Friday March 31, 2023

Time for decisive action

January 11, 2023

Never before in recent decades has Pakistan been in such a state of crisis. Our economy, politics and society are in disarray.

About the economy, the question being asked is: ‘will we soon default?’ The combination of external debt, imports, and forex exchange reserves leave many wondering. Understandably, the focus at present is on survival.

But even when policymakers take a longer view of the economy, soundbites about GDP growth and IMF programmes replace vision and strategy. There is no deeper inquiry about what is best for the country. Whether GDP growth results from increase in manufactured goods or from one-time spending of borrowing does not figure in our discussion.

Nor do we discuss how to use the IMF programme to strengthen the country’s economic fundamentals and avoid future crises. Both agriculture and manufacturing are in decline, consequently plunging exports. Slow accumulation of capital and slow productivity growth have reduced the economy’s potential for growth.

For years, the apparent object of our economic policy has been to survive the current economic crisis by piling debt on debt, until the next one comes along. We continued to take on more debt from wherever it came, including at very high rates from the bond market. No one gave any thought to how it would be repaid. Since 2008, Pakistan’s total stock of debt and liabilities has grown by $85 billion. We have paid about $114 billion since 2008, yet the debt stock has still grown by $85 billion. A more flawed economic policy is hard to find.

Until a few years ago, the debate in Pakistan about economic growth centred on whether we are a security or a development state. That line of thought suggested that we may be spending too much on defence at the expense of the economy. The debate is redundant now. So much of government spending goes to paying interest on loans that all expenses, including defence, have taken a back seat. In fiscal 22, the federal government spent almost 85 per cent of its net receipts on interest. Most other expenses are met from borrowing.

Our troubles are not for want of capital. They result from unimaginative policies. Post 9/11, the country was awash in foreign exchange. By 2008, we had spent it all and were back with the IMF with a sudden 40 per cent devaluation. There was nothing to show for the money spent.

Much of the debt went into meeting imports and debt servicing needs. Two-thirds of our external debt has been spent on the budget and BoP, and only one-third on development. Apart from CPEC investment, the debt amount was not invested. Even the CPEC projects selected by Pakistan have not so far increased our ability to repay. There was no ‘game changer’.

Economic partners no longer take us at our word. In over a year, endless discussions with the IMF have borne little fruit. All commitments to the IMF are now ‘prior action’ because we have lost their trust. Even traditional partners, China and Saudi Arabia, are reluctant to help. They know that this patient is addicted to life support.

The key question that needs to be asked by economic planners is where we want the economy to go from here. What kind of an economy Pakistan aims to have in five, ten or even fifty years. Specious talk about wanting to be a knowledge economy or a producer of high-tech goods does not cut it if we do not put in the needed hard work and investment into these ideas.

Political capacity too is fragile. With elections in a few months and the people dizzied by prices and taxes, the back and forth in the commitments made to the IMF shows the government’s quandary. This is the cumulative effect of the inability of successive governments to offer a serious vision for the economy. Expediency and special interests are no substitute for strategy.

It is time to get serious. Bluster can no longer work as policy, nor as negotiating strategy. We must have a plan not just to exit the present crisis, but also to put the economy on a surer footing for the future. While taking the difficult measures to restore the IMF programme, the government must look at the future. The restored IMF programme will only see us through another year or two. And it will further increase our debt. What happens next?

We may like to weigh the pros and cons of seeking external debt relief. Both the IMF and G20 have established mechanisms for doing so. Decision-makers must decide on which is best. I do not recommend debt rescheduling, as that merely postpones servicing while increasing liability.

The money saved must go to paying back the remaining debt at a faster rate and investing to increase the productivity of the private sector. Gradually, new debt should be for projects only, such that the economy essentially needs for growth and exports.

We have not seen prolonged periods of growth. The economy will not grow by targeting just a few firms or sectors. Overall demand must increase. For that, the income and purchasing power of the majority of our people must increase.

Even within the present constraints, we must find ways to increase private investment. They do not have to be in large industries alone. Entrepreneurship at all levels must grow, especially small and micro industries. The latter’s need for capital, technology or energy is not high and suits the economy’s present circumstances.

Small firms bring a lot of value. They are presently operating in an unhelpful governance climate. To facilitate their growth, they must have government support. An economy prospers when consumption and production increase. With proper help these small firms will boost production and increase purchasing power. They could sow the seeds of future large firms. Increasing income at the micro level would help growth in demand for the large industries.

The government’s incentives for investment are skewed. Incentives must go to encourage manufacturing, especially for exports, imports substitution and to sectors where the private sector reinvests its profits. Incentives for private power or auto production come at a very high cost to the economy, are import dependent and have not created many backward linkages to stimulate upstream manufacturing. There has been no fixed rate project financing available in Pakistan since the nineties after the closing of DFIs. Pakistan must have DFIs for private project finance.

The government must also review public expenditure. In FY22, the federal government’s second highest expense after interest was Rs2.8 trillion spent on subsidies and grants. This amount is twice that of defence. Much of the subsidy went to private power producers as tariff differential. PSEs also received large sums to meet their losses. Improved policy and governance in the power sector and PSEs would reduce the budget deficit. Thus, the government will incur less debt. While subsidy expenditure has climbed to 2.3 per cent of GDP, public investment has fallen.

Public investment too is an enabler of private investment as it provides the public goods, physical infrastructure and better human resources to raise private sector productivity. Investment in PSDP should focus on water, logistics, power transmission, technical skills development and R&D.

It is crucial for Pakistan to understand that our goal is not just to survive the present crisis, but to stay out of trouble forever – and for the economy to grow.

The writer is chair and CEO Institute for Policy Reforms. He was federal commerce minister in 2002-2007.