‘Pakistan on the brink of massive economic crisis’

Source: http://www.dailytimes.com.pk/default.asp?page=2008%5C07%5C22%5Cstory_22-7-2008_pg7_13

* Dr Meekal review says SBP missed opportunity to act early

By Khalid Hasan

WASHINGTON: The Pakistani economy today faces the looming risk of a full-fledged balance of payments crisis, domestic and external fiscal imbalances that have reached alarming proportions and show no signs of self-correction or correction through policy action, according to an economic expert.

Dr Meekal Aziz Ahmed, who served senior advisor to the IMF executive director dealing with the region and as senior economist with the Pakistan Planning Commission, writes in a brief review of Pakistan’s economic plight that inflation has accelerated to levels never seen before in the country’s history and it is set to rise further, devastating the fixed income groups and the poor. There has been “criminal negligence” behind the power crisis, which has led to untold losses in domestic production and exports. Added to these disasters the country has a food crisis, an oil crisis, an emerging water crisis, not to mention a political crisis. There is agreement among economists, he notes, that Pakistan’s short-term prospects are grim. With economic policies likely to remain broadly unchanged, the economy will continue to slide downward until the country runs out of its foreign exchange reserves. At the point of reserve exhaustion, Pakistan will not be able to pay for its imports or meet its debt service obligations. The country, in short, will be bankrupt, Dr Ahmed predicts.

Dr Ahmed points out that Pakisan’s present predicament did not happen overnight, but is the direct consequence of the government’s “short-sighted and misguided policies” in the recent past, characterised by its single-minded obsession with producing high growth GDP rates, without consideration to the quality or sources of growth which have a crucial bearing on sustainability. Such an economic strategy, largely consumption driven and fueled by cheap credit, rather than being driven by the more desirable route of investment and exports, was, sooner or later, bound to run into resource constraints. Eventually demand would outstrip available capacity, macroeconomic imbalances would widen and inflation will start to turn upwards. The view that today’s economic problems are the lagged consequence of past policies is neither conspiratorial nor does it amount to playing the blame game. There have been long lags between policy actions and policy outcomes and what the Pakistani economy is witnessing today are the lagged consequences of policy actions taken earlier. “The chickens have come home to roost,” he adds.

Dr Ahmed writes that the State Bank’s recent actions to tighten monetary policy reflect a failure to gauge the strength of the inflationary pressures building up and the failure to act in time. Given the long lags in the monetary policy transmission mechanism, the monetary policy should have been tightened much earlier. The State Bank missed the opportunity to act early and responsibly and its belated actions are a classic illustration of “too little, too late”. Dr Ahmed says he is dispirited by what appears to be the State Bank forfeiting its hard-won autonomy. Despite possessing considerable statutory powers, the State Bank seemed to have waited for a nod of approval from government, rather than act in accordance with its mandate and tighten monetary policy immediately. Inflation, many observers believe, is now out-of control, which is troubling because Pakistan has little experience with high inflation and policy-makers may not know how to control it.

According to Dr Ahmed, the new government missed an excellent opportunity to demonstrate that it was taking charge of the rapidly worsening economic situation by failing to devise a bold fiscal strategy aimed at reducing aggregate demand pressures and starting the process of restoring macroeconomic stability. This could have been achieved through the implementation of a sound 2008-09 budget. A tight fiscal stance, desirable in its own right from a macroeconomic standpoint, would have reinforced the tight monetary policy stance. The “awam dost” budget that followed showed that the government was no aware of the crisis towards which the country was hurtling. The budget was a major disappointment, being loose, abounding in exemptions and concessions and amnesty schemes, despite bitter experience from the past.

The poorly thought out plans to “help” the poor are likely to be ill-targeted, costly, and only make matters worse. The tax revenue target is fanciful and completely out of line with what the Federal Board of Revenue (FBR) has been able to achieve in the past six decades. To add to that, the budget expenditures are seriously understated. All this boils down to a fiscal deficit outcome that is likely to be significantly higher than budget projections. Demand pressures will grow, and spill over into the external sector via enhanced imports, the last thing the economy needs. With limited autonomous or induced financing, there is not much left to sell by way of privatization.

Dr Ahmed predicts that the speculative stock market and real estate “bubbles will pop,” creating havoc in the financial sector and wiping out the lifetime savings of small investors. According to some economists, the economy could fall apart as early as December this year or March 2009 by the latest, even with the respite offered by the recent Saudi oil facility. What the economy needs is an immediate and drastic tightening of macroeconomic policies, to be achieved principally through deep and durable expenditure cuts. These cuts have to be real and not cosmetic. They can be implemented quickly. Similarly, quick-yielding revenue measures could also be considered. Pakistan needs to halt adverse trends and start the process of reversing them. Valuable time has already been lost, confidence is being rapidly eroded as reflected in the recent fall of the domestic currency and the stock market, which are symptoms of accelerated capital flight. The government will become unpopular because of the belt-tightening, but there are no other options. Getting inflation under control and back into low single digits will not be easy, he warns. There is no “soft option,” Dr Ahmed adds, no easy way out. He rejects the idea of donor conferences as being unrealistic. Any aid given will be conditional and attached to a programme, which is consistent, coherent and doable, with assured implementation. He suggests that Pakistan should give the IMF a programme which is strong and credible, with appropriate conditionality, and ask the IMF and donors to finance it.