All the serious challenges national economy is facing today like very wide budget and trade deficits, galloping inflation, increase in the level of poverty, power outages, water shortages, closure of industries, food insecurity, etc, has diverted our attention from realising the very serious challenge that we have overcome.
Since the 1950s we had a system in this country where the Ministry of Finance and all the economic ministries were headed by World Bank and IMF officials of Pakistan origin. With increase in the indebtedness of the country the situation got from bad to worse. The worst period was the decade of the 1990s when not only the economic ministries, but even prime ministers came from these institutions.
During negotiations between the Government of Pakistan (GoP) and the International Financial Institutions (IFI)s, it was difficult to distinguish between the GoP and the (IFI)s, as both sides comprised of IFI officials. These were very trying times for those of us who value independence and economic sovereignty of the country. In my several articles I question the wisdom of a system which even after elections denied the representatives of the people to head economic ministries.
In my paper on 'The Impact of Foreign Borrowing on our Political Structure' read at the Eminent Persons Group (EPG) seminar and published in the Business Recorder (31 December, 1996) I raised these points. So I personally feel vindicated to see representatives of the people occupying ministries of finance and economic affairs.
Let me now discuss the serious challenges confronting us and suggest how the new government can over come these. But before we venture into discussing specific problems and challenges let me present two broad observations. One, that it is quite acceptable for a country to deviate from its normal course during times of emergency and ultimately come back to the designated path.
For example, the United States of America states that it is committed to liberalisation and globalisation. Yet, in the aftermath of a crisis it imposed a 30% tariff on the import of steel. Therefore, crisis management warrants we deviate temporarily from liberalisation to fix the distortion, and return to the path when things return to normal. Second, in order to retain our economic sovereignty it will be better not to resort to policy based lending.
Debt management: The debt/GDP ratio needs to be borne in mind when embarking upon further lending from the IFIs. If the debt/GDP ratio goes up to unacceptable limits, then the involvement of IFIs in economic affairs will be back and the elevation of elected representatives to economic ministries will be a short lived phenomenon.
Our experience shows that increase in debt has led to installation of governments comprising of IFI officials of Pakistan origin. Thus, the very sovereignty of the country is at stake. Moreover, it is in the interest of the country not to increase the ratio as this is bound to increase the burden on our future generations.
The approach of the new government in dealing with this problem appears to be in the right direction. For example, recently the Finance Minister signed a debt development swap agreement with the Italian Government for $100mn. This is a very desirable approach as it breaks the deadlock between debt and development. This way Pakistan will be able to reduce its debt burden, while at the same time bring development to the country.
At a post budget seminar of the Institute of Chartered Accountants of Pakistan (ICAP), I read my paper 'A Debt Management Strategy for Pakistan', wherein I had suggested that by using debt development swaps:
"We can kill several birds with one stone ie provide debt relief to the country, increase the education level of the country. The best part of the exercise will, however, be that debt servicing and expenditure on the social sector will not pose a trade-off, with both the objectives being pursued simultaneously. And it is this expenditure on the social sector, which is so vital if democracy is to deliver higher levels of welfare."
Macro economic balance: The rate of growth of the economy during the last three four years improved a bit, but was modest when compared with the rate of growth of our neighbours, China and India. Another feature of the growth phenomenon that needs to be looked into is the un-sustainability of the growth rate. When the growth rate becomes a little respectable for two or three years, prices start rising and almost immediately a clamour for a tight monetary policy starts.
Compare this with the Chinese experience, where the GDP grew at almost ten percent during the last two decades before prices started rising. Why do prices start rising almost as soon as the growth rate picks up? Are prices rising as a result of excess demand on account of government borrowings from the State Bank of Pakistan (SBP)? Or are prices rising due to increase in the price of oil, and the concomitant increase in prices of electricity, transport, etc, which this increase brings about?
The two situations warrant very different approaches. If inflation is of the demand pull type then tightening the monetary policy will, through dampening demand bring prices down. If, however, inflation is of the cost push type, then a tight monetary policy will make matters worse. And that is what has been happening in Pakistan over the last few years. Monetary policy has been used excessively to contain inflation, irrespective of whether it is of the demand pull or cost push type.
Even if prices are rising due to hoarding, monetary policy has been used and advocated to contain inflation. Such a tight monetary policy has resulted in reducing the rate of growth of the economy, without reducing the rate of inflation.
What should the new government do to contain inflation? First, it needs to determine whether prices are rising as a result of demand pull factors or cost push factors. If prices are rising due to demand pull factors then tightening the monetary policy will be an appropriate policy. But if prices are rising due to cost push factors then we need to identify the factors that are pushing up prices and find alternatives to these. The excessive use of monetary policy to fix up every problem in the economy is hurting the economy.
Monopolies and cartels have played a major role in restricting output and escalating prices in Pakistan. Most of the members of cartels are ministers and other influentials. It thus took several years for the government to convert the Monopoly Control Authority (MCA) into Competition Commission. The new government needs to make it effective, formulate a competition policy and enforce it. Competition policy is the appropriate policy to deal with the problems of monopolies, hoarding, excessive profit margins, etc.
My own research 'Industrial Concentration and Economic Power in Pakistan: A Study of the Firms Quoted on the Karachi Stock Exchange,' published in the Pakistan Business Review, (April 2003), shows that several industries have very high concentration ratios and Herfindahl Indices. And when there is collusion between these firms, it produces a monopoly situation, with the concomitant reduction of output and increase in profit margins.
The Competition Commission needs to compute the Concentration Ratio and the Herfindahl Index for each industry and determine their acceptable levels for each industry. And if the concentration level in any industry exceeds the acceptable level, then the Commission should ensure that through promotion of competition, industries are made to conform to desirable behaviour and conduct.
BUDGET DEFICIT: The budget deficit for the first six months of FY07-08 was 3.6% of the GDP and the likely figure for the 12 month period is expected in the range of 6% of the GDP. Most of this was on account of increase in development expenditure in the run up to elections, energy related subsidies and the inability of the government to increase and diversify the tax base.
First let us see how this deficit can be curtailed. First on measures to curtail expenditures. Here the approach of the new government appears correct. The prime minister's decision to reduce the expenditure on the Prime Minister's House by 40% is a step in the right direction. Similarly, Shahbaz Sharif has announced 70% reduction in the non-development expenditures of the Punjab Government. Other such steps to reduce non development expenditure along with the Finance Minister's statement of looking into the possibility of reducing the defence budget are steps in the right direction.
These need to be supplemented with resolve on the part of the government to curtail borrowing from the State Bank of Pakistan. And the Finance Minister has given a statement to this effect. This will not only reduce the budget deficit, but also ensure that the demand pull is not the major contributor to soaring of prices. Tightening of the monetary policy will no longer be required and appropriate policies that deal with cost push inflation will take care of the problem.
On the revenue side, the government will have to tap new sources to generate receipts in order to bridge the gap. New sources for generating tax revenues should be those sectors of the economy where profits have increased in the past few years, but have not been brought within the tax net. These include agriculture and service sectors, especially oil companies, banks and financial institutions, portfolio investments with drawls of portfolio investments from Pakistan and real estate.
(To be concluded)
(Paper presented at the pre-budget seminar organised by the Southern Regional Committee of the Institute of Chartered Accountants of Pakistan (ICAP), at a local hotel in Karachi on 10th April, 2008.)