Troubled waters ahead

By Sakib Sherani
Published in DAWN on April 09, 2021

AFTER 21 months of IMF-mandated fiscal austerity and demand management, the prime minister appears to have had enough and has signalled a change of course. The finance minister overseeing the implementation of the IMF programme, which the prime minister publicly committed himself and his government to on several occasions, has been unceremoniously sacked.

A confluence of factors appears to have shaken the prime minister’s resolve with regard to seeing through the tough conditionality of the Fund programme. Rising inflation and depleting political capital are the most obvious reasons. In addition, the PTI government’s time is fast running out in terms of the election cycle too. While on paper, its mandate runs till August 2023, governments tend to become lame ducks well before the end of their term. More importantly, the electorate appears to discount a government’s performance closer to the elections, and carries to the polls perceptions and sentiments of how the incumbent government did earlier in its tenure. This is obviously generating a lot of pressure in a number of quarters.

A final factor that appears to be tilting the prime minister towards a more populist stance is the government’s flawed reading of the state of the economy. A short-run bounce in economic activity that has accompanied each episode of stabilisation is being misread as something more durable.

Key vulnerabilities of the economy remain in place, immediate improvements in the external account notwithstanding. As predicted, the trade deficit is widening with economic activity in certain sectors pulling in a greater quantity of imports. Increase in imports is outstripping exports two-to-one (2:1) so far this fiscal year. International commodity prices across the board remain elevated, from oil to industrial and food categories.

The government will have to navigate through difficult straits on a number of fronts.

While pressure is building up in the external current account, the financial account remains highly vulnerable too. Inward foreign direct investment remains well below one per cent of GDP, while external debt repayments remain elevated for the medium term. Excess global liquidity means that international sovereign bond issues, like Pakistan’s recent Eurobond issuance, could continue to provide a source of financing, but the price Pakistan paid for its Eurobonds, as measured by the spread over US Treasuries, is higher than what it paid for in 2017 — and substantially wider than what other similarly rated sovereign issuers have paid in this environment.

Clearly, Pakistan’s external account is not out of the woods. In terms of the internal balance, the situation is even more dire. Despite resort to predatory, anti-formal sector taxation to bump up revenues, the fiscal deficit remains well above sustainable levels. The public debt burden remains elevated with the medium-term outlook non-benign.

Into this milieu walks in the Biden administration. The Democrats are back — and so is their unquenchable keenness to “dial up the pain” for Pakistan. In this setting of unfavourable economics, politics and geopolitics, the government appears to be embarking on a new course of populist measures.

The situation is fraught with risk. The seeds of almost all economic crises in Pakistan’s recent history have been sowed in the run-up to elections. Hence, the government’s actions, if not calibrated carefully, can hasten the next balance-of-payments crisis while also setting up a collision course with the IMF.

So how can the government manage the inherent conflicts in its policy goals of sustaining growth without worsening the external account, reducing inflation without a tighter fiscal or monetary stance, and providing relief without worsening the fiscal balance?

The first principle it should commit itself to is that of ‘do no harm’ (or try to minimise it at least). The second is to curb the impulse to throw money at the problem. There is no fiscal space and, equally importantly, ramping up development spending at this stage of the election cycle is pointless given its lags. A better political strategy would be to increase the pie of targeted subsidies for the lower middle class (the Ehsaas initiative is already catering to the poorest), and to fund it from the development budget, especially by diverting funds from non-critical early-stage or completely new projects.

The agriculture sector can provide quick wins in terms of growth as well as rural votes. It is also the only sector where growth can be positive for the balance of payments by generating exportable surpluses or opportunities for import-substitution.

A recognition that economic growth can be accelerated by more potent ways than just tax incentives and subsidies can also go a long way in managing the situation. Removing constraints and bottlenecks in the business environment, including regulatory overreach, bureaucratic red tape and discretion, and ambiguities in the tax code can all have powerful effects and pay-offs. Any effort must start with FBR — which has not only begun to resort to predatory taxation to meet targets, but where reports of corruption have increased significantly under this government.

A recent move by FBR is illustrative of how it manages to kill sectors with economic potential. Income tax commissioners have been given the power to decide applicability of income tax on ICT/software exporting firms. Reportedly, a $5 million tax demand has been generated for a reputed global firm that has been operating in Pakistan for the last few years, and was in the final stages of expansion and hiring. It has now decided to move its operations to the Philippines. Actions such as these by FBR are completely self-defeating as well as avoidable.

Finally, in response to the US cold-shouldering and posturing, the government should signal a stronger — and clearer — commitment to its strategic relationship with China and double down on the implementation of CPEC phase two. The fuzzy new ‘geo-economics vision’ introduced recently requires an early reset; there is no bigger ‘geo-economics’ opportunity than CPEC, and Pakistan should first focus on getting it right — and then leveraging it for regional connectivity. CPEC phase two remains a potent growth driver under the current constrained environment, and Pakistan should grasp it firmly and leverage it wisely.

The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

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