The stabilisation effort

There have been many negative developments in the national economy in 2018-19. The headline statistic is, of course, the precipitous drop in the GDP growth rate to 3.3 percent from 5.5 percent last year. There are reasons to believe that the growth rate may actually be even lower. The Ministry of Finance (MOF) has projected, probably on the basis of the IMF estimates that the growth rate will fall further to only 2.4 percent in 2019-20.
The loss of momentum in the economy runs counter to the fact that there have been some positive developments. First, the incidence of acts of terrorism has visibly declined since the peak a few years ago thanks to the special operations by our armed forces. It is only in Balochistan where there continues to be a spate of acts of terror.
Second, the economic disruptions caused by extended periods of power load- shedding have decreased substantially. From the peak in 2012-13, time losses due to outages have declined by over 70 percent. Third, there has been a peaceful transition to a newly elected government with full five-year tenure.
Why then has the GDP growth rate fallen so sharply? One very likely explanation is that the policy emphasis has shifted from growth to stabilization in 2018-19, necessitated by the emergence of very large and unsustainable deficits both in the current account of the balance of payments and (the budget) public finances.
Consequently, there has been a need to devalue sharply the currency, raise interest rates and take measures like a big cut in development spending. There has been someimprovement in the current account deficit which is likely to fall by 30 percent by the end of the year. Also, according to MOF estimates, the primary deficit in the budget is expected to come down to 2 percent of the GDP as compared to 2.2 percent of the GDP last year.
The somewhat positive developments have led to a degree of optimism. For example, the SBP Governor has said that Pakistan has nearly achieved economic stability and the economic future of the country is bright. However, there is the contrary view that unless the fiscal deficit is reduced substantially, the consequential spillover into aggregate demand will continue to put pressure on the external balance of payments position of the country. Also, there is need for much more reduction in the current account deficit, which will remain at close to 5 percent of the GDP in 2018-19. A safe level is about 2.5 percent of the GDP, which means that next year the deficit will have to be brought down to about $6.5 billion, from the likely level of almost $14 billion this year. This implies a very large reduction of over 50 percent in the current account deficit next year.
The fundamental question is whether enough steps have been taken to ensure that the process of stabilization proceeds further in a decisive way. In this context, of prime importance is the budget for 2019-20. Does this budget ensure stabilization on the fiscal front? This is analyzed below.
The most important indicator of likely success or failure is the projected size of the budget deficit. Contrary to expectations, there is very little proposed reduction. The MoF expects that it will be marginal from 7.2 percent of the GDP this year to 7.1 percent of the GDP next year. Therefore, prima facie, it appears that the level of aggregate demand will not be subdued further in 2019-20 with no contribution thereof to managing the current account deficit.
The level of Federal expenditure is expected to grow by a handsome 31 percent next year. The Provincial budgets also reveal growth rates in expenditure of 20 to 25 percent. Clearly, the fiscal stance is expansionary in nature, if viewed from the expenditure side. This is counter balanced by heavy additional taxation and Federal tax revenues are projected to rise by almost 35percent. However, there is, more or less, a consensus that the FBR revenue target is way beyond the realm of possibilities.
The problem with the budget does not end here. Some of the fiscal measures proposed have a distinct anti-export bias while others may be conducive for higher imports. The partial withdrawal of the zero-rating scheme for exporting industries with the levy of the full sales tax on domestic sales, in the presence of serious problem of pending refunds, may exacerbate further the liquidity position of exporters and thereby impact on their competitiveness. On the import side, the withdrawal of regulatory duty in some cases and the duty exemption on other items may increase the demand for imports.
The suggested IMF remedy to the yawning trade deficit lies in depreciation of the currency based on a market-determined rate. If fiscal measures are inadequate then there will have to be, more or less, complete reliance on a big and rapid devaluation of the rupee. Already, over the last few days this process has started and the currency has fallen by over 11 Rupees per US$. The consequential impact will be further fuelling of the rate of inflation in the economy. It has been projected at 11 to 13 percent in 2019-20. However, it will not be surprising if it approaches the late teens next year.
Therefore, what we have is an expansionary fiscal policy combined with a very restrictive monetary policy, including a steep depreciation of the exchange rate and a further hike in interest rates. Unfortunately, the experience this year is that exports do not respond significantly to a downward movement in the exchange rate while imports are increasingly now of a more essential nature.
The optimal strategy ought to have been one of combining a more restrictive fiscal policy, especially in terms of containing the growth in expenditure, and a less restrictive monetary policy to achieve stabilization. This could have had less impact on the rate of inflation, leading thereby to more moderate interest rates and a smaller increase in the cost of debt servicing. This would have implied a smaller fiscal deficit and less pressure on aggregate demand.
The federal budget has been approved with some minor amendments. The year, 2019-20, will start with ambitious targeted growth of almost 35 percent in Federal tax revenues. Sooner or later, there is the likelihood of a significant shortfall in revenues and the need thereof to make adjustments to meet the IMF program criteria. Therefore, uncertainty will be at a peak next year. How far will tax rates be further increased? How steep will be the fall in the value of the rupee? How high will interest rates go? How much will there be a cut in development spending? All this will, no doubt, have implications on the political front but also on the lives of the people. They are likely to face 'stagflation' of the worst form with falling real incomes, rising unemployment and raging inflation.
(The writer is Professor Emeritus and former Federal Minister)