Moment of truth

Dr Maleeha Lodhi
The writer is special adviser to the Jang Group/Geo and a former envoy to the US and the UK.

Despite an encouraging start talks between government and opposition teams to evolve a bipartisan reform agenda have yet to make the progress needed to address the deteriorating economic situation. The fiscal deficit crisis is like a runaway train hurtling towards derailment that can be averted only by prompt and bold corrective actions.

The recent visit to Islamabad by an IMF team and a senior economic adviser of President Barack Obama saw similar messages being delivered to the government: that time was running out on the economy and on patience in Washington. Without necessary reforms, which the PPP-led coalition committed and retreated from, there could be no revival of the IMF programme or prospect of help from donors.

The top political leadership still seemed to harbour the hope that the IMF would consider releasing the sixth tranche of an $11 billion standby arrangement. Having utilized $8 billion from that loan since 2008 with little structural adjustment to show for it, the government’s economic credibility is in serious question.

The visiting officials went away with no clear indication of what action plan the government was prepared to implement to enable the IMF to review Pakistan’s request for disbursement of the next tranche ahead of the budget. Progress on previously agreed performance criteria will have to be demonstrated before the Fund programme, now inoperative, can be resuscitated or a fresh one negotiated.

Prime Minister Yousuf Raza Gilani publically acknowledged that the economy was “under pressure” but found comfort in the country’s present level of foreign exchange reserves. This underestimates how the external position can slip rapidly if the runaway budget deficit is not expeditiously addressed.

Nevertheless five rounds of talks between the government and PML-N teams seemed to indicate common recognition of the seriousness of the problem and the need to do something. But negotiations began with a disadvantage: policy reversals by the government - on the reformed general sales tax and fuel price increase - that signaled its weak political will.

Talks have also been disadvantaged by the political and long-term nature of several of the ten points of the PML-N’s negotiating agenda. Although there is nothing in them to disagree with, an expansive agenda that does not distinguish between the urgent and the important can scatter the focus needed to evolve a minimum economic consensus. Stabilization of the economy is necessary for the attainment of most of the ten points.

Not surprisingly, the differing priorities - and constituencies - of the two sides have slowed the negotiations. What could also be complicating the process is that the ruling party, its allies and the PML-N all seem to have an eye on the next elections even though they are two years away. In theory there is a one-year window to take tough steps but in practice electoral considerations are weighing on leaders’ minds.

The consequence is that the urgency warranted by a worsening economy is not yet translating into talks being able to prioritize areas for immediate action.

This is worrying, as both sides know what needs to be done and why action must be taken quickly. Without new measures the gap between the government’s expenditure and income will widen further, even push the budget deficit to a record 8 per cent of GDP this fiscal year. With no additional internal or external resources available to fund this at a time when the oil import bill is rising, resort will - as at present - be made to borrowing from the State Bank.

This will fuel more inflationary pressures on the economy at a time of falling growth and produce ‘stagflation’ which can generate conditions for social instability. More borrowing will also start depleting foreign exchange reserves, put pressure on the exchange rate and erode confidence in the country’s currency.

Without structural reforms on both the revenue and expenditure side the economic slide cannot be halted. This requires a minimum consensus on urgent steps in three core areas.

One, agreement on domestic resource mobilization and specific tax measures. But people will only accept additional taxation if credible steps are taken upfront to reduce inessential expenditure, impose official austerity, stop tax leakages through corruption and improve collection from the existing regime.

But there is no getting away from attacking the source of all fiscal problems: Pakistan’s appallingly low tax to GDP ratio. Unless the present 9 per cent of GDP is increased by 3-4 per cent, reliance on bank borrowing, with all its pernicious effects on the economy, cannot be ended. This is essential to achieve a durable reduction in inflation, a major reason for the rise in poverty in recent years.

Agreeing on tax actions is a challenge as the two sides have differing proposals and priorities. Consensus has to be mobilized to enforce the reformed general sales tax and the flood tax legislation that was put on hold in the National Assembly. Removal of hundreds of tax exemptions (which cost the economy billions of rupees) revival of the wealth tax and commitments by provincial governments to institute an agricultural income tax should all be part of a package deal to accommodate the demands of all stakeholders.

This will help prevent a situation where any political party can use the non-acceptance of its favoured tax proposal as an alibi to oppose another.

The second point of consensus has to be on expenditure control. The PML-N’s demand for a 30 per cent cut in spending has to meet the test of practicality because after the substantial slashing of the development budget, debt servicing and defence are what are left, and the limitations here are obvious. There is however still scope to curtail non-interest and non-defence current spending.

Federal expenditure control will have to be matched by similar action by the provinces, which are unaccustomed to spending restraint. Provinces have benefited from the transfer of resources under the National Finance Commission Award but without a reciprocal obligation to raise revenue from taxes in their jurisdiction. Without provincial expenditure cuts, efforts by the center will be inadequate.

The third area that needs immediate agreement is arguably the most politically difficult: elimination of general subsidies. Ostensibly aimed to help the less well off, subsidies are untargeted and a budget liability irrespective of what product they are for. They add to the fiscal deficit and are financed by additional government borrowing. This produces more inflation - the most insidious tax on the poor - and neutralizes the presumed ‘pro-poor’ intent of the subsidy.

A structural reform agenda to attain sustainable economic stability will have to go beyond agreement on just these policy measures. A debt management strategy has to be evolved. But first adherence is required to the principles already set out in the Fiscal Sustainability and Debt Limitation Act. The limits prescribed in this have already been breached but must be respected.

Restructuring of public sector enterprises needs to be urgently undertaken to stem the losses that are such a heavy drain on the national exchequer. Also critical is energy reform including action to eliminate untargeted subsidies, while protecting the poor, and addressing the load shedding problem and growing circular debt.

While strategies to deal with longer-term problems have to be put in place the immediate priority is to forge agreement on what is absolutely essential to deal with the spiraling budget deficit. The aim should not simply be to qualify for another IMF tranche but to find durable solutions to the economy’s underlying problems.

The government cannot expect the opposition to compensate for its lack of resolve any more than the PML-N, which runs the country’s largest province, should seek to enjoy power without responsibility. Both must learn to share the pain of adjustment.

This is a moment of truth for Pakistan’s political leaders: a test of whether they can subordinate their political and partisan interests to the goal of saving the economy. The country’s very stability depends on whether economics can take precedence over politics.