The government has wisely chosen to allow the IMF to release the first post-programme monitoring (PPM) report that was discussed in its board on March 5, 2018. The report has provided a detailed analysis of the major conclusions that the IMF presented in its press release, which we discussed in the article ‘Where the economy stands’ (March 13).
Justifiably, the report has caused anxiety among people who now want to understand the mixed messages contained in it. On the one hand, the report acknowledges the strong performance of the economy – high growth, muted inflation, rising investments, solid consumer demand. On the other hand it warns against the major imbalances – fiscal and current account deficits, declining reserves and worsening risk indicators on debt accumulation. What should an ordinary person make out of these contrasting aspects of our economy?
In reality, we are facing a paradox that we have not faced in the past. When we entered the last IMF programme in 2013, the economy in the preceding five years (2008-2013) had registered one of the poorest performances – having been hit by global financial crisis, unprecedented high commodity prices, particularly oil, and the devastating floods of 2010. The 2008 Fund programme had also ended in failure. Although the 2008 programme was entered into after an exceptional run of economic growth and price stability between the year 1999 and 2007, the political instability in the penultimate year of that spell, coupled with the simultaneous global crisis, had pretty much taken the sheen out of that exceptional performance. Thus, on both these occasions (2008 and 2013), before the beginning of the Fund programmes there was a significant downturn in economic activity alongside macroeconomic instability.
At the conclusion of the last Fund programme, we saw resurgence in growth and stability in prices. Undoubtedly, this was aided by a massive decline in oil prices, general recovery in major economies and, most notably, the arrival of CPEC in Pakistan. But the present government, which made the success of the Fund programme possible, was caught up in both the Panama Papers incident and the disruptions faced in its aftermath – leading to the government’s focus on economic management being diverted. In fact, there has been no worthwhile economic management in witness for nearly two years. As a result, the imbalances corrected during the programme have resurfaced and, rather than aiding the growth momentum generated by the programme, are now threatening the nascent recovery.
At present, the paradox is that the economy is moving up-the-curve in all leading indicators, while failing miserably in policy management. The buoyancy in economic outlook is palpable in growth, investments, productive imports and unprecedented consumer demand in all sectors – from real-estate to consumer durables, from cement to iron and steel, and so on. It should, however, be acknowledged that some of this buoyancy is contributed by growing imbalances – rising fiscal deficit, over-valued exchange rate and low interest rates – whose correction would have a dampening effect, at least in the short run. But in the medium-term, the economy will continue to prosper as its fundamentals are in place.
Let us now consider the major imbalances identified in the PPM report and the consequences that will follow their correction. First, we have to fix fiscal deficit. Unfortunately, this has become a Gordian knot with the transfer of significantly larger share of divisible pool to provinces. The country was able to reduce fiscal deficit during the IMF programme because the provinces – that had the larger share of resources – agreed to refrain from spending a part of their share, thus providing critical savings. Last fiscal year, they had drawn down on those accumulated savings with a vengeance and might do so this year as well. With such high level of provincial spending, the much-needed fiscal adjustment could only come by massively cutting development spending. Also, the government has to find ways to cut expenditures, whatever they may be, by resorting to a zero-budgeting model: all expenditures have to be justified to an independent commission comprising people of high stature from all public services.
The exchange rate adjustment would be painful but inevitable for correcting external imbalance. No institution – the IMF, World Bank or ADB etc – is prepared to lend to Pakistan for the purpose of supporting an over-valued exchange rate. The commercial borrowings would soon become uneconomical or bond investors would shy away seeing an unstable macro framework. But the required adjustment might have a significant impact on the budget on three accounts: first, the high cost of public-sector imports; second, capital loss on external debt; and third, the higher cost of debt servicing.
The policy rate adjustment is needed both to restore order in a chaotic government debt market – no investments in PIBs during the last eight months or six- to twelve-month T-bills) and to move away from an accommodating monetary policy that has allowed unhindered government borrowing from the SBP. The higher interest rates, again, would exert pressure on the budget by increasing debt servicing cost.
Perhaps the most challenging correction would be required to settle the circular debt (CD), which is threatening fiscal finances. Here, we would suggest that there is no other option but to revive the debt settlement plan prepared by the Ministry of Finance and the Ministry of Water and Power as part of the ADB-WB power sector loan operation, duly adopted and endorsed by the IMF. Another consolidation along the lines of what was done in 2013 would be no solution. If the underlying causes engendering CD remain unheeded, the problem would resurface besides imposing huge budgetary cost.
Finally, the above adjustments would significantly impact consumer welfare by causing a spurt in inflation. The exchange rate, policy rate and debt settlement would all have an adverse effect on prices. The rise in inflation is then the cost of adjustment. By not setting economic variables to their right values, we have spawned a series of distortions where the true costs were not borne by economic agents. For instance, an over-valued exchange rate is another name for subsidising imports at the expense of exports; unrealistic policy rate discourages savings and unduly increases demand for investment. All such distortions need corrections and soon.