Mar 26, 2009

In a topsy-turvy world

These are extraordinary times, demanding extraordinary solutions. A confluence of domestic crises -- security, political and economic -- has, as luck would have it, coincided with an uncertain environment for global trade. To address the tenuous economic situation locally, largely self-inflicted, we entered into an IMF stabilisation programme that we now discover is unnecessarily compromising prospects for growth in an increasingly difficult international setting. So, what should be done under the strenuous circumstances that confront us?To begin with, especially with inflation easing in the dynamic sense, a falling Kibor and better liquidity position of the banks which, admittedly, is slowly being translated into lower interest rates for borrowers, the State Bank should reduce the discount immediately and use the exchange rate as an instrument to curb demand and reduce pressure on the external trade deficit, the objective that underlay the earlier decision to raise the interest rates. We need to lower the value of the rupee, artificially overvalued because of inflows on the capital account (and even some on the current account like peaking remittances), a large proportion of which are temporary, and hence unstable and unsustainable in nature. The inflationary impact of such a move can be minimised, thanks to the fortuitous plummeting of international prices of commodities, like oil, edible oils, rubber, chemicals, etc. This will be beneficial for exports (as well as for manufacturers of products essentially consumed at home) the pressure on whose production cost curve can be eased, augmenting their competitiveness, and thereby maintaining, or even creating, jobs.Although commodity prices have fallen internationally, there has not been a concomitant decline in domestic markets and the reason is only partly because of the initial weakening in the value of the rupee. The poor transmission mechanisms that are supposed to convert the falling global prices into lower domestic prices and weak government regulation explain the failure of such an outcome. Instead of choosing the more arduous route of cutting non-salary non-development expenditures or/and raising tax revenues by elimination of exemptions, the government has taken the easier option of not cutting oil prices drastically, which have now dropped internationally to one-third of their peak in July 2008. By not doing so, it is earning Rs12 billion a month, unnecessarily burdening the economy and affecting industry's ability to compete. We should immediately lower the cost of diesel, thereby reducing cost of transportation, cost of operating agricultural tube-wells and cost of running generators (this additional cost being in excess of Rs11/kwh).Although prices of most imported goods have plunged, government procedures for valuation of cargo to calculate import duties discourage the acceptance of the invoiced price, mainly because of tax revenue targets. Customs staff insists on ITP prices or prices declared for previous shipments, thereby keeping prices high in the local market. Declared invoiced prices of imports should be accepted, recognising that such an instruction will facilitate a degree of under-invoicing, a practice that flourishes even today with the collusion of customs personnel.The government is trying, belatedly, to raise the utility tariffs to cover up for past losses of WAPDA and KESC on account of failure to raise rates when oil prices had skyrocketed. Increasing utility prices when oil prices have collapsed would be a huge mistake as it would be inflationary and also hurt industrial competitiveness. The government would be well advised to absorb past losses of the utilities and help them collect their dues for electricity consumed and billed. Furthermore, cartels have been formed by producers of, for example, vegetable ghee, who have not lowered their prices to reflect declining international prices of edible oils. The government should attack cartels by strengthening the effectiveness of the Competition Commission and put pressure on domestic producers to lower their prices by allowing direct imports of critical food items e.g. edible oils or even, as a last resort, use a public sector agency to perform this task.To facilitate availability of credit at lower interest rates to the private sector and save the more efficient manufacturers (who are also likely to be bigger borrowers and more leveraged) the State Bank should review the interest rate spreads of banks, soften its prudential regulations on provisioning against borrowers not servicing their loans regularly and provisionally lower the capital adequacy requirements of banks. Do not throttle, if not kill, the goose which lays the golden eggs. Give the banks more room to manoeuvre on who to lend to and who they regard as less able to service their loans.The above measures will not only reduce the inflationary pressure in the economy but also improve industrial competitiveness.Finally, the government should try to stimulate growth by focusing on sectors that are labour-intensive and have high employment elasticities, like agriculture, livestock, housing and domestic commerce that will boost local demand. Furthermore, it should reprioritise programmes and projects with short pay-back periods that will create more jobs and generate higher returns to the domestic economy while opting for interventions that do not place a heavy demand on scarce financial resources.

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