Policy imperatives for equitable growth and human well-being

No doubt, the current account deficit has tremendously narrowed down on the back of drastic decline in imports. That allows build-up of reserves and so does the increase in portfolio investment that is witnessing an upward trend over the last few months largely due to higher policy rates for many months now. Another reason for keeping interest rate high is to induce savings rate in the country, which is otherwise on the lower side. Moreover, tight monetary policy stance is overall being maintained with a view to containing inflation and constraining aggregate demand. Exchange rate determination is mostly market-determined. At the same time, higher food inflation is being checked mainly through the provision of subsidy of Rs 10 billion over five months (Rs 2 billion per month) to utility stores, by increasing their numbers significantly across the country, and by envisaging a plan to curb cartels that influence prices artificially.

The government and the State Bank of Pakistan (SBP) contend that these are important steps to stabilise the economy, which was in dire straits when this government took office roughly around one-and-a-half years ago. Having said that in dealing with economic issues, as in life generally, there are certain necessary steps that need to be taken mainly to deal with the immediate aspects of the problem. Yet, there are at times competing ways to reach the same goal, with opportunity cost associated with each policy option. Hence, a prudent government chooses those necessary steps with least opportunity cost associated. At the same time, sustained fixes to economic issues require addressing root causes, and they hold the promise of meeting the sufficient conditions of policy response.

In this regard, the questions needing plausible answers are whether the government and the SBP have come true on meeting the best of necessary conditions made any reasonable strides towards meeting the sufficient conditions. Let's analyze.

Firstly, Pakistan is a net importer of oil, and overall imports contribute significantly to economic growth in the manufacturing and agricultural sectors. It was not the best option then to narrow down current account deficit on the back of virtually market determined exchange rate because this led to causing a huge impact of import-related pass-through on inflation, significantly reducing imports of machinery and other related items, in turn severely dampening growth in the manufacturing and agricultural sectors. At the same time, keeping high policy rate for many months also meant that the cost of borrowing loanable funds increased substantially, leaving importers with inadequate working capital.

On the other hand, high interest rates meant a substantial increase in domestic debt repayments for the government (where it remained the major borrower of loanable funds) that in turn pushed the fiscal deficit overall, causing curtailment of development expenditure and ballooning of deficit on the back of this. Bailing out the energy sector (where circular debt has reached great heights of Rs 1.7 trillion) and state-owned enterprises, resulted in a greater push to not reduce the burden of taxes on domestic consumers, importers and exporters, especially the proportion of indirect taxes/levies in petroleum products and energy tariffs; even the pass-through of falling crude oil prices globally has been delayed.

Hence, while it was 'necessary' to reduce the current account deficit, it was also necessary to not do this at the cost of growth in the real sector. The government was required to take the middle way to ensure that managed floating exchange rate is 'manage' to the extent as not to bring out the sharpest blade of stabilization for this narrow end of deficit curtailment. Rather, domestic production should have been encouraged through reasonable a) depreciation of exchange rate, and b) policy rate hike, which also rationalized to this end, at the back of both government and SBP showing understanding that Pakistan being a developing country, inflation was equally a fiscal phenomenon.

This approach would have allowed exports to be boosted on the back of reasonably ample domestic production which with lower cost of production would have been more competitive exports; not to mention the lowering of the otherwise significant cost-push element in the overall high inflation levels being faced. At the same time, institutional reforms - incentive and governance structure reforms mainly - in the external and real sectors would have allowed enhancement in exports volume, improvement in supply chain domestically, producing sustainable positive consequences for achieving the objectives of reduced inflation, and greater growth prospects for the manufacturing and agricultural sectors with brighter outcomes for the employment situation, equity and poverty concerns.

Secondly, the deep stagflationary situation - both stagnation in economic growth and high inflation - the country finds itself in as a consequence of correct policy choices for appropriately reaching the best possible necessary conditions, and reforming effectively to yield any meaningful solutions, is moreover not going to be resolved with 'solutions' such as providing subsidy to the utility stores and increasing the number of stores.

As a necessary condition here, a 'price commission' for rationalizing prices, needs to be formulated (details of which the writer provided in these columns earlier) to check the working of cartels and economic agents who are involved in setting prices to their advantage in both real and financial sectors, and obstructing efforts aimed at reaching true price signals.

At the same time, a sufficient solution, or a solution that strengthens the institutions, underlying organisations and markets, is the need for undertaking appropriate institutional reform so that an incentive and governance structure is evolved, which facilitates organisations and markets to effectively deal with the challenge of artificial prices.

Thirdly, increasing the savings rate depends more on the correction because only when inflation is on the lower side will the broad group of the people in the country be able to save more. Given the high incidence of income inequality in the country, disposable income after taxes and high inflation do not allow much space for savings therefore. A light monetary policy, if anything, allows only the minute rich class to save and invest more at higher interest rates and inflation levels to perpetuate or consolidate further their wealth, and exert influence over policy through conniving with political elite - through financing their election campaigns and sharing with them profits - earned through policy manipulated in favour of economic elites and formulated by political elites.

Fourthly, the policy of attracting portfolio investment through keeping policy rate high is a policy that cannot bring about sustained outcomes for narrowing down the current account deficit since high interest rates cause cost-push inflation, reduce volume of exports, dampen prospects of needed innovation, and overall make them uncompetitive. This 'hot money' is also very fluid and is likely to leave once the policy rate shows a downward trend. And recognition of this policy is not something new as well, as Napoleon Bonaparte pointed out that 'Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.'

It is about time the PM took the bull by the horns and not allow his economic team - primarily hailing from Ministry of Finance and SBP - to a) hide behind each other; b) show reluctance, to challenge the IMF programme fundamentals in terms of more recent economic wisdom globally; and c) more broadly for the lack of reforms initiated in the real and financial sectors during the tenure of his government. One important step could be to include in his economic team policymakers who are well-versed in heterodox economics.

The PM is therefore required to correct the choices in terms of meeting necessary conditions of policy, and in increasing momentum and choosing better policy options for reaching sufficient solutions for the economy, and more broadly the quality democracy without any further loss of time. The PM should also realize that growth in itself is not a necessary condition; rather the quality of growth is more important. At the same time, the sufficient condition is not growth alone but equitable growth and human well-being; for instance a 'well-being budget' presented by the government of New Zealand last year. All economic policies should be geared towards achieving this goal.

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund)

He tweets@omerjaved7