A low growth trap: assessing challenges

Over the past two years, the Pakistani economy has weathered a highly turbulent period. Inflation reached unprecedented levels, marking a historical peak, while real economic growth plunged into negative territory in the last fiscal year.

The nation teetered on the brink of default on its external debt for nearly eighteen months, and the prevailing political and economic uncertainties eroded confidence, leading to a substantial drain on both human and financial capital.

This economic downturn resulted from a combination of external factors, such as the global commodity supercycle triggered by the aftermath of COVID and the Ukraine war, and internal factors driven by misguided economic policies influenced by perceived political compulsions. However, as 2024 unfolds, there is a glimmer of relatively positive news.

Economic indicators suggest a potential bottoming out, with inflation, which stood at 31 percent in the last calendar year, projected to drop below 20 percent this year. The currency is anticipated to remain relatively stable, in stark contrast to the significant depreciation experienced in 2022 and 2023. Consequently, market-based interest rates have already shown a decline of 3-4 percent from their peak.

There is also a perceptible shift in the stance of international financial institutions, notably the International Monetary Fund (IMF). Unlike the reluctance during the tenure of the Pakistan Democratic Movement (PDM), the IMF has extended a relatively relaxed standby facility during the caretaker government’s stay in power, and the caretakers are effectively managing it.

However, despite these positive developments, does this signify that the economy is on a trajectory of robust growth, capable of absorbing the millions of young people entering the working age annually? That’s an unequivocal no. The economy appears ensnared in a low-growth period until there is a substantial influx of investment to finance a healthy current account deficit while concurrently achieving fiscal stability.

One factor contributing to the stabilization of the economy in a low-growth equilibrium is the pursuit of a zero current account deficit policy. In the latter half of 2022, faced with depleting State Bank of Pakistan (SBP) reserves and an aversion to widespread economic slowdown through fiscal and monetary tightening, a policy was adopted to curtail imports, particularly non-essential ones.

In 2023, under pressure from the IMF and due to unintended consequences of suppressing certain sectors, the responsibility for managing imports shifted from the central bank to commercial banks. Banks were informally tasked with overseeing forex inflows and outflows. This policy remains in effect today, with businesses and banks acclimating to its parameters.

The tacit endorsement from the IMF indicates their acceptance of this managed current account policy, along with the crackdown on currency dealers and smugglers, as effective measures that have resulted in inflows in the interbank market, used to partially clear pending liabilities.

The future appears more optimistic, with global commodity prices expected to remain subdued, and the fear of economic default significantly diminishing. The economic management by the caretakers sets the stage for the next IMF programme and support from other lenders, essential for meeting debt and external liabilities in the coming years.

However, the challenge lies in the inability to sustain a current account deficit of 2-3 percent, crucial for an economy like Pakistan’s heavily reliant on growth. The key solution is attracting foreign investment to the productive sector to fund the deficit and stimulate economic growth. Unfortunately, this seems unlikely given the persisting medium-term structural and political risks. To achieve this, gaining the confidence of private sector investors, both local and foreign, becomes imperative.

This involves more than mere statements or threats to non-taxpayers, hoarders, and smugglers. It demands a resolute effort to put the fiscal house in order and adopt an inclusive growth strategy with a clear focus on diversifying exports beyond the traditional textile sector, redirecting government spending towards human development.

Crucially, monitoring the State Bank of Pakistan’s foreign exchange reserves, ensuring they cover at least four months’ of import expenses, becomes paramount. Until this is achieved or geopolitical rents from the West and Middle East materialize, the country remains unfortunately trapped in a low-growth period, with drain on human and capital resources persisting.

Copyright Business Recorder, 2024