Risks to the economy

Improvement in economic fundamentals is touted as a major achievement of the present government. Indeed it was but lately the economy has witnessed substantial weaknesses in some key areas which, if left unattended, could become a source of severe headache both for the people and the policy-makers of the country in the coming days.
In its latest Outlook on Pakistan, the World Bank has identified some "major risks" to Pakistan's economy in the short and long terms owing to continuously rising fiscal and current account deficits and structural bottlenecks. According to its assessment, "the debt dynamics are vulnerable to downturns, inflation target for the year will be missed and the performance of exports and revenue is worrisome". Based on current trends, the average inflation during 2006-07 would be in the range of 7-7.5 percent.
During the first quarter of FY07, current account deficit has increased to 2.7 billion dollars, roughly equal to half the magnitude of the full year deficit in the previous year. If the first quarter trend continues, the current account deficit could end up in the range of 5-5.5 percent of the gross domestic product (GDP). Trade deficit has widened to 3.2 billion dollars despite deceleration in import growth to 13.4 percent. Pakistan's tax system continues to under-perform in fundamental ways.
"The tax revenue at 10.3 percent of the GDP and accounting for two-third of total revenues remains low against government spending needs". Agriculture and services sectors remain outside the tax net, depriving the system of additional revenue resources. Sub-national revenue collection is weak, amounting to less than one percent of the GDP.
During the current fiscal year, the reliance on domestic borrowing has increased, with government borrowing from the central bank reaching Rs 86 billion at the end of October 2006, an amount roughly equal to two-third of the amount targeted for the whole fiscal year. Pakistan has also to raise savings and investment rates considerably to sustain higher growth rates.
While most of these aggregates are easily verifiable, an intriguing aspect of the Outlook is the huge difference between the World Bank and the government of Pakistan about the measurement of poverty level in the country.
The government in its latest Economic Survey had given a pleasant surprise to the nation by revealing that poverty in the country had declined by 10.56 percentage points from 34.46 percent in 2001 to 23.90 percent in 2005. The extent of decline in urban and rural areas amounted to 7.79 percentage points and 11.6 percentage points respectively. Figures of the World Bank, on the other hand, are much less encouraging.
According to its estimates, poverty rate at the end of FY05 stood at 29.2 percent, a decline of only about five percentage points from 34.4 percent in 2000-01. Moreover, the poverty estimate of 29.2 percent was just 0.8 percent better than 30 percent estimated in 1998-99 when President Musharraf assumed power. The poverty incidence in urban and rural areas in 2004-05 stood at 19.1 percent and 34 percent respectively.
This is not the first time that policy-makers of the country have been cautioned about the deteriorating trends in a number of key areas in the economy. Nor, in our view, they can be so naive so as to be unaware of these unhealthy developments. Only a few days ago, the State Bank in its annual report, released on December 2, had also highlighted most of these weaknesses and suggested necessary measures to overcome the emerging risks to the economy.
The problem, however, is probably the lack of proper recognition of the bitter realities on the economic front and the absence of the necessary will to confront these problems squarely in the relevant quarters. The highest functionaries of the government are, perhaps, made to believe that all aspects of the economy are in excellent shape and this mantra is repeated day in and day out.
Besides, it is also not certain whether the powers that be would even be willing to consider the possibility of harsh measures needed to correct the emerging weaknesses when the elections are due in a year's time. The IMF monitoring that generally goaded the authorities to swallow bitter pills in the past is also not that effective because at the moment the country has no programme with this institution.
However, all of this does not mean that Pakistan can postpone the resolution of the problems indefinitely with the hope that these will disappear automatically. Sooner rather than later, measures will have to be taken to narrow the external sector deficit to manageable levels, raise the tax-GDP ratio, increase the domestic saving rate substantially to finance a reasonable level of investment and reduce inflationary pressures in the economy.
The policy initiatives like widening of the tax net to agriculture and services sector, better returns to the savers, competitive exchange rate and economy of expenditures are known.
We can only urge the government to take appropriate measures to deal with the emerging situation in a resolute manner and in time. Higher doses of bitter medicine would become necessary if, despite the early warning signs of the disease, is not treated properly.
A sharp difference between the government and the World Bank with regard to the measurement of poverty would certainly be uncomfortable for the policy-makers of the country. A careful reading of the government publications would suggest that the authorities are not sticking to the definition and not following the international standard of measuring poverty level.
We would advise the government not to try to hide the facts from the people who, by now, have become quite mature in their judgement and follow the international standards on a consistent basis.
There is also some controversy about the competitiveness of exchange rate after the publication of the 2006 Article IV Consultation Report prepared by the IMF, which was said to have advised the Pakistani authorities to devalue the rupee by 10 percent.
This news annoyed the State Bank to an extent that the Governor had to emphasise through an announcement that the rupee rate is determined by the market and that the central bank was not in the business of devaluing or artificially backing the currency. Any assessment offered by analysts of any organisation is often highly eclectic and subjective in nature as different approaches and methodologies offer different inferences.
While going through the IMF report, it becomes obvious that what the Governor has said is right. Only one of the three methodologies adopted by the IMF suggested overvaluation of the rupee by about 10 percent. While the Fund staff appeared to be in favour of some depreciation of the rupee, the Pakistani authorities viewed the current level of the real exchange rate as broadly appropriate.
It needs to be pointed out that such differences are normal in discussions with the Fund staff. However, since we don't have any programme with the IMF at the moment, such an advice is not binding on the country. Notwithstanding this difference in opinion, it needs to be pointed out that the appropriateness of exchange rate must be consistently reviewed in view of the widening deficit in the external sector of the country.