Economic stress

Since around September 2021, and especially since April last year, economic stress has come to Pakistan from a number of sources. First is political instability for many months now, which has recently turned acute. No surprises, it discouraged investment, and increased speculative activity in the currency, bonds, and commodity markets.

Secondly, global inflationary surge at the back of global supply shortages, and ‘greedflation’ since the heyday of the pandemic, and accentuated due to war in Ukraine, required non-austerity, counter-cyclical policies at the back of efficient import compression, effective energy subsidy, meaningful progressive taxation, greater debt relief, and significant International Monetary Fund’s special drawing rights (SDRs) support.

Instead, overboard monetary-, and fiscal austerity policies, on one hand, and lack of factors indicated above, on the other, fed into each other, and overall created a serious problem of stagflation – rising inflation, and falling economic growth.

Here, overboard monetary tightening in developed and developing countries alike, including Pakistan, has mostly depressed economic growth, but has not much dented inflation, which has seen a rise, pointing in turn to fixing the problem through focusing on the supply side – on the energy and food side for instance – and checking over-profiteering through an effective ‘strategic price control’ policy.

Highlighting the importance of dealing with supply-side bottlenecks primarily through the use of fiscal policy, and substantiating it on the basis of Spanish experience of managing energy prices effectively – an important determinant of inflation in Pakistan as well –a recent ‘Monetary Policy Institute Blog’ published article ‘Fiscal policy is superior to monetary policy in reducing inflation without harming growth.

Some arguments from Spain’ pointed out in this regard: ‘The fall in inflation in Spain since August 2022 is entirely explained by the contribution of energy prices.

The Spanish Government has promoted a wide range of measures to reduce inflation and alleviate its consequences on the disposable income of households and the viability of companies in the most affected sectors. According to the Bank of Spain, these measures have effectively reduced inflation (by around 2.5 points in 2022).

Moreover, it has also boosted GDP growth (by 1%) and alleviated the effects of higher prices for households and firms in the most affected sectors. …These positive effects of national policies against inflation stand in sharp contrast with the monetary policy stance and the impact of the interest rate hikes implemented by the ECB from July 2022 onwards, reaching 3.75% in May 2023.

Firstly, the fall in inflation… can hardly be attributed to the rise in interest rates, which, as the ECB acknowledges, affects prices with significant delays. Secondly, the rise in the rate acts precisely by damaging economic growth (through its negative effect on consumption, investment, and even the possibilities of the authorities to deploy fiscal policies such as those they have been developing) and increasing the difficulties of households to cope with the loss of purchasing power…’

Moreover, highlighting the importance of introducing ‘strategic price control’ policy, like China did to its great benefit in both effectively managing inflation, and cost-push inflationary channels for important sectors for economy’s growth and distribution consequences, a recent The Times published article ‘Lone voice on inflation grows louder’ pointed out ‘[Noted economist Isabella] Weber had touched a nerve in a Guardian article in late December 2021. It suggested that surging energy prices after the end of Covid-19 lockdowns could be countered by price controls, mimicking interventionist policies in the US and UK after the Second World War.

Weber drew on her award- winning research on how China avoided the “shock therapy” of economic liberalisation when it moved from a command-driven economy after the 1980s.

Today, Weber’s energy price controls are used in big economies such as the UK and Germany, and her work on how corporate profits are helping to drive inflation is exercising the minds of the world’s most powerful central bankers. She was named one of the 100 Women of the Year by Focus magazine and was drafted in to help the German government design its energy price brake last year.’ It is important that policymakers in Pakistan also takes her advice, and if possible, engage the noted economist in shaping up an effective ‘strategic price control’ for the country.

Thirdly, as a result thereof, domestic production, and exports fell, in turn diminishing built-up in foreign exchange reserves, and also falling growth also dented revenue collection – especially in the wake of lack of any meaningful progressive taxation reform.

