Twenty-third International Monetary Fund (IMF) programme, on average three year per programme, in our 75 years of existence, implies that only in six years was Pakistan not on a Fund programme. However, this is an overestimation as it does not take account of Pakistan abandoning several of the previous 22 programmes part way, or as soon as the current account reached a sustainable level, only to seek another programme as it again was pushed into the unsustainable territory.
There is a consensus that growth is led by domestic consumption as opposed to exports (with Pakistan exporting surplus output rather than engaging in producing specifically to export), thereby accounting for the current account becoming unsustainable every five to six years. In this context it is relevant to note that last fiscal year’s upgrading of the growth rate to nearly 6 percent was largely attributable to a massive rise in domestic consumption after the pandemic lockdown was over — partly satisfied by inventories and partly by higher domestic output. But what should be concerning is that the gap between one unsustainable current account deficit period to the next is getting shorter as the state of the economy steadily worsens due to continued structural impediments.
This shortening of the period indicates a cyclical fault line embedded in fiscal and monetary policies pursued in the country to this day.
The major source of government revenue is from indirect taxes including duties/sales tax on imports on a wide range of items including oil, petroleum, (whose incidence is greater on the poor than on the rich), raw materials, semi-finished products (taxes passed onto the consumers) and non-critical food and cosmetic items with all recent administrations declaring their intent to widen the tax net through use of data available with Nadra, but backing down as pressure is ratcheted up by powerful groups. A rise in imports therefore raises government tax revenue, fuels growth but at the same time eats into the scarce foreign exchange reserves by widening the trade gap with implications on the current account deficit.
Monetary policy then comes into play with a high discount rate (discouraging imports but automatically also domestic output) and a depreciating rupee makes imports less attractive and exports more so though in Pakistan’s case the link between a cheaper rupee and exports has yet to be empirically established. The result, a narrowing of the trade deficit that translates into a sustainable current account deficit. Lower growth is accompanied by rising unemployment raising the prospect of civil unrest thereby putting pressure on an administration to shore up its popularity through higher subsidies that the treasury can ill afford.
Pakistan’s finance ministers have been dealing with dangerously low foreign exchange reserves and budget deficits through increasing reliance on external borrowing that appears as a plus in the balance of payments though, over time, it has rendered the budget outlay hostage to interest and payment of principle as and when due.
Add the element of an unsustainable pension system and the recipients of current expenditure unwilling to accept a freezing of their annual allocation leave alone an actual reduction and one is faced with the prospect of dangerously high external borrowing levels — not only to pay off past debts, but also to supplement foreign exchange reserves that enable payment for imports as well as strengthen the rupee value. Remittances of course are a desired form of foreign exchange inflows and rose dramatically in post pandemic years though the rise in the current account deficit in June indicated that other macroeconomic imbalances outweighed the benefit of remittances.
Disturbingly for the current year the finance minister has publicly stated that the country is seeking over 40 billion dollars of external assistance in contrast to what was rightly lamented as a significant rise during the Khan administration but in comparison was a lot less - 45 billion dollars in three years and eight months. Add domestic borrowing which escalated during the Khan administration from 16.5 to over 27 trillion rupees and the reason behind the 40 plus percentage rise in the Sensitive Price Index last week is evident.
The IMF correctly notes that “macroeconomic imbalances and longstanding structural impediments to growth have prevented full realization of Pakistan’s potential. Problems in the energy sector, security concerns, and a difficult investment climate have combined with adverse shocks to undermine economic performance in the past decade.”
The economy has been allowed to become ever more fragile over time due to multiple sectoral flawed policies that have spanned decades, several administrations, and include: (i) an increasingly indebted energy sector with a circular debt today of 2.4 trillion rupees that is severely impacting on not only the quality of life of the general public (through ever rising rates as an IMF condition to achieve full cost recovery and load shedding) and productive sectors labouring under an energy cost that makes it a challenge for them to compete internationally.
Households and the productive sectors demand subsidies, many unfunded, that increases circular debt. And while a multilateral may support subsidies for the poor and vulnerable (read the Benazir Income Support Programme) the productive sectors, especially large scale manufacturing sector, do not qualify – more specifically the cheaper energy rates, the cheaper interest on loans and lower taxes; besides as noted above the linkage between subsidies and output or exports has yet to be definitively established. There is no doubt that the situation in this sector is dire attributed to successive governments particularly the PPP and the PML-N’s past focus on energy supply preferring to sign off on very expensive contracts with Independent Power Producers (IPPs) reliant on imported fuel with capacity payments rather than payment for units purchased and in dollar terms.
In spite of efforts to change the energy mix for the past five to six years there is little on the ground change; (ii) state-owned entities’ poor performance continues and attempts by subsequent governments to hire on merit have not stayed the steady rise in the budgeted support for these entities at resent nearly 1 trillion rupees and rising each year; (iii) the tax sector remains reliant on indirect taxes rather than direct taxes while direct taxes (levied on the ability to pay principle) are largely withholding taxes on consumer items, or in the sales tax mode; and (iv) governance issues continue to take their toll in not only the federal but also provincial finances.
To conclude, the incumbent government, like its predecessor, has so far not made any effort to implement structural changes, continues to rely on the same taxes for revenue enhancement and is reliant on the same policies to check the current account deficit with heavier than ever reliance on external borrowing. These are worrying policies and need a revisit.
Copyright Business Recorder, 2022