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May 29, 2019

Economic policy: where they went wrong

Opinion

May 29, 2019

This fiscal year, July 2018 to June 2019, is proving to be the worst for our economy in decades. A year that filled many young Pakistanis with hope due to the start of the PTI’s government, has turned into an ‘annus horribilis’, a betrayal of hope, with inflation, devaluation, debts and deficits. How did we manage to so quickly turn our economic fortunes downwards and spread so much despair?

When the PTI came to power, the economy was humming along fine, except for an increasing current account deficit that had to be controlled in the next two to three years. I think the current government made four major mistakes in its handling of the economy, which led to a reduction in our national income, expressed in dollars, by ten percent.

First was the unnecessary and myopic disparagement of the Pakistani economy and destruction of consumer and investor sentiments. From prime minister to ministers it was routine to say that Pakistan was near default or bankruptcy, that government finances were in tatters and that all our people – except the angels in the ruling party – were corrupt, that all institutions were useless and venal, and that but for the arrival of our saviour Imran Khan himself, we were doomed.

This predictably killed consumer and business confidence and we saw a decline in (local and foreign) investment and commercial lending to the government. From a GDP growth of 5.8 percent we nose dived to a growth rate of perhaps 3 percent. New investment and new jobs opportunities came to a halt.

Consumer confidence in the economy is a leading economic indicator and to destroy consumer confidence just to denigrate the previous PML-N government is really the cardinal sin of this government. But a combination of immaturity and contempt for political opposition meant that the PTI didn’t think about the harm it was doing to the Pakistani economy just to badmouth the PML-N.

The next mistake was the decision to not enter into a programme with the IMF early on, and try and opt for a home-grown solution. This neem-hakeem remedy led to Pakistan rapidly increasing power and gas tariffs, raising interest rates and drastically devaluing the currency. However, because the government had already scared off business investments in Pakistan, and due to the raising of utility tariffs, industrial activity declined perceptibly during the year. This made not just tax collection but import substitution difficult too, therefore not allowing the government to substantially reduce imports in spite of the heavy devaluation. And because 40 percent of Pakistani exports are outside the five protected sectors, and their input prices had increased considerably, exports didn’t go up at all. The result is that we still have a relatively high current account deficit but we have doubled the inflation and cut growth to less than half.

How useful the current government’s economic strategy was can be seen from the fact that, while our economy has decreased from $313 billion to $280 billion, our imports have only fallen from around $5 to $4.6 billion per month, meaning that our imports have actually grown from 19.2 percent to 19.6 percent of GDP! Even our current account deficit has only improved by about one percent of GDP. The people of Pakistan can legitimately ask the PTI what sort of economic policy it is pursuing, in which to reduce current account deficit by one percent it reduces Pakistanis’ income by ten percent.

What’s worse is that while we pursued this confused economic policy, we exhausted the goodwill (and dollar deposits) of our friends, particularly China, so that by the time we went to the IMF we really had no option left than to agree to what seem to be the most harsh and contractionary demands.

The third mistake is the huge budget deficit the government is running this year. The PTI’s economic team perhaps believed its own rhetoric, thinking that running the government was easy and that there was a pot of gold placed somewhere that was easy to obtain. That you can run governments by selling used cars and buffaloes and collecting donations. But making speeches atop a container are easier than actually governing a country. Once you start running the government you realise that there are many legitimate demands on the government’s funds – and resources are few. Running the country is a balancing act. The ruling party neither understood the need for this balancing act nor was prepared for it. Hence this year we are going to run a record budget deficit of 7.5 percent of GDP.

A budget surplus – the government taking in more revenue than it is spending – means that the government is saving money. (For the record, Pakistan’s first budget had a small surplus. Prime Minister Liaquat Ali Khan didn’t use colonial misgovernance as an excuse to run a deficit.) Conversely, a deficit means that the government is dis-saving or borrowing. If the government is borrowing then someone has to lend this money to it. This could come from private savings, but since private savings in Pakistan are already less than private investments, the private sector in Pakistan is also a net browser.

Thus government borrowing (along with private net borrowings) has to come from foreign sources. And that happens when foreigners supply (on credit) more goods to Pakistan than we supply to them. (Since the government has to borrow in dollars to pay for our net imports, this means that all net imports are foreigners lending money to us). This therefore means that budget and trade deficits are linked, and indeed trade deficit will increase in response to the government’s budget deficit. For the government to try to limit the trade deficit and at the same time run the largest budget deficit made no economic sense – the two policies are contradictory. No government can logically claim to reduce current account deficit by running a large budget deficit.

A budget deficit this year of 7.5 percent of GDP (last year’s PML-N deficit was 6.6 percent and for three prior years less than six percent each) means that not much improvement can be had on the trade deficit front. So all this devaluation and raise in interest rates is going to be in vain. And this third mistake almost single-handedly made sure that the PTI’s economic plan would fail.

Now we come to the fourth mistake. This mistake can perhaps be reversed but not without cost. This is the monetisation of debt, or printing of money. The more money the government prints, the less the value of the income you receive. This is a direct way of bringing in inflation and making people poorer. After years of lectures about how competent its team is, and how its leaders have the mettle to make the right decisions under pressure, for the PTI government to print money really is a negation of any compact they had with the people or any sense of fiduciary duty they had towards Pakistan.

With all these strategic mistakes under our belt, we are about to embark on a new round of belt tightening. Let’s hope the next fiscal year is better than the current one.

The writer has served as federal minister for finance, revenue and economic affairs.

Twitter: @MiftahIsmail

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