Fourthly, currency also saw historic losses during the last one year at the back of mainly a difficult external debt repayments situation, and a stalled IMF programme, not to mention the political instability factor.

Here, the recent increase in political turmoil in the country pushed PKR to historic low at around Rs. 290 against the US$. This will further make it difficult to control overall inflation on one side, given a significant supply side nature of inflation, imported inflationary channel, and cost-push determination of inflation and, on the other, will add to already difficult debt distress situation.

Highlighting the very difficult inflationary situation in the country, a May 2 Bloomberg published article ‘Pakistan’s inflation outpaces Sri Lanka as Asia’s fastest’ pointed out in this regard: ‘Pakistan took the crown for Asia’s fastest inflation from Sri Lanka as a weaker currency and rising food and energy costs drove price gains to a record in April.

Consumer prices rose 36.4% in April from a year earlier, the highest since 1964, according to data released by the statistics department Tuesday.’ Moreover, the same article remained highly critical (and rightly so) of a weak performance of Rupee, whereby it indicated: ‘The Pakistani rupee is one of the worst performing currencies globally so far in 2023, declining 20% to the dollar, and making imported goods more expensive.’

These political and economic causes, among other sources of economic stress, have in turn made it difficult to tap into the bonds market to give boost to its debt repayment capacity, given rising sovereign risk spread for the country.

The sovereign risk on Pakistan’s bonds also saw mostly a sharp increase since around February 2022, which overall increased from around 600 basis points to roughly increasing six folds in October to reach around 3500 basis points with some periods in which it fell somewhat, for instance, during July 2022, and then during October-November 2022. Hence, with some fall till mid-December – when it roughly dipped to around 2300 basis points – it saw a drastic increase once again, whereby recently it crossed 3500 basis points.

Given this overall doom and gloom on the horizon of Pakistan’s economy, there are indeed rays of hope. Firstly, the upcoming Budget for fiscal year 2023-24 presents a great opportunity to break the cycle of monetary and fiscal austerity shocks.

Hence, a non-austerity, and counter-cyclical Budget is presented; made primarily possible by introducing in parallel meaningful progressive taxation and a non-neoliberal reform package to deal with circular debt, and losses of state-owned enterprises (SOEs). Given the lack of success of austerity policies, it is indeed overdue that reversal of emphasis – in the shape of moving towards counter-cyclical, non-austerity policies – made by IMF in its programme conditionalities.

Secondly, the recent banking crisis in the US and Europe has intensified pressure on US Federal Reserve and ECB to halt and even somewhat reverse the monetary tightening process. Since interest rates in developing countries, including Pakistan, in general follow (wrongly) such tightening to compete for foreign portfolio investment, easing conditions in that regard will also likely reduce policy rate – which is at the historic high of 21 percent currently – in Pakistan. Such a reversal will also likely weaken the US$ against the Rupee.

A May 3 Project Syndicate (PS) published article ‘Dollar relief for the Global South’ highlighting the possibility of ‘rebalancing of US monetary policy’ pointed out: ‘Yet there could be an unlikely silver lining to the US financial system’s cloudy outlook.

Recent interconnected developments – the collapse of SVB and other regional banks, the Fed’s forecast of slower US GDP, and last month’s precipitous drop in the Institute for Supply Management’s manufacturing index (indicating a possible recession) – may lead to a rebalancing of US monetary policy, triggering a depreciation of the dollar. This, in turn, would greatly reduce the pressure on low-income countries’ depleted foreign-exchange reserves, creating the fiscal space they need to boost investment and economic growth.’

Monetary loosening and employing fiscal policy, especially through the policy of ‘strategic price control’ will also help, especially developing countries, and in particular highly climate change vulnerable countries like Pakistan to enhance much-needed fiscal space for dealing with climate change crisis.

Climate disaster, like the one that hit the country last summer in the shape of devastating floods, has immensely contributed to the economic stress in Pakistan. Overboard monetary tightening has negatively affected a climate change-needed finance base.

Copyright Business Recorder, 2023