Article: Why is the foreign exchange crisis a surprise?
The balance of payments crisis has been a regular feature of our economy. What we need to see is why it keeps happening. While, at present, the government has the unenviable task of ensuring that we stay afloat, it rightly also has looked at the root causes of the crisis. The balance of payments pressure is the result of our economic policy and priorities. One reason is our endemic reliance on external finance. Not only has external debt grown, what has caused the problem to worsen is recent increased reliance on high-cost external debt. Such debt was incurred knowing that the economy does not earn enough foreign currency to service them. Our debt servicing needs grew along with a decline in exports and higher imports. The crisis was inevitable. For a few weeks after the new government took over, there was concern about meeting our external obligations. This has been partly resolved with Saudi help and will be resolved further through continuing negotiations with China, the UAE, and the IMF. This should help us not only meet repayment obligations, but also help us address serious issues of tenure and cost of debt. Later, there are real questions that decision-makers must contend with. For one, how long before we are faced by another balance of payments emergency? Also, why is a foreign exchange crisis always around the corner in Pakistan? To answer these, we may analyse why the economy is always close to default. There are both immediate and long-term reasons. The particular reason this time was that for four years, the government held the rupee value at about Rs105 to USD1. This dampened international demand for exports and made imports cheaper, increasing the trade gap. In the event, the drawdown of reserves, themselves built on external credit, was the cost of maintaining a high rupee value. Adding to these woes, the US has also stopped Coalition Support Fund transfers to Pakistan. This crisis also brings forth the enduring reasons for Pakistan’s economic malaise. It shows that high economic growth is not possible within the economy’s present framework. Translated, this means that our macro fundamentals are not strong enough to support high or even moderate growth. For one, the economy does not save enough to increase investment without resorting to foreign savings. Within its present framework, the economy can avoid an external crisis only if it functions at a low equilibrium with modest levels of savings, investment, imports, and exports and low GDP growth. Though federal tax revenue grew by 71 percent between 2014 and 2018, total GoP revenue was still short of spending. In fact, for decades, the Pakistan government has not generated enough revenue to meet its needs. It, therefore, borrows to bridge the gap, from within and outside. While borrowing for financially viable projects generates returns that help repay loans, using external credit for purposes that do not directly stimulate the economy strains our ability to service the loans. The way to break out of this bind is to strengthen macro fundamentals and generate growth based on higher production and productivity. What makes this a challenge is that both macro indicators and increase in production are mutually related. At under 14 percent of GDP, our manufacturing sector is small. It also does not produce the goods that can compete with other emerging economies and so does not earn enough foreign exchange for the economy. Pakistani manufactured goods have one of the lowest knowledge contents in the world. So, they rely on government incentives or protection to export or to survive. Agriculture too has not done much better. There are many reasons for this, but one reason is the government’s lack of funds and its skewed priorities. Despite increase in recent years, the scale of public investment falls short of what is needed to build essential business-stimulating infrastructure, such as efficient transport services or power and water supply, as well as to develop the country’s human resource and knowledge base. So, where would growth come from? The economy is locked in a circular logic. Growth in production of goods is low because of weak fundamentals, which are weak because we do not invest and produce enough. Breaking the loop requires addressing the structure of the economy. Only an efficient economy with corrected priorities, progressive taxation, less subsidy, and well-thought-out protection will increase competitiveness. It is good to see that the new government is alive to these fundamental issues. The balance of payments crisis reflects these realities. It shows that, historically, governments have not raised enough funds in Pakistan. Nor has the economy been internationally competitive. Also, public investment has been small compared to needs, and what was spent was not prioritised or managed well. For decades, governments have carried the avoidable burden of loss-making PSEs and of a power sector that does not recover cost. Plus, so far, we have subsidised and protected inefficient industries. Furthermore, we have locked ourselves out of regional trade opportunities. These factors, along with security concerns, also have precluded large-scale growth of FDI. What should be done? To ward off the present crisis, the government is on the right track: immediately seeking grant and aid on easy terms to service debt. Already, the depreciation of the rupee has reduced growth of imports into the country. The next steps should be to increase revenue, especially in the provinces. This must be done even if it irks key constituencies. The government must also reduce avoidable expenditure. It must address PSE deficit and resolve the governance and policy issues that hobble the power sector. The key to this plan is that, along with placing the macros on better footing, it must begin a programme to expand and upgrade manufacturing in the country. All this must be done within the necessary constraints that an IMF programme would impose. The challenge is how. I am glad to see a solid plan evolving. I know its implementation will have to be done with uncompromising rigour even if there are difficult decisions to take. The choice before us is to either embark on this difficult journey or stay trapped in an endless loop of vulnerable external account and low growth. We must also revisit our security paradigm. Pakistan is militarily strong to withstand any outside pressure. Recent events have shown, however, that we may not be strong enough to cope with pressures from within. At home, we must have a no-nonsense approach. For example, the National Action Plan, which all political parties had signed on to, needs rigorous implementation. Externally, we must improve relations in the region and with global powers. The writer was commerce minister from 2002 till 2007. He is chair and CEO of the Institute for Policy Reforms.