Friday March 24, 2023

Economy: myths and failures (Part – II)

March 18, 2023

This is the second of this two-part series on the mistaken policies and false beliefs that have plagued our national economy and have been responsible for reducing us to periodical crises requiring constant donor interventions and a consequent rising mountain of debt.

Here, I will describe four further fundamental errors that have brought us to this pass and need correction if there is to be a way forward.

Following on from the first four, the fifth fundamental error has been: ‘The belief that Pakistan is not over borrowed since its debt-to-GDP ratio is lower than successful and mature economies; hence we can continue to borrow more’. This is false.

First, let me highlight that GDP used as a denominator in this calculation is grossly inflated in high inflation environments, and therefore can be a misleading denominator. Second, as regards foreign debt, the determination of whether a borrower is over-borrowed is by gauging whether he has sufficient foreign income to meet the debt service outflows. In reality, once we offset export revenue with imports there is no net revenue available to service any foreign debt service costs. In fact, since the 1960s, we have had no capacity to service foreign debt or FDI.

Another mistake which successive governments have made is to use qualifying expenditure albeit in rupees to seek disbursement of equivalent foreign currency multilateral loans. Serving such loans is yet another source of spiraling foreign debt. Thus, Pakistan is in a spiraling and compounding foreign debt trap.

The sixth erroneous belief has been: ‘Escalating inflation is the consequence of rising international prices of foreign imports and devaluing rupees, which we cannot control. This is both false and dangerous. This explanation has resulted in omitting to recognize the central bank – the State Bank of Pakistan – as the main culprit for runaway rupee devaluation and inflation. It has caused a spiraling growth in money supply by failing to curb the government’s penchant for running fiscal deficits. It has facilitated this habit by directly lending to the government and by leaving the barn door open for the government to borrow unabated from the banks. By lending, both banks and the central bank grow money supply. By not restricting government borrowing from banks and itself, the central bank is the key instigator of the money supply growth , inflation, and depreciation of the rupee.

If it had restricted the government and diverted its borrowing needs exclusively to individual savers and non-bank institutional savings institutions, it would not only have curbed the government’s binge on expenditure, but also would have mopped up the money supply generated by excess government expenditure. And we would not have witnessed the explosive increase in money supply channeled into savings in property and motor vehicles and avoided the rise in food, property and vehicles prices as capital would not have been diverted from lower margin business to property and durables investments.

This brings us to the seventh false practice: ‘The government’s approach is to budget expenditure first and then look at desperate measures to raise revenue’. This is a major failing and has led to a ballooning of the size of government and government expenditure. Let us face it: no government has had the courage to widen the income tax net to adequately include sacred cows like agriculture or small businesses and traders. Desperate measures are then taken to enhance revenue. Some of these fail and some go counter to enhancing economic activity.

The healthier approach like any family or business budget would be to realistically forecast its revenue, not assume any additional borrowing (which is anyway supporting consumption) and cut the size of government expenditure to fit within the forecasted inflow. This will reveal the drastic need to reduce the size of government and prioritize money to activities based on measuring the benefit derived from individual spends based on productivity measures.

Ambitious unaffordable government expenditure has made the government in its desperation an addict to maintaining and raising import duty revenues. In healthy governments, these would be temporary levies to protect nascent industry to be removed after a set number of years. Benefiting from our government’s addiction has removed the urgency for industries to increase scale and product quality to become internationally competitive exporters. Another anomaly that has resulted is that the effective exchange rate for importers is that which results from adding the import duty rate to the market exchange rate. Yet exporters by not earning this effective exchange on their repatriation are forced into uncompetitive pricing of exports.

Finally, we come to the eighth erroneous belief: ‘Curbing Pakistan’s burgeoning population is not a matter that concerns the government and would also be counter to the doctrines of Islam and will be resisted by the wider population” – This is false, intellectually lazy and irresponsible. Pakistan’s population is expected to reach 350 million in 25 years – an alarming prognosis that keeps me awake many nights. The small size of our economy, even with all the right strategies, cannot provide for our current population let alone the unchecked growth that lies ahead. Chaos, disenfranchised, homeless, hungry multitudes, burgeoning cities and mushrooming crime is the spectre I see ahead. I have devoted considerable time and effort studying other Muslim countries in trying to understand and address our inhibitions to avoid similar potential disasters. Without exception, their experience confirms that Islam mandates responsibility on parents to act responsibly in procreating.

Governments actively devote efforts to educate and implement family planning and co-opt and incentivize clergy in this effort; the country’s leaders take a central role in leading and monitoring progress in this effort. Most successful developing countries have worked tirelessly to overcome regressive religious and cultural beliefs and can boast population growth rates of less than 1.3 per cent per annum. Pakistan lacking this focus and priority is doomed to remain an unlivable country with large swathes of teeming poor notwithstanding our best endeavours on the other economic initiatives.

I keep hearing of the need for a Charter of Economy, which has not happened. Besides, the wider the agenda the greater the likelihood of divergent views leading to a stalemate. I have tried to distil the eight core principles that we lack by articulating the regressive assumptions currently in play and thereby suggest a more progressive way of setting core principles. Once these boundaries are adopted, they become the framework within which the leaders, businesses, and citizens should be left free to operate.

I have resisted the desire to add other important areas, such as agriculture, education, skill building etc. And I do believe my readers would have other highly beneficial initiatives to suggest. My point is only to get the beliefs, and therefore the boundary framework, right. The rest can then fall into place.


The writer is a senior international banker exposed to markets in the Middle East, Far East, Africa, and Europe. He was invited to Pakistan in 2020 to restructure, commercialize and successfully privatize UBL.