A minister’s job

It has been reported in the press that on January 1, 2014 the federal finance minister gave a briefing to the cabinet on the state of the economy. If the briefing was only to the cabinet, it could be taken as a positive development implying that the government was giving high priority to taking difficult policy measures to address the deep-rooted economic problems of the country.

But it was a cabinet meeting that was also attended by media representatives. If it was a regular cabinet meeting to which the media was invited, there are many question marks relating to the rules of business/good governance practices in conducting cabinet meetings. If it was a briefing to the media to which the entire cabinet was invited then it should not have been a monologue by the finance minister. Rather, it should have been a question-answer session.

The economy is in very serious difficulties with the majority of the people suffering from sustained double digit inflation and the country facing a balance of payments crisis. Given the gravity of the situation, the problems should have been discussed objectively to prepare the media and the public for difficult policy decisions.

Instead, the finance minister gave a one-sided talk blaming the previous governments for everything and claiming to have set lofty targets to get out of the mess. The minister focused on defending the government’s position rather than explaining what was required to be done.

The most startling statement made by the finance minister was that the present government was not creating excessive money through its fiscal operations and that inflation was not caused by money creation. In particular, the minister stated that the recent rise in prices was due to the previous government’s failure to increase utility prices in their tenure.

Moreover, without giving an alternative theory of inflation, the minister dismissed the cause-effect relation between money and prices being taught in economics classes all over the world. In this regard, it is enough to quote economist Gottfried Haberler that “there is no record in the economic history of the whole world, anywhere or at any time, of a serious and prolonged inflation which has not been accompanied and made possible, if not caused, by a large increase in the quantity of money.”

The finance minister repeated the macroeconomic targets that were set by him in the budget and were included in the documents prepared for the EFF arrangement with the IMF. Those targets are:

• The real growth of GDP to be increased from 3 percent in FY13 to 6-7 percent in FY16

• Investment-to-GDP ratio to be raised from 12.6 percent to 20 percent

• The tax-to-GDP ratio to be increased from 8.5 percent to 13 percent

• Fiscal deficit to be reduced from 8.8 percent of the GDP to four percent

• Foreign exchange reserves to be increased from about $3 billion to $20 billion

• Public debt to be reduced to 60 percent of the GDP

However, these targets mean nothing without a plan of action to achieve them – and no such plan was presented in the meeting. Proverbially, people are reminded that if castles could be built in the air all of us could live there.

Let us briefly spell what it would take to achieve these targets starting with the target of the rate of investment of 20 percent of the GDP to realise a growth rate of 6-7 percent. Let us assume that the public sector investment would need to be increased to six percent of the GDP and private sector investment to 14 percent. The real issue then is the availability of domestic/foreign savings to finance such investment.

If the government intends to bring down budget deficit to four percent of the GDP as indicated in the above targets, then the public sector must save equivalent to two percent of the GDP to be able to increase the public sector investment to six percent of the GDP.

Currently the public sector is a net dissaver to the extent of two to three percent of the GDP. In the coming years, the debt servicing liabilities will increase substantially even if other current expenditure is contained through austerity measures. In this context, the current public sector dissaving of two to three percent of the GDP will have to be replaced by a similar level of saving to finance public sector investment of six percent of the GDP, given the budget deficit target of four percent of the GDP.

It would require the tax-to-GDP ratio to increase by 6-7 percentage points of the GDP in the three-year period. Such a massive increase in tax revenue is not possible from the present narrow tax base. But the minister gave no indication of the tax measures he would propose to increase the tax-to-GDP ratio by six to seven percentage points of the GDP.

The government should eliminate all tax exemptions given to existing taxpayers through SROs. Second, the provinces must be made to impose and collect an agricultural income tax that is at par with the federal income tax. Third, the existing sales tax must be converted to a lower rate VAT variety on a consumption base with exemption only for food items and medicines.

Fourth, the underground economy should be dismantled and forced to integrate with the recorded economy. Fifth, the tax administration should be modernised and made autonomous to enforce tax laws without fear or favour. Sixth, the financial bleeding of the public sector enterprises must be stopped through their restructuring/privatisation. Seventh, most price subsidies should be phased out.

In the absence of these structural fiscal reforms that expand the tax base and improve tax collection, it is impossible to finance public sector investment of six percent of the GDP except by using inflationary means and thereby exceeding the budget deficit target. Lowering of the public sector investment target would hurt the prospects of achieving the growth rate target of 6-7 per cent on a consistent basis.

In the matter of private sector investment, the government would need to take concrete steps to control lawlessness, frame new laws to ensure security of new investment, guarantee property rights, improve energy supply, put in place transparent macroeconomic policies, let the State Bank pursue a prudent monetary policy to make credit available to the private sector at reasonable real rate of interests, and ensure a positive real rate of return on financial savings, and follow a flexible exchange rate policy to encourage exports and contain imports. All avenues of capital flight would need to be closed.

Finally, the target of building foreign exchange reserves to $20 billion simultaneously with reduction in the debt-to-GDP ratio to 60 percent is possible only if the foreign trade gap is reduced substantially, remittance inflow continues to rise and the current account deficit is replaced by a surplus which, in combination with direct foreign investment, could help build up reserves.

Increasing reserves by borrowing from abroad will land the country in the same difficulties in which the previous government placed it by heavy front-loaded short term borrowing from the IMF without structural adjustments. The government had to exhaust those reserves within a few years for repayment of the external debt.

It is easy to criticise the previous governments and to set high-sounding and eye-catching macroeconomic targets. But finance ministers are supposed to come up with policies to attain them, prepare the public to accept difficult policy decisions and then use their influence to convince the political leadership to implement them in an orderly manner.

The writer is a former governor of the State Bank of Pakistan.

Email: doctoryaqub@hotmail.com