Mar 22, 2009

A poor start

The first year of the PPP-led government has not thrown any surprises, at least on the econmic front

By Hussain H Zaidi
It has been exactly one year since the Pakistan People's Party (PPP)-led government came to power after the Feb 18 general elections. Though one year may not be enough to come up with a definitive assessment of the economic performance of a government elected for five years, one can judge the same by looking at the government's response to the major macro-economic problems.
The most important economic challenge for the PPP-led government has been to ensure growth with stability. For a developing country like Pakistan, economic growth is always a major macro-economic objective. However, as Pakistan's own experience shows, this growth has to be stable; otherwise, it will be difficult to sustain. The bursting of the bubble of economic growth just before the PPP-led government came to power exposed the essential flaws in the economic policies of the previous regime. Sustained growth rate is the effect, rather than the cause, of the increased productive capacity of the economy and, therefore, attention needs to be paid to shoring up the productive capacity of the economy.
However, during the Musharraf regime, little was done to increase the productive capacity of the economy; efforts were aimed largely at showing an increase in numbers, such as gross domestic product (GDP) growth and per capita income rates. Hence, though the economy of Pakistan grew on average at a healthy rate of 7 percent per year during last four years of the Musharraf regime, this growth did not rest on strong fundamentals, as reflected by the low level of savings and investment, high inflation, deteriorating balance of payments position, and large-scale unemployment.
Thus, the PPP-led government was required to correct the economic fundamentals. However, stabilisation policies are not without cost. The most obvious cost is that they slow the pace of economic growth, because the government pursues either a restrictive fiscal or monetary policy, or both. The PPP-led government faced this stability-growth trade-off and so far, it has preferred stability to growth. The federal budget for 2008-09 (FY09) set GDP growth target at 5.8 percent, which was subsequently revised to 3.4 percent and later to only 2.5 percent.
Even this modest target, the lowest in a decade, may be difficult to achieve if the political and energy crises linger on. During the first five months of FY09 (July-Nov 2008), the large-scale manufacturing sector registered negative growth of 5.6 percent. When economic growth shrinks, jobs are lost and incomes fall. Consequently, unemployment and poverty levels rise.
The government's priority has been to arrest the unsustainable fiscal and current account deficits. During 2007-08, the fiscal deficit rose to 7.4 percent of the GDP from 4.3 percent during 2006-07 (FY07). During FY08, the total revenue collected was Rs1.49 trillion, while the total expenditure incurred was Rs2.27 trillion, thus a fiscal deficit of Rs772.2 billion, more than double that during FY07. During FY08, the revenue-GDP ratio fell to 13.4 percent from 13.9 percent during FY07. During FY08, the tax revenue-GDP and direct tax-GDP ratios remained 9.6 percent and 3.7 percent, respectively, the same as during FY07. Not only did the fiscal deficit rose drastically in FY08, the way it was financed was also unsatisfactory. About 67 percent of the fiscal deficit of Rs520 billion was financed through bank borrowing, in particular central bank borrowing, which, though the most convenient source, is highly inflationary.
For FY09, the fiscal deficit target of 4.7 percent of GDP was set. In order to curtail the fiscal deficit, the government was required to increase public revenue and reduce public spending, including taking the politically difficult decision of eliminating or substantially reducing oil and power subsidies. During FY08, the government had provided subsidies worth Rs407.48 billion, including a subsidy of Rs175 billion on petroleum products in the wake of an unprecedented increase in the international oil prices. In an unpopular move, the government abolished the fuel subsidy and decided to phase out the power subsidy by the end of the current fiscal year.
In FY09 budget, tax target of Rs1.25 trillion was set, which has now been increased to Rs1.30 trillion. According to figures recently released by the Ministry of Finance, during first half of the current fiscal year (July-December 2008), total tax revenue collected by the federal government was Rs556.02 billion, while the non-tax receipts were Rs240.24 billion. If we deduct the provincial share in the federal divisible pool, the net federal government revenue comes to Rs545.68 billion. During the same period, total expenditure was Rs793.01 billion. This gives us the budget deficit of Rs247.33 billion, which is 1.84 percent of the GDP for the whole year. As in the past, the government has heavily relied on bank borrowing for deficit financing; over 85 percent of the budget deficit has been financed through bank borrowing of Rs209.72 billion.
In November 2008, forced by trade deficit of $21 billion, current account deficit of $14 billion (until June 31, 2008), depletion of foreign exchange reserves to $7.31 billion (as on Oct17, 2008) and drastic depreciation of the rupee, Pakistan had to sought capital assistance from the International Monetary Fund (IMF). Under a two-year stand-by arrangement, the IMF will be providing $7.6 billion credit to Pakistan. It is important to mention that the IMF assistance is a bailout, and not a development, package. The purpose is to help the country service its debt, make payment for imports and build up its reserves.
The IMF assistance will not be spent on poverty alleviation or infrastructure development. The assistance from the IMF has saved the country from having to default on debt re-payment and made it possible for it to pay for imports. Now what the country imports from the IMF money is another issue altogether. It may import essential goods, such as food, raw materials and machinery necessary for industrial development, or luxuries like bulletproof cars for VIPs or even defence equipment. World Trade Organisation (WTO) rules allow a country facing a balance of payments problem to restrict imports temporarily, but whether the government has the political will to do so? Unfortunately, the signs so far have been far from positive.
The IMF assistance is at best a temporary recipe. In the long-run, Pakistan's balance of payments position will be determined by the relative demand for (imports, debt servicing, etc) and supply of (exports, foreign capital inflows, etc) foreign exchange. A continuing adverse balance of trade will put pressure on the reserves and depreciate the rupee. During the first seven months of FY09 (July2008-Jan 2009), the country has registered current account deficit of $7.75 billion, compared with $7.63 billion during the corresponding period of FY08. During the same period, the trade deficit reached $8.53 billion, compared with $7.95 billion during the corresponding period of FY08, notwithstanding a record slump in international oil prices. Given these figures, it may be difficult to reduce the current account deficit to 6 percent of GDP during FY09, from 7.5 percent during FY08.
The huge trade and current account deficits have put strong pressure on foreign exchange reserves. On June 30, 2007, foreign exchange reserves were $15.61 billion, which decreased to $11.39 billion on June 30, 2008. As on November 25, 2008, the reserves shrank to $6.4 billion. On November 26, the country received the first tranche of $3.1 billion from the IMF, of the total agreed assistance of $7.8 billion. The IMF capital eased the reserves position and as on December 5, they had risen to $9.09 billion. As on week ending Feb 27, 2009, the reserves had increased to $10.13 billion.
Containing the rising inflation has been another challenge for the government. The FY09 budget set inflation target at 12 percent. In order to bring down inflation, the State Bank of Pakistan (SBP) has been pursuing a rather restrictive monetary policy for quite some time. In July 2008, the discount rate was increased by 100 basis points (1 percentage point). Subsequently, in Nov 2008, the discount rate was pushed up by 2 percentage points to 15 percent. Overall, during 2008, the discount rate was increased by 5 percentage points.
The Monetary Policy Statement for Jan-March 2009 has retained the 15 percent discount rate. However, strong inflationary pressures persist in the economy. During the first seven months of FY09 (July 2008-Jan 2009), average inflation as measured by the consumer price index (CPI) was reported to be 23.9 percent, nearly three times more than that during the corresponding period of FY08. For the whole FY09, average inflation is projected to be 20.3 percent, while during FY08 it was 12 percent. Does this leave room for further argument?

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