Growth versus lower deficit

Dr Hafiz Pasha while speaking at a talk show on Aaj News urged the government to focus on pro-growth policies in the forthcoming budget instead of on reducing the fiscal deficit. The federal finance minister, Ishaq Dar, during a press briefing on 9th May, 2014 revealed that under the 6.64 billion dollar Extended Fund Facility from the International Monetary Fund the deficit would be brought down to 4.4 percent in 2014-15 budget clearly indicating that he is opting for a contractionary policy, which would be at the cost of growth.
Austerity versus growth is a debate that gathered momentum during the 2009 debt crisis as well as the effects of a global recession facing many countries at the time, particularly Greece as well as the United States and more recently China and India - countries that do not have a high debt profile. In 2010, the general consensus in the West was that a stimulus was required and the US as well as several European governments injected hundreds of billions of dollars into floundering economies with the objective of propelling growth designed to (i) fuel productivity that would generate employment opportunities and thereby ease genuine concerns of the general public and reduce incidents of social unrest, and (ii) generate higher tax collections linked to higher output that could then be channelled into reducing the deficit. The inflationary impact of expansionary policies could be checked in these economies through an autonomous central bank, which would not only ensure a realistic exchange rate (that would not reduce exports) but also be a lender of last resort for the government with the ability to refuse to lend to the government beyond what was appropriate.
The IMF, historically a firm proponent of reducing the deficit, has in recent years taken the view that growth must be supported over austerity. In 2008, a study undertaken by the Fund concluded that a 3 percent reduction in government deficit causes a one percent increase in unemployment or austerity increases unemployment with major socio-economic implications. And this thinking was reflected in the IMF terms agreed with Greece. The European Union and the European Central Bank requested the IMF to determine the terms of the 110 billion euro bailout package - with the major donor Germany clearly supporting austerity over growth - the IMF called for a smaller deficit to encourage growth. However, here too the IMF clearly miscalculated: it had projected a rise in unemployment to 14.8 percent while it actually rose to 26.4 percent. This compelled a review of the study by the Fund in 2012, which produced new results: the impact of a 3 percent fiscal consolidation would increase unemployment by 1.8 percent; and of course this would no doubt vary between countries.
Bernanke, the US Federal Reserve Chairman, responded in January 2013 to a query from Republican Senator Pete Sessions on his claim that it was less important to reduce the deficit than to continue to encourage recovery and growth: "What we want to do is have a credible, strong plan so that the economy doesn't hit a huge pothole." In other words, Bernanke was in favour of a deficit reduction that could phase in over a longer period of time than the automatic one set for January 2014.
In the context of ongoing debate between austerity and growth, Dar appears to be committed to reducing the deficit - which would have negative implications on his ability to generate the budgeted 3.9 trillion rupee tax collections next year. His argument is that growth is proceeding apace in the country and has projected a 4.1 percent growth rate for the current year - a rate that the IMF has estimated at 3.3 percent while declaring that inflation remains a source of concern. He also has resisted the grant of real autonomy to the State Bank and continues to favour the policy of his predecessors namely slashing down development expenditure to meet deficit targets. In addition Dar has also opted to increase the country's indebtedness which effectively implies a higher chunk of the 2014-15 budget allocations going for interest payments in addition to defence.
Add massive loadshedding as well as rising utility bills and a controlled-exchange rate (with negative implications on the country's exports), policies that have begun to fuel massive street protests, and one can easily comprehend Dr Pasha's impeccable logic rooted in sound economic theory. Focus on growth that would generate employment and help ease concerns of the general public and at the same time reduce the deficit over a longer term. IMF's conditions are not set in stone and given its recent revision of growth versus austerity study the government can easily argue for a deferral in the deficit reduction target. The Finance Minister also needs to make the SBP autonomous in letter as well as in spirit that would help ease the inflationary rate.
It is unfortunate that Finance Minister Dar has shown a penchant for consulting with all but not taking any of the stakeholders' recommendations on board - other than those directed by the prime minister. He is also accused of manipulating data through his control over the Federal Bureau of National Statistics prompting calls both within and outside parliament to make the FBNS autonomous. His flawed data as well as policies are already leading to increased participation of the people in public rallies of the opposition and PML (N) would be well-advised to get some economists into a decision-making role in the ongoing budget making exercise.