A difficult economic triangle

In a recent Financial Times (FT) article ‘IMF urges eurozone to boost spending to fuel economic recovery’, Martin Arnold and Miles Johnson pointed out that ‘Eurozone countries should increase government spending by an extra 3 per cent of gross domestic product over the next year to mitigate the economic impact of the coronavirus pandemic, the IMF said on Wednesday.’ On the other hand, the International Monetary Fund (IMF) in its recently-released Extended Fund Facility (EFF) programme review report with regard to Pakistan, stated: ‘The primary deficit narrowed to 1.8 percent of GDP in FY2020, implying a fiscal effort of 1.8 percent of GDP. … A gradual improvement in the primary balance remains the key fiscal anchor to ensure fiscal sustainability and build resilience. The authorities recognize that the elevated debt burden makes Pakistan susceptible to shocks and remain firmly invested in the program’s fiscal strategy based on spending discipline and an ambitious revenue mobilization effort supported by high-quality, permanent tax policy measures and administration reforms. … The fiscal program for FY 2021 targets an underlying primary deficit of 0.5 percent of GDP (excluding grants and one-off spending). This is in line with the budget adopted in June 2020 and balances the program debt sustainability objectives against the economy’s cyclical position. Execution was broadly on track until end-December 2020.’

Hence, while the Eurozone, which is to start with has much stronger economic and welfare base than a developing country like Pakistan, is being asked to increase spending for boosting economic growth, Pakistan on the other hand is being asked to have ‘spending discipline’, adopt ‘ambitious revenue mobilization effort’, and ‘reduce’ primary deficit from 1.8 percent in FY2019/20 to 0.5 percent in FY2020/21. So, while according to IMF’s own recently released World Economic Outlook (WEO), projected economic growth rate for 2021 for advanced economies, and euro area stood at 5.1 percent, and 4.4 percent respectively, with the enhanced spending suggestion by the IMF adding to materializing these projections, the same enthusiasm is missing for a developing country like Pakistan which, according to WEO, is projected to grow by only 1.5 percent during FY2020/21.

No doubt, Pakistan is stuck in a difficult economic triangle of high fiscal deficit, elevated debt position, and low economic growth, where growth may just be coming into the positive after remaining under the pandemic-caused recession, whereby economic output contracted during FY2019/20 at 0.4 percent. Yet, the United States, which has provided very big stimulus to the economy over the many months of the pandemic now, even though its fiscal deficit rose to 15.8 percent of GDP in 2020, according to IMF’s recently released ‘Fiscal Monitor’ (FM) report, and which will continue to make expenditure as its projected fiscal deficit for 2021 to likely stand at 15 percent in 2021, and WEO indicated economy projected to grow at 6.4 percent. Similarly, euro area fiscal deficit stood at 7.6 percent in 2021, but still the IMF underscores the need for enhancing expenditure even though WEO projections pointed towards 6.7 percent euro area fiscal deficit; while euro area economic growth stood at 4.4 percent.

Agreed, Pakistan’s tax base and economy is nowhere as strong as US’ or euro area’s, but that does not change the fact that there is strong need to provide economic stimulus to a country, which in the absence of providing any significant stimulus is likely to grow during this fiscal year below even its population growth rate, is rather being asked by the IMF – under the EFF programme – to curtail primary deficit. That approach needs to change, whereby it should be acknowledged that the country needs a stronger economic stimulus, as is being recognized by the IMF for instance for euro area, and even broadly. The question then remains how to reorient policies under both IMF programme and overall, so that Pakistan is able to manage its economy, which is stuck in a difficult triangle of elevated level of fiscal deficit, high debt, and very low economic growth.

Firstly, with regard to budget deficit, the focus should be on curtailing fiscal deficit, and not primary deficit, which means the heavy component of interest payments should be reduced, while if anything primary deficit should be increased by making needed expenditures to provide stimulus to the economy, especially the health sector and for reducing unemployment. Also, spending discipline should ensure paying less in terms of interest payments at the back of further accommodation in monetary policy, along with slashing unnecessary current expenditures, but not stimulus spending, which should be significantly increased.

Hence, an accommodative monetary policy stance should be further employed, given there is more room to slash policy rate, since it should be recognized that inflation is equally a fiscal/governance related phenomenon, and that imported inflation component should be meaningfully controlled through enhancement in foreign exchange reserves. A reduction in policy rate will drastically help reduce interest payments on domestic debt, and save the economy from volatile foreign portfolio investment, and interest payments in this regard, which in turn should be replaced with enhanced SDR allocation from the IMF, likely to be made available during the next few months under a likely SDR allocation enhancement initiative to the tune of $650 billion. Moreover, this initiative, which has been long overdue given the pandemic is more than a year old now, should be fast-tracked well before the likely endorsement of the plan in June.

Secondly, a boost in foreign exchange reserves should be significantly made by the IMF through this SDR allocation, while a greater multilateral effort should also be made by other development partners to provide support to the country’s reserves on similar lines. The IMF should play a role in boosting confidence among development partners that Pakistan should be allowed to create needed fiscal space. It is important to note that the IMF in its recently report has stated that the country’s economic fundamentals have shown improvement. It must do in a spirit that it has already displayed for euro area, advocating increased expenditure. Moreover, it must also be allowed to make needed expenditures to boost otherwise very low projected economic growth rate. Overall, the build-up of reserves will help reduce imported inflation component, which is significant given the presence of triple nationalism – vaccine, oil, and food – phenomenon building up strong inflationary pressures in Pakistan.

The recent suggestion by the IMF in the shape of a ‘solidarity’ wealth tax imposed globally, for a temporary time duration of the pandemic, on those sectors, and individuals in very high-income brackets, and who have performed exceedingly well during the pandemic, like the technology/IT-related sectors, or through stock exchange buoyancy, among others, so that some proportion of their profits should flow back to making needed expenditures during the pandemic, indeed makes sense.

A recent article ‘IMF calls for wealth tax to help cover cost of Covid pandemic’ in The Guardian by its economic editor, Larry Elliott, pointed out: ‘Governments should consider levying higher taxes on the income or wealth of the rich to help pay for the enormous cost of tackling the Covid-19 pandemic, the International Monetary Fund has said. Inequality had widened in the year since the virus first hit the global economy, the IMF said, and there was a case for the better off being asked to pay more on a temporary basis to meet crisis-related financial costs.’ Such a step should be welcome and adopted in countries across the board, including Pakistan.

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

He tweets@omerjaved7

Copyright Business Recorder, 2021