Economic turnaround moment?

By Najy Benhassine | Martin Raiser
Published in DAWN on January 03, 2024

AFTER a commendable long period of uninterrupted decline in poverty rates, Pakistan’s economy is now facing one of its worst crises. Poor policy choices, combined with a series of shocks — Covid 19, the 2022 catastrophic floods and adverse global conditions — caused growth to slow, poverty to increase, and brought the country to the brink of debt default.

Moreover, human development outcomes remain at levels we see in much poorer countries, while per capita income growth has been declining in the face of low productivity and high fertility.

These challenges call for deep, sustained reforms. We recently launched Policy Notes, which lay out our views on what these should entail. What we propose is not new.

We and others have made similar suggestions before. What is different this time is that the alternative of muddling through with short-term fixes and external financing is riskier and much harder to pull off.

Many countries’ turnarounds have emerged out of similar crises. For Pakistan, too, this could be an opportunity to address deep-rooted issues that have plagued the country’s development for too long.

First, Pakistan must address its human capital crisis. Seven per cent of children die before their fifth birthday — that is multiple times higher than in comparable countries. Forty per cent of children under five suffer from stunted growth — more than 50pc in poorer districts.

Halving stunting rates in a decade is feasible, but will require a shift from the traditional focus on nutrition and health only, to providing wider access to clean water and sanitation, birth spacing services, and improved living and hygiene environments.

It will take strong cross-sectoral and local coordination, a national mobilisation and behavioural change campaign, and investments of close to 1pc of GDP every year. A weak education system compounds the effects of stunting: 78pc of 10-year-old children are unable to read an age-appropriate text, while over 20 million children are out of school.

Second, to finance improvements in service delivery and human capital development, Pakistan must generate more fiscal space. Tax collection has remained at a low 10pc of GDP for decades. Abolishing expensive tax exemptions and reducing compliance costs alone could quickly generate about 3pc of GDP in added revenues.

More could be raised at the provincial and local levels from undertaxed sectors, like real estate, agriculture, and retail — potentially raising another 3pc of GDP. Expenditure savings could be achieved by more efficient management of public resources. Most loss-making public enterprises should be privatised.

Poorly targeted subsidies in agriculture and energy should be cut, while protecting the poorest. Overlaps between federal and provincial spending should also be cut. These measures could provide savings of 3pc of GDP per year.

For Pakistan, crises could be an opportunity to address deep-rooted issues that have plagued its development.

Over time, bold fiscal reforms could potentially generate more than 12pc of GDP in new fiscal space. This is three times the additional resources needed to address human development gaps — leaving enough resources to raise public investments in infrastructure and reduce public debt. But to put Pakistan’s public finances on a more sustainable footing will ultimately not be possible without stronger economic growth.

Third, Pakistan must strive for a more dynamic and open economy. Current policies distort markets for the benefit of a few, while preventing productivity growth. Frequent overvaluation of the currency coupled with high tariffs lead firms to focus on domestic markets, disincentivizing exports.

A challenging business environment deters investment, as does a strong state presence in contested markets. Tax distortions also discourage productive investment and support non-tradable sectors such as real estate.

Accelerating the sale of productive assets or selectively attracting foreign investment deals may bring in much-needed forex reserves in the short term, but lasting impact will require addressing urgently the core issues behind low investment and declining productivity growth: levelling the playing field, spurring competition, cutting red tape and increasing policy predictability.

Fourth, the agriculture sector must be transformed to safeguard food security in the face of climate change and rising water scarcity. Current subsidies, government procurement and price restrictions lock farmers into low-value, undiversified farming systems and water-intensive crops.

These subsidies should be reallocated into public goods such as research on seeds, veterinary services, irrigation, and drainage services, promoting regenerative agriculture and building integrated agriculture value chains. Such measures could generate productivity gains, boost on- and off-farm incomes, and make Pakistan more resilient against climate shocks.

Fifth, energy-sector inefficiencies need to be addressed faster and more consistently, as they have long been a drain on public resources. Recent tariff increases have helped limit losses while protecting poor consumers, but large distribution and transmission losses, combined with high generation costs, have to be reduced to put the sector on a sustainable footing.

Fortunately, Pakistan has access to some of the cheapest hydropower and solar resources. Leveraging these will require investment, which will only come if long-standing issues in the distribution and transmission systems are addressed, notably through more private participation.

Also, tariffs adjustments needed to recover costs have to be shielded from politics, in order to provide credible incentives for investors over the long term.

All these policy shifts cannot be achieved at the federal level alone. Local governments will need to be empowered with capacity to raise and efficiently allocate funding to invest in much-needed local services.

The decentralisation agenda needs to be revived. Moreover, a more dynamic economy will provide opportunities for most Pakistanis, but to leave no one behind, social safety nets will need to expand while improving targeting and coherence across federal and provincial instruments.

By implementing such fundamental reforms in the coming years, Pakistan can achieve upper-middle income status by its centennial in 2047. We have no doubt it has the human capacities and a proven implementation ability to reach this goal.

The country has ample potential to not let this economic crisis go to waste and instead make it a historical turning point. The year 2024 could mark “Pakistan’s moment”.

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