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Dr Muhammad Yaqub
Sunday, December 23, 2012
From Print Edition

There is all the evidence that the present government has put the economy on a path that – without a major change in the direction of the fiscal, monetary and exchange-rate policies in the foreseeable future – will inevitably lead to an economic crisis. The government still has a few more months to inflict further damage to the economy, which will be followed by a period of status quo in economic policies under an interim government.

Obviously, even with good intentions, the interim government will not have the mandate, the environment or the time to change the direction of the economy. It may not add to the drift, but the interim government will not have the ability to take corrective measures to halt the slide that has been engineered by the present government and will be intensified in the remaining few months of its tenure.

It would also be naive to think that, without painful structural reforms, the end of this government will be the beginning of improvement in the economy. If a new government is not installed well ahead of the beginning of the next fiscal year in July, or if it is not a strong government committed to good governance and structural economic reform measures, an economic crisis will be knocking at the country’s door by about the end of 2013. The new government, unlike the present one, will not have the luxury to play around with the economy for some time without going through such a crisis.

Although the main cause of the imminent crisis is the reckless fiscal and monetary policies of the government, the crisis will rear its ugly head in the external sector. Two developments in the external sector will create a crisis by the end of 2013.

First, the foreign-exchange reserves would have dipped to a precariously low level to create a foreign-exchange crisis. At present, the foreign-exchange reserves of the State Bank of Pakistan (SBP) are hovering at around $8 billion. In calendar year 2013, the current account of the balance of payments is likely to record a deficit of $3-5 billion and the payments to the IMF to be made in 2013 are of about $3.7 billion. In the absence of net capital inflows, those two items will bring the level of foreign-exchange reserves to a dangerously low level, creating panic in the foreign-exchange market.

Second, the dwindling foreign exchange reserves have already begun to put pressure on the exchange rate, and it is likely to accentuate in the period ahead, particularly with the SBP action to prematurely reduce the policy rate and to provide liquidity to commercial banks to continue to lend to the government. Once the exchange rate crosses the barrier of the psychological level of $1=Rs100, there will be an acceleration in capital flight and further depreciation of the exchange rate.

Some assistance from the US, sale of some national assets to foreigners or deferred payment arrangements for oil imports may delay the timing of the crisis somewhat, but they will not be able to stop it.

It should also be remembered that any coercive measures taken to halt the slide of the exchange rate or depletion of foreign-exchange reserves will only accentuate the problem. The country is committed to Article IV status as a member of the IMF. Therefore it cannot impose import restrictions, except under the cover of national security and economic emergency, without violating its obligations as an Article IV country. In fact, import- or exchange restrictions make the underlying situation worse. There are therefore not many pleasant choices open for the country to administratively stop the slide of the exchange rate and depletion of the foreign-exchange reserves.

The depreciating foreign exchange rate will accentuate the budgetary problem and hit hard the industries that rely on imports. Thus, a new factor will be added to the already explosive price situation, unemployment and poverty. A continuation of the cheap-money policy will further aggravate the price situation.

At that stage the country will be faced with the trauma of external debt default or harsh conditionalities for a rescue package from the IMF. The consequences of external debt default are so devastating that no patriotic government would like to embrace it and its consequences. Accordingly, the government may have no choice except to knock at the door of the IMF for a rescue package.

But the policy cost of any rescue package from the IMF will be high. The government will have to take drastic measures to mobilise taxes and contain expenditure. Revenue cannot be increased without offending the strong lobbies of landlords and tax-dodgers in the urban sector, and overhauling of tax collection and tax administration. In addition, severe expenditure controls will need to be instituted, including removal of price subsidies, restructuring of public-sector entities and cut in defence expenditure. Such unpopular expenditure controls will not be liked by the defence establishment, or the public at large. Only a politically strong government that lays bare the options available to the country and takes the public into confidence will be able to get through the political and social turmoil that is likely to follow.

The political parties that aspire to lead the country in the next five years should take the imminent economic crisis seriously and begin to frame a policy package involving fundamental reforms and prepare the public to accept difficult economic decisions. Sugar coating or false promises of economic relief will only come back to haunt them if and when they assume power.

A warning is in order here. There are some ever-present opportunistic and self-serving economists who would claim that they know better than most others and pronounce that those who are giving warning signals about the economy are wrong. They have been seen in the corridors of power before and represent a group that is always hungry for appearance on television and in newspaper columns and to attract the attention of those in power, thereby offering themselves to “serve” the country.

There is no magic wand to save the economy from the looming crisis, and only a determined government that undertakes structural economic reforms will bring some hope of economic recovery, with assistance from the IMF.

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