Economy: Turbulent Times Ahead By Waqar Masood Khan

Vagaries of Consciousness
The menu of reforms is large
On the expiration of the National Assembly’s term, a new beginning is on the horizon. A multitude of challenges await the new administration. Nowhere is the need for correction more urgent than on the economic front. The news that the interim finance minister has asked ministry officials to engage in a dialogue with the IMF was a breath of fresh air. In hindsight, it is felt, that the outgoing government had washed its hands off economic management as it chose to pitilessly draw down on country’s reserves and resorted to indiscriminate borrowings from whatever sources available (only Chinese banks have kept pouring in a great deal of balance of payments loans at fairly cheap pricing). For them, any suggestion for talking to IMF was a taboo, because they knew they would be asked to abandon their profligate ways of dealing with country’s finances. They wanted to make political gains so long as the sun was rising on their government.
Not surprisingly, a terrible mess has been left behind. Only a painful adjustment would bring stability in the economy. The menu of reforms is large, but let’s just focus on the minimal set of corrections that have to be made to restore the declining economic health.
At the outset, we must understand that in an open economy, like that of Pakistan, having sufficient quantities of hard currency (foreign exchange reserves) is the ultimate test of survival. In its absence, the country would face extreme hardship, and risk of default on foreign obligations. Accordingly, the aim of stabilisation has to be to disperse the dark clouds of default that have gathered around us: stem the decline in reserves and start building them up afresh.
What would it take to achieve this goal? The list is long, but we would restrict to the most essential requirements. First, there has to be a steep cut in the budget deficit. Even though the government has touted a fiscal deficit estimate of 4.9pc in the budget, experts have traced that a number of projections, particularly on the revenue side, are so soft that this is an unrealistic target. The underlying deficit, after making the revenue side adjustments (over-estimated tax revenues, gas cess and assumption regarding provincial surpluses) the deficit is more likely to be around 7pc. If on top of this, government attempts to undertake some significant consolidation of circular debt (which looks inevitable) then it could be more than 8pc.
A zero-budgeting approach should be adopted and no expenditure should be declared above scrutiny by the Commission
Cutting this deficit, in the first year, to say 5pc of GDP, would require resource mobilisation of nearly Rs1.1 trillion, clearly a momentous task. An extra-ordinary appeal has to be made by the new government to the provinces, through the CCI, to contribute 1/3rd of this amount by generating surpluses in their budget. The previous government at the beginning of its term had made this request during the IMF program and provinces obliged in two out of three budgets. The second source has to be a new tax effort to generate another 1/3rd of the resources. The concessions announced by the outgoing government (like the individual tax rate reduction from 35pc to 15pc and increasing the taxable income from Rs400,000 to Rs1,200,000) need to be rolled back, besides finding new sources of revenues. Another unpleasant thing to be faced by the interim government or the new government would be the adjustment in petroleum prices. The outgoing government has cleverly evaded the responsibility of raising the prices thereby sacrificing government revenue, as it was considered politically expedient to leave to the successor governments. The longer it is delayed the more harmful it would be for country’s finances. Lastly, the development budget has to be slashed to provide for the remaining 1/3rd for bridging the gap. But for finding durable solution to run-away expenditures, a High Power Commission (comprising most eminent persons from civil, law enforcement, judiciary and military background) should be constituted to search the deeper layers of government and determine their justification and utility for public spending. A zero-budgeting approach should be adopted and no expenditure should be declared above scrutiny by the Commission. The Commission would also bring order in the chaotic pay and pension system that is slowly disintegrating the public finances.
Second, the limitations on government borrowing both under the Fiscal Responsibility and Debt Limitation Act 2005 and from the SBP be strictly enforced. In fact, parliamentary approval for spending beyond the legislative limits should be prescribed by amending the relevant laws.
Third, although the central bank is independent in taking its decisions, an involved consultation would be warranted to raise the policy rate significantly to reduce the demand for credit. In fact, the level of credit expansion would have been explosive but for the massive decline in net foreign assets or reserves (Rs600 billion), which have counteracted the effect of such expansion.
Fourth, despite two rounds of depreciation, the exchange rate remains considerably overvalued as evident from continued worsening of the external account deficit, which is heading for 6pc of GDP, highest in more than a decade.
Fifth, resumption of privatisation on fast-track basis would be the most urgent structural reform. A number of big-ticket items in the power sector were brought to fruition and then abandoned at the last minute. Revival of those transactions would be a major signal for encouraging foreign and domestic investments.
Finally, and this is closely related to the last point, the menacing problem of circular debt has to be addressed on war footings. Everybody knows there is nearly a 1pc of GDP shortfall in cash flow in running the erstwhile WAPDA utilities. A combination of changes in tariff setting, public private partnership and transfer of administration to provincial and local authorities has to be answer to solve this problem that poses real danger to the fiscal finances of the country.
All of what has been said above, is a recipe for painful economic adjustment. These are very harsh realities, but, unfortunately, all of our own making. As consequence of implementing this agenda, inflation would rise, public investments would decline, taxes would increase, interest rates would rise, exchange rate would depreciate and, above all, the growth momentum would be disrupted, adversely affecting poverty and inequality in the country.
The sheer size of the agenda is beyond the competence of the interim government. What is amusing is that under Section-230 of the Election Act 2017 severe restrictions have been imposed on the conduct of the interim government, which essentially means that they may only push files around unless an urgency warrants otherwise. How could an Act of the Parliament put conditions on the conduct of the Interim government when the constitution has not done so nor has asked the p;arliament to do legislation in this regard.
In country’s history, several interim governments engaged had with the IMF to work out a program, which was always subject to the concurrence of the new elected government. This was a very rational arrangement as the interim governments can take decisions on the basis of economic realities and not be concerned with political expediencies. The fact that the cabinet division has issued a notification reminding the government secretaries of the above section of Election Act 2017, clearly signals that the interim government would not be engaging in any serious dialogue with the IFIs.
This leaves the entire burden of facing the economic challenges on the new government. It will not be the most auspicious beginning for any government. However, we may learn a few lessons from the government of David Cameron who used his coalition government to undertake most serious austerity measures in the modern history of the Great Britain.

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