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Higher for longer

Since 2010, the global economy has been on a spending spree, with close to zero interest rates being around for more than a decade. Such historically low-interest rates led to an unhealthy transition towards acquisition of growth fueled by debt. As investors continued to look for higher returns, frontier markets like Pakistan were able to borrow in foreign currency to largely fund its consumption, thereby driving economic growth.

The era in which cheap capital was available to fund consumption-oriented growth has come to an end. Interest rates in dollars continue to increase, wherein long-term interest rates have topped at 5.0 per cent on an annual basis for now, increasing from less than 0.5 per cent only a few years back. Such a surge in interest rates has already triggered a flight to quality, where capital available for high-risk economies like Pakistan remains constrained.

More importantly, countries across the emerging and frontier markets continue to restructure their debt given resource constraints, and inability to service that debt, including Sri Lanka, Ghana, Zambia, among others. The increase in cost of borrowing, and the inability of sovereign countries to generate sufficient income to service debt continues to trigger debt restructuring decisions across the emerging, and frontier markets. Over the next few quarters, many more countries will be looking at debt restructuring options as they find it difficult to service their external, and domestic debt.

Pakistan continues to teeter on the edge. Although it has been able to avoid a restructuring of its debt up till now, there needs to be a fundamental change in how the country’s finances, and the economy is run to bring it in-line with the realities of an elevated interest rate environment. Higher interest rates mean that it will remain difficult for Pakistan to borrow capital to bridge its foreign currency requirements, mostly to sustain import-oriented consumption field growth.

The growth equation for Pakistan needs to change such that it reallocates domestic capital towards export-oriented and foreign currency-generating investments, while tactically reducing dependence on imports. It is estimated that even growing at a sub-par rate of 4.0 per cent per annum would require incremental foreign currency debt of more than $7 billion to bridge consumption-oriented growth, in addition to refinancing of existing debt. Inability to raise such debt will lead to constrained growth, pushing the country in a low-growth trap, wherein per capita income will stagnate, as population continues to grow at a rate of more than 2.0 per cent annually.

It has been identified time and again that structural changes are critical to sustain a stake growth rate, particularly in a global macroeconomic environment where the interest rates are expected to remain higher for longer. This means increasing reliance on mobilization of domestic capital by bringing it within the system, and reallocation of this towards more productive enterprise that actually generates output, generates foreign currency, and generates jobs. An industrial policy that targets this trifecta is non-existent, while an energy policy that can actually support an industrial policy is also non-existent.

The economy moves from putting out one fire to another, without taking any structural decisions that can steer the economy towards a path of sustainable growth. Costs associated with debt servicing continue to make up more than 80 per cent of the federally generated revenues, widening the fiscal deficit while restricting the ability of the state to serve its citizens, since any state activity can only be conducted through more borrowing. It has been many decades at this point where the ability of the state to widen the tax base has remained compromised.

The inability to generate more direct taxes while bringing in more economic segments and households within the tax net continue to result in increasing fiscal deficits, which eventually fuels inflation. Furthermore, the inability to rein in expenses, while burning cash in loss-making state-owned entities has led to a scenario where the state’s capacity to support such activities has been considerably weakened, while market structure has been distorted through heavy state intervention.

All of this needs to change if there is any hope for even a modicum of growth over the next one decade. The era of cheap capital is over, and the sooner policymakers realize this, the better it is for everyone. Being attuned to availability of cheap capital through multilateral institutions and friendly countries can only provide so much impetus, and it can never enable generation of sustainable growth through a consumption-oriented growth model.

The country needs a vision for the future. Economic plans that didn’t work in the 90s won’t suddenly start working again. The same actors that have been running the show intermittently for the last three decades may not suddenly start doing things in a rational manner. It is time for a fresh start – something that puts people first and plans for the future, rather than reacting to challenges on an ad-hoc basis. Not much has changed in terms of policymaking in the last few decades; if this continues, we may just be pushing hundreds of millions more towards poverty, just because of the inability to plan and take decisions due to bad policy and anachronistic policymakers.

Ammar Habib Khan, "Higher for longer," The News. 2023-10-29.
Keywords: Economics , Economic growth , Economic plans , Export , Imports , Pakistan , Zambia