During his recent visit to Pakistan Steel Mills, one of the largest public-sector enterprises (PSEs) of the country, Prime Minister Raja Pervaiz Ashraf prayed for its revival. But he ruled out privatisation of the Steel Mills, despite its being a white elephant, for the reason that his party’s government was emotionally attached to it.
The prime minister’s remarks show that the government’s economic policies are guided less by pragmatism and more by emotional considerations. Whether a PSE is sold out or not, the decision needs to be based on cost-and-benefit analysis, not sentiments. For the present government, political expediency rather than utility principally prescribes what it does or avoids doing in the realm of economics, even when PSEs such as the Steel Mills are precariously placed. In fact, political expediency is the one powerful factor behind the present predicament of the economy.
The prime minister’s visit to the Steel Mills coincided with the announcement of the bimonthly monetary policy by the head of the State Bank. The state of the economy depicted by the Monetary Policy Statement is far from encouraging. For quite some time, the economy is in stagflation-an unenviable combination of low growth and high inflation. Usually, economies face a trade-off between high GDP growth and low inflation. Acceleration in growth drives up the aggregate demand, thus pushing up the price level. On the contrary, growth deceleration brings down aggregate demand, thus driving the price level down. However, at times, the economy reaches a stage-in the main because of supply-side inflation-where this trade-off is no longer available. The result is hike in prices accompanied by contraction of output growth and a consequent fall in employment and incomes.
The low-growth/high-inflation equilibrium has persisted ever since this government was sworn in. During FY09, the first full financial year under the PPP-led coalition, the economic growth rate fell to 1.7 percent, which was one of the lowest in Pakistan’s history. Even that growth rate, low as it was, became possible through downward revision of the preceding year’s GDP growth, to 3.7 percent from the original figure of 5.8 percent. But for that revision, the economy would have contracted rather, than expanded. A modest economic recovery was made in FY10 as the growth rate went up to 3.8 percent. However, the next year (FY11), the economic growth rate receded to 2.4 percent, well below the 4.5 percent target. In FY12, the economy grew by 3.7 percent against the 4.2 percent target.
On the other hand, notwithstanding a rather restrictive monetary policy, inflationary pressures have persisted. The average inflation scaled up to 21 percent in FY09, was driven down to 12 percent in FY10, and rose again to 14 percent in FY11. The average inflation in FY12 came down to 11 percent. The major cause of inflation is the fiscal deficit and the way it is being financed: bank borrowing. Reliance on bank credit as a major source of deficit financing is highly convenient but highly problematic. Borrowing from the central bank takes the form of printing of currency, which fuels inflation like nothing else, while drawing upon commercial banks’ liquidity crowds out private-sector investment-the real engine of economic growth. Thus, in FY12, largely on account of excessive bank borrowing by the government, the net flow of credit to the private sector came down drastically to Rs18.3 billion, from Rs173.2 billion a year ago. Hence, not surprisingly, while announcing the monetary policy, the State Bank governor was critical of bank borrowing by the government in “violation” of relevant rules.
Why is the government borrowing so heavily from the banks? The answer: to finance the growing fiscal deficit in the absence of other sources. In FY09, the fiscal deficit was reduced to 5.3 percent (Rs680.4 billion) of GDP from 7.6 percent a year earlier. However, it rose to 6.3 percent (Rs929 billion) in FY10 and 6.6 percent in FY11 (Rs1,194.4 billion). Provisional estimates for FY12, as reported by the State Bank, put the fiscal deficit at Rs1,328 billion, which makes up 6.4 percent of the GDP.
Two courses are open to the authorities for cutting back on fiscal deficit: bring down expenditure or shore up revenue. For reasons partly political (defence spending and the huge army of ministers, deputy ministers, special assistants and advisors) and partly economic (debt-servicing and subsidies to loss-making PSEs), it’s difficult to significantly cut public spending. This leaves increase in public revenue as the only way to control fiscal balance, which, however, is not coming through either.
Pakistan has one of the lowest tax-to-GDP ratios-under nine percent-and there’s no way an economic turnaround can be brought about without pushing that level up. In a population of 180 million, less than two million pay taxes. The majority of taxpayers are from the salaried class whose contribution to the national exchequer is deducted at source. Most of the eligible taxpayers either wholly evade taxes or the amount they pay is peanuts. These include several of our frontline political figures, business leaders and celebrities. Governments-past and present-have been remarkably consistent in their failure to widen the tax net and milk some holy cows (the landed gentry, for instance). It was failure to undertake the agreed fiscal reforms that led to Pakistan’s premature exit from the IMF programme in September 2011.
Regrettably, over the years, the revenue-GDP ratio has gone down, instead of going up. For instance, in FY08, the revenue-GDP and tax-GDP ratios were 13.7 percent and 9.9 percent, respectively. At the end of FY11, the ratios had come down to 11.7 and 8.9, respectively. Direct tax-GDP ratio came down to 3.2 percent in FY11 from 3.9 percent in FY08.
Technical matters aside, raising tax revenue is above all a matter of political will, in which our ruling class, past and present, is markedly deficient. Not long ago, all political parties of note had joined hands in getting the 18th, 19th, and 20th constitutional amendments through parliament. It’s a pity they can’t agree on shoring up public revenue. Not surprisingly, on average the economy has posted a fiscal deficit of around 6.8 percent during the last five years (FY08-FY11).
Another matter of concern is the falling investment-GDP ratio. The total investment as percentage of GDP has fallen to 12.5, from 22 four years ago. The investment-economy relationship goes both ways. While addition to the capital stock is necessary for making the economy grow, investors, on their part, must have confidence in the politico-economic environment to undertake productive investment. In the absence of such confidence, investors shy away from committing their capital to long-term projects, and instead prefer to earn easy money by investing in the stock or real-estate market. Hence, as in the case of Pakistan, a fragile macroeconomic environment is both a cause and an effect of falling investment levels.
The current economic scenario-though by no means encouraging-is not one doomsday either. By all accounts, the economy is not in a hopeless situation and one can see a silver lining. Despite the global economic downturn, Pakistan’s export performance has been reasonably good. Remittances have surpassed $13 billion and the current-account deficit has come down to less than 2 percent of the GDP. Economic revival can be effected-or at least a beginning can be made-provided those at the helm take some time from political engineering to give it to economic management.
The writer is a freelance contributor based in Islamabad. Email: hussain email@example.com