Economic free fall ahead

Dr Muhammad Yaqub There is a near-unanimous professional view outside official circles that the economy is in a very bad shape. The political leadership is unable or unwilling to understand the depth of the economic troubles and is busy with its usual business, as if all is well on the economic front. For public consumption, government representatives talk about becoming self-reliant or depending on trade rather than aid, without evolving a strategy to do so. The government promises to control inflation without developing a concrete plan to limit domestic bank borrowing for deficit-financing. There is a daily promise to reduce unemployment without a coherent and consistent policy framework meant to promote private investment and economic growth. We hear talk about pursuit of an independent foreign policy and strong national defence, without the realisation that they are impossible amid a decaying economy. In short, the political leadership is trying to build a castle in the air and a fools’ paradise, promising the people to take them there out of the hell of their daily economic miseries. The technocrats hired to give politicians a sound professional advice are either unable to explain the real state of the economy to them or the politicians pay no attention to the views of their professional advisers, who even then hold on to their positions to enjoy associated perks and privileges. In their presence, and even through them, the government continues to spend without restraint by borrowing from the domestic banking system, including the State Bank of Pakistan, and incurring more external debt on increasingly harsher terms. The country is being mortgaged. We are used to the unfulfilled promises of politicians, but it is unfortunate that even the technocrats hired to do a professional job are acting like politicians. There is a general tendency on their part to depict a rosy picture of a gloomy economic situation, based on twisted facts, false hopes and empty promises. The most recent example is that of the finance minister (who is an economist by profession) informing the nation that the comfortable level of foreign exchange reserves has led the government to withdraw from the IMF programme with no fear of external debt default or adverse economic consequences. When the IMF programme was operational and people were suffering, they were led to believe that their economic hardships were mainly due to the tough conditionality of the IMF. Now when the IMF programme has been terminated, and people’s sufferings continue unabated, they are being misled that the economy is on its way to recovery and all will be well. There could be nothing farther from truth. History has also been a poor teacher for the economic managers in Pakistan. Both in 1994 and 2007, when foreign exchange reserves went up temporarily for exogenous reasons, the governments decided to pull out of IMF programmes with self-created illusions and poor advice of their immediate advisers. After a very short period, the government ended up back in the IMF’s lap on their terms. The current economic team of the government has also made a similar decision. Unable to persuade the political leaders to undertake the necessary economic reforms that would have kept the IMF programme operational they have pre-emptively disengaged from the IMF claiming victory for themselves over the IMF. They are likely to repeat history on their watch once again. The economic team has not found it necessary to tell the nation the truth that foreign exchange reserves have increased due to substantial borrowing from the IMF and other international financial institutions, bilateral loans and cash reimbursements by the US tied with Pakistan’s role in the Afghan war, unusually high export proceeds reflecting a high level of world cotton prices and unusually high inflow of remittances unrelated to government policies. All of these are nonrecurring and reversible factors, and in some areas reversal has already begun. It is an unsustainable situation without strong policy action and change of direction in economic management. From now onwards, there would be a net outflow to the IMF in the absence of a programme, other creditors would need to be paid while their disbursement levels will decline, export growth may be nominal and remittance inflows will remain uncertain. With market psychology turning negative, speculative holding of dollars will increase and foreign exchange reserves will decline at a steady pace. Once market panic sets in, the decline in reserves will accelerate. With the termination of the IMF programme, there is a more urgent need, not less, to address the structural economic problems to halt a further slide of the economy. The public needs to be taken into confidence about the forthcoming economic hardship for it to be prepared for more sacrifices if we have indeed decided to stand on our own feet. In the absence of an operational fund programme, there will be a decline in the net foreign financing of the budget from what was expected and budgeted, mandating more austerity in expenditure and a bigger domestic resource mobilisation effort. But given its track record, it is inconceivable that the government would be prepared and able to take tough additional revenue generating and expenditure reducing measures. The more likely scenario is that the government will engage in excessive spending on the eve of elections. The rising expenditure in the context of a fall in the net external financing of the budget will be financed by more domestic borrowing. This borrowing will mostly be from the State Bank and commercial banks which, in turn, will accelerate the rate of inflation and depreciation of the exchange rate. In its own turn, the depreciation will add to inflation, speculative holding of dollars and a further deterioration in the fiscal situation due to a rise in foreign debt servicing in rupee terms, completing a vicious circle. Inflation is taxation on the poor to subsidise the rich. Hence, economic disparity will widen and social tensions will mount. People’s trust in the local currency will decline and dollarisation, commodity hoarding and real-estate investments will be used as a hedge against inflation by those who can afford to do so. The other segments of society will begin to move towards the poverty line, if they are not already there. Ultimately all these developments will lead to political instability and social and economic chaos. If such a chaos is to be averted, it is important that the government undertakes prompt structural economic reforms. It should be understood that status quo is not a viable option. Those policy measures have been discussed in details in the print media, in TV talk shows and in drawing-room conversations. We have crossed the stage of discussions and the government needs to take concrete action if the economy is to be saved from freefall.