant delay in the completion of the 9th review. Despite the completion of prerequisites such as a market-based exchange rate, a hike in utility prices, and the mini-budget, the government could not restore confidence and the IMF is currently waiting for confirmations from friendly countries for their previously agreed financial support.

The government is struggling to control inflation and the State Bank of Pakistan is continuously increasing the annual range as inflation expectations remain anchored.

The increase in the policy rate up to 300 basis points in the quarter will manifest the outcome with a lag of a few months. However, the supply chain disruptions, halt in manufacturing activities and restriction on imports will keep the prices inflated in the coming months.

The government needs to allow imports by reducing tariff and non-tariff barriers to facilitate manufacturing activities and promote competition in the sector. It is also imperative for the government to revaluate its role in the economy by moving away from business and focusing more on regulations to create a business conducive environment in the country.

The facilitation of businesses also requires simplification of the taxation system and reduction in the rates of taxes to promote compliance. The reduction in government borrowing from commercial banks will ensure the availability of necessary capital for the private sector to enhance manufacturing activities and cater to supply-side inflationary pressures.

Copyright Business Recorder, 2023