Hundred days of economic management

During the five-year tenure of the PPP-led government, loadshedding became rampant affecting the productive activities and daily lives of people, growth rate declined to an annual rate only slightly higher than the population growth, saving and investment rates plummeted, inflation remained in double digit, budget deficit reached new heights, monetary expansion was unusually excessive due to government bank borrowing, public debt more than doubled in the five year period and the country was heading towards an external debt default. The then government functionaries tried to fudge economic data to make them look good but it fooled nobody.

Prime Minister Nawaz Sharif and other leaders of the PML-N have repeatedly stated, and rightly so, that the previous government brought the economy to the brink of collapse. The PML-N promised to usher in a period of good economic governance and turn around the economy to put it back on the track of sustained high rate of economic growth with a moderate rate of inflation. It also pledged to have a transparent government that tells the truth to the people and takes steps to break the begging bowl to make the country self-reliant.

An economy mismanaged for a long time cannot be set right in 100 days. Therefore, it would not be fair to draw definitive conclusions about the economic policy performance of the Nawaz Sharif government in its remaining tenure based on the evaluation of its first 100 days or so. But the initial actions of the government, which gave top priority to rehabilitation of the economy, can provide some clues as to the direction in which the economy is heading.

The PML-N government indeed made a promising beginning in some areas. The size of the cabinet has been kept under control and some of the key ministries are headed by competent people of integrity. There is an effort underway to keep current expenditure in check. An attempt is also being made to make public sector appointments on merit. Policies to get out of the darkness of loadshedding have been announced.

The government also avoided a potential external debt default by negotiating a new loan arrangement with the IMF. Planning is underway to restructure/privatise some of the loss-making public sector enterprises. These are all promising initiatives that ought to be appreciated. At the same time, there are some alarming signs that need to be highlighted hoping to get the government out of a trap of its own optical illusion or cobweb of flattery of sycophants.

It was hoped that the Nawaz government would learn some lessons from the previous government and immediately put a halt to note printing as a source of budget financing. Not only has that not happened, the present government has indulged in note printing from June 5, 2013, when the present government came to power, to September 6, 2013, at the daily rate of Rs11 billion as compared with Rs1.3 billion by the PPP-led government from July 1, 2012 to June 5, 2013. It does not give a good feeling about budgetary discipline, inflation control and exchange rate stability.

It was hoped that, unlike the PPP-led government, the present government would avoid concealing the truth from the people. That has not happened. For example, it has been boastfully stated that the floating debt of the public sector has been cleared via “cash management”. There is no such thing as cash management in a revenue-starved government. The reality is that it has been paid by borrowing from the banking system.

Similarly, it has been officially claimed that the IMF negotiations involved no discussion on the depreciation of the exchange rate. The reality is that the IMF programme agreed to by the government explicitly bases its financial programming on depreciation of the real effective exchange rate of 7.7 percent in FY14, which means a much higher rate of depreciation of the nominal exchange rate.

The present government had promised to break the begging bowl and reduce government dependence on external budgetary support. But the budget for FY14 relies more heavily on foreign inflows than was the case in the previous year. The IMF projects that total government debt as a percentage of GDP will go up from 64.2 percent in FY13 to 66.0 percent in FY14.

The budgetary data used by the IMF in preparing the financial programme is quite different from that presented to the National Assembly with the budget for FY14. To give just one example, the budget included government development expenditure of Rs1162 billion in FY14 but the IMF takes it as Rs842 billion. Maybe the government reduced development expenditure to a lower level to achieve the budget deficit target but it should not have been inflated in the first place without the availability of real resources.

In the design of the financial programme, the IMF has focused on a build-up of gross foreign exchange reserves in the next three years perhaps to ensure that Pakistan continues to meet foreign debt servicing and debt repayment obligations. Double digit inflation and a sharp depreciation of the nominal exchange rate have been taken as given in FY14. At the same time, it has no real structural reform measures in it. It may be a framework of policies that suits the interests of the IMF/ government but not of Pakistan. There remains a wide gap between what is required to be done structurally to set the economy on the right path and what is intended to be done under the programme agreed with the IMF.

The government seems to have no desire to overhaul the country’s taxation system to make it all-inclusive and equitable because it does not want to confront the powerful vested interest groups. The signals coming from this government are that it is endeavouring to raise revenue on a short-term basis from the existing taxpayers and taxed sectors.

With the underground economy expanding at a fast rate and by now having reached a size bigger than that of the recorded economy, with agriculture and service sectors practically out of the direct tax net, and without an all-inclusive concept of income for tax purposes, there is not much hope of a substantial increase in direct tax revenue. The proposal to introduce VAT has also been shelved. Without major tax reforms, the tax-to-GDP ratio cannot go up to a level at which the dependence of the budget on internal and external borrowing comes down significantly.

While tax revenue is not even enough to cover the debt-servicing obligations and defence expenditure, and no real new tax effort is in sight, there are ambitious plans to undertake large infrastructure projects of questionable economic justification requiring huge resources. These include a network of highways, new transport systems in large cities and modern airports, large public sector housing projects and schemes to provide interest subsidies on loans to a large unemployed population. Adoption of such a path of massive increase in expenditure without major tax reforms would lead to either large additional foreign debt burden or excessive note printing or both, which the country cannot afford.

There is a difficult economic road ahead requiring courage to take very difficult decisions intended to break the status quo, particularly in the taxation field. While there are major economic policy areas remaining unattended, the proclamation of the director of the Middle East and Central Asia department of the IMF on a recent visit to Pakistan that he was greatly impressed by the authorities’ pursuit of “a home-grown comprehensive programme to steer Pakistan toward the ranks of dynamic emerging economies” was, to say the least, a very unprofessional statement.

There are no short cuts to economic and social transformation. With or without the IMF, the government needs to decisively move to undertake difficult structural reforms now so that it can reap their benefits by the time the next elections arrive. Failure to do so will prove disastrous for the economy and land this government in deep political trouble by the end of its tenure.

The writer is a former governor of the State Bank of Pakistan. Email: doctoryaqub@hotmail.com