Wednesday July 17, 2024

Navigating these choppy waters

By Dr Muhammad Shahid
May 08, 2023

Historically, Pakistan has faced several economic crises, and the most recent economic challenges are not only disturbing but alarming as well.

At the moment, we face several economic issues including very high and volatile inflation, fiscal deficits, trade imbalances, substantial depreciation of the Pakistani rupee, unemployment, poverty, and income inequality besides the permanent threats of disasters and natural calamities.

The turbulent economic situation in the country is caused by both domestic and external factors. At the domestic front, political instability and the uncertain policy environment are damaging investment and affecting economic growth. Economic instability, frequent and significant fluctuations in economic indicators inflation, exchange rate depreciation, increase in unemployment rates, and surge in poverty incidence are largely exacerbated by the current waves of political uncertainty. Furthermore, devastating floods in the current fiscal year, higher global commodity and grain prices, and slowdown in global growth have also hit our economy hard.

Ignoring the fact that the current political unrest is a major obstacle to economic growth and stability comes with a severe cost. The uncertain policy environment due to political unrest is creating a negative perception of our country among investors, leading to a decline in foreign investment. Without addressing political uncertainty, we cannot stop the significant negative impacts on foreign investment, inflation, unemployment, poverty and economic growth. Therefore, it is essential for policymakers and people in the power corridors to address the underlying causes of political unrest and promote political stability to ensure long-term economic development and prosperity in the country.

The waves of high and volatile inflation have badly affected everyone in the country by reducing their purchasing power. They have also negatively damaged investors’ sentiments, businesses and undermined economic stability. Theoretically speaking, the State Bank of Pakistan can, by raising interest rates, reduce inflation expectations and promote price stability, which can help restore confidence and support long-term growth.

In this context, the SBP has made several upward adjustments in the interest rate to tackle inflation but so far its demand management policy has proved ineffective. One of the reasons for the ineffectiveness of monetary policy is the supply side dynamics of inflation. The disrupted global supply chains, causing shortages of raw materials, intermediate goods, and finished products led to higher prices for goods and services.

Focus on supply-side policies is crucial. Without addressing the supply side, any surge in policy rates would kill our growth by discouraging borrowing and investment. Therefore, reducing inflation requires a combination of monetary, fiscal, and supply-side policies, tailored to our specific domestic economic circumstances.

Governments can implement supply-side policies to increase the supply of goods and services, which can help reduce prices and inflation. This can include measures to increase productivity, reduce regulations, and encourage investment. It is important for policymakers and the SBP to strike a balance between controlling inflation and promoting economic growth and stability.

Another serious issue is the persistent imbalances at the external front. The continuous trade deficit is a huge drag on our foreign exchange reserves, causing a substantial depreciation in Pakistani currency while adding further to our economic woes. Pakistan is a net importer of raw materials used in the domestic manufacturing sector. A weaker Pakistani currency increases the cost of imported goods and raw materials, leading to higher inflation and making it more expensive for businesses to operate in the country. Furthermore, consumer and business confidence in the country has declined due to the falling rupee as investors seek to move their money to other countries with stronger currencies.

The growing uncertainty and reduced confidence in the domestic economy are causing delays in spending and investment decisions. The tighter monetary policy stance of the SBP to control inflation, arrest the depreciation, stabilize the currency and attract foreign investment is making borrowing more expensive for businesses and consumers, which can also hamper economic growth. There is another negative aspect of the exchange rate depreciation. Pakistan is indebted in foreign denominated currency and any depreciation of the rupee is making debt servicing more expensive.

Another pressing economic problem is the presence of a fiscal deficit. The fiscal monitor report of the IMF has revealed that Pakistan will miss the fiscal and debt reduction targets of this fiscal year. The report further indicated that the situation will become worse in the next fiscal year with a budget deficit peaking at 8.3 per cent of GDP. Therefore, serious efforts are needed to have fiscal consolidation to bring the public debt level down to a sustainable level. This is crucial and this approach requires a coordinated effort at all levels of government.

Our governments can decrease spending by reducing non-essential expenditures, cutting wasteful programmes, and improving the efficiency of government operations. This requires a careful balancing act to avoid cutting programmes that are essential for social welfare and economic growth. Governments can also increase revenue by raising taxes, implementing new taxes, or improving tax collection. Tax increases should be targeted towards those who can afford it the most. Careful considerations are needed to impose taxes in a way that minimizes negative impacts on economic growth.

Economic growth can also help reduce fiscal deficits by increasing government revenue through higher taxes on income, profits, and sales. In this connection, pro-growth policies are required that encourage investment, innovation, and entrepreneurship to stimulate economic growth and reduce fiscal deficits over the long term. Furthermore, effective public debt management policies are needed to overcome our severe debt crisis. Governments can manage public debt by refinancing existing debt at lower interest rates, extending maturities, and reducing the cost of borrowing. This requires a careful balancing act between managing debt and avoiding excessive borrowing that could lead to higher interest rates and fiscal instability. Adherence to the fiscal responsibility and debt limitation act is also necessary.

We know that navigating such choppy waters can be a challenging and complex task for the government, but there are some steps that can be taken to bring the economy back on track. This can be done with a combination of short-term policies to address immediate concerns and longer-term structural reforms to promote sustained economic growth and stability. In many cases, economic crises are caused by structural weaknesses or imbalances in the economy.

Addressing these underlying issues often requires comprehensive reforms. This can include policies to control inflation, generate employment opportunities, reduce income inequality, promote trade balance, fiscal discipline, implement exchange rate stability, and measures to build resilience against external shocks. Furthermore, addressing the current political instability and the uncertain policy environment in the country will help arrest its wide ranging negative impacts.

The writer has a PhD Degree in Economics from PIDE and has 17 years of experience as a journalist in economic reporting.