Policies must recognise ground realities

Prime Minister Imran Khan has become visibly more actively engaged in the economic policies of his newly installed economic team and has begun to regularly seek clarifications/explanations of the likely impact of their policy decisions taken under the roadmap agreed with the International Monetary Fund (IMF). One area of concern has been the decisions taken by the State Bank of Pakistan (SBP) whose Governor Reza Baqir recently stated that the central bank has taken all measures agreed with the Fund. One such measure, raising the discount rate to 13.25 percent has further throttled private sector's productive activity, a claim made by a delegation of businessmen to the Prime Minister last week. The Governor's explanation delivered to the business community whom he met reportedly on the instructions of the Prime Minister was that as the inflation rate projected for the year by the Fund was 13 percent therefore the discount rate of 13.25 percent implied a rate of return of 0.25 percent only which was appropriate.
Such complete lack of understanding of the Pakistani economy as displayed by the Governor should be a source of serious concern for the Prime Minister according to noted economist and former finance minister Dr Hafeez Pasha. First, a rise in the discount rate in Pakistan, unlike in the West, has a limited capacity to contain aggregate demand to the level in the West, given that borrowing by the household sector in this country is no more than 4 to 5 percent of total credit. The sectors affected with a raise in rates are the productive sectors and the large-scale manufacturing (LSM) sector in particular who rely on borrowing to meet their working capital needs, especially given the rising refunds that the Federal Board of Revenue has been unable to disburse to show better revenue collections. Last fiscal year, LSM declined by 3 percent and this year it is expected to decline further due to the raise in rates which in turn would imply a further contraction of the economy. Additionally, our government also borrows from the commercial sector, including the inefficiently-run energy sector, and any raise in rates would impact on government's borrowings.
Secondly, the 13 percent inflation rate cited by the Governor is the projection of Consumer Price Index which includes food and fuel inflation, with neither a component of core inflation, because they are not affected by any fluctuation of the discount rate. Core inflation as per the Pakistan Bureau of Statistics was 7.8 percent in July 2019 and considering that SBP announced 13.25 percent on 17 July, the difference between core inflation and the rate of return was a whopping 5.45 percent.
The decision to implement a market-based exchange rate by the SBP Governor was supported by several economists given that a grossly overvalued rupee was considered to be the primary reason for the historically high current account deficit inherited by the present administration. There appears to be an over-correction in the exchange rate as the real effective exchange rate is 10 percent undervalued as per SBP data, according to Pasha.
A similar disturbing scenario is evident in the policies being implemented by the Ministry of Finance. Revenue shortfall during the first two months of the current fiscal year has been acknowledged at 64 billion rupees and at this rate the total shortfall would be 384 billion rupees by the end of the year. Expenditure continues to rise and in spite of protestations to the contrary the political compulsions of the government can be held accountable for a significant rise in current expenditure with one of the largest ever federal cabinet and the number of parliamentary secretaries. No attempt has been made to slash those federal ministries whose subjects were devolved to the provinces through the Eighteenth Amendment.
To conclude, it is critical for the economic team to implement Fund policies based on emerging ground realities rather than on following directions to the letter for that way lies not only an economic contraction that would account for a historically low growth rate in the country, even lower than the 2.4 percent projected by the Fund, but may well fuel social unrest that is likely to spill onto the streets. Sadly, the economic team continues to refuse to heed the advice of stakeholders and it is only up to the Prime Minister to rein in their penchant for following the directives of the Fund rather than in adjusting policies with a view to achieving the macroeconomic targets set by the Fund.