In 2000 Goldman Sachs published a report identifying Brazil, Russia, India and China (BRICs) as countries that will dominate world Economy in the future. In 2006, Goldman Sachs added eleven more countries to this list calling them the “Next Eleven”. Pakistan was one of these countries. Goldman Sachs had reached this conclusion based on the performance of Pakistan’s economy at that time. The per capita income had doubled. GDP was growing at an average rate of 7% per year and large scale manufacturing at 12%. The tax revenues had tripled. The KSE index had risen to 15,400 with a capitalization of $66 billion. Exports had more than doubled and the PSDP had increased five fold. State Bank reserves had reached $16.4 billion and the debt to GDP ratio had reduced to 55%. The Rupee had been stable for a number of years and poverty had shrunk to 24%. Pakistani Bonds were being sought after in international markets, fetching many times more than the targeted amounts.
What went wrong then? The security situation, the international economic crisis, the caretakers and the new government all contributed. Towards the end of 2007, the international commodity prices started moving up rapidly. This affected prices of food commodities and oil. These increases in prices were not passed to the consumers by the caretaker regime nor by the new government. Massive slippages started taking place. The fiscal deficit shot up to over 7% from 4.3% of GDP, primarily due to un-sustainable level of energy related subsidies and sharp decline in external financing flows. As a result, the current account deficit shot up to over 8% of GDP from 5.3%. Inflation peaked in August 2008 at 25.3% with food inflation at an even higher level of 34%. Fiscal gaps were filled by heavy State Bank borrowing by the government. By the end of fiscal 2008 the Federal Government had borrowed a whopping Rs.688.7 billion from the State Bank of which only Rs.23 billion had been borrowed till the time the previous government left. Even after the announcement of budget in June 2008 the Federal Government continued to borrow from State Bank and reached a level of Rs.379 billion from July till November 2008. The reserves started falling rapidly, debt started increasing, growth tumbled and foreign investment virtually disappeared. The investors confidence, both domestic and foreign, reached an all times low. There was rise in dollarization and an outflow of deposits from the banking system. A bewildered government looked every where for help but found even our friends shying away. Amazingly, as a great achievement, with a lot of fanfare and trumpeting it was announced that we have landed squarely in the lap of IMF, the lender of last resort.
What did the IMF do? It forced us to increase interest rates, slash public sector development, increase taxes, increase gas and power tariffs and increase petroleum prices. The result was that the rupee depreciated, the power, gas and petroleum rates doubled as did the commodity prices. While the IMF forced us to increase interest rates in the country to bring the inflation down, which brought manufacturing sector to a grinding halt, everything else they asked us to do fuelled inflation. After coming down initially, every inflation indicator has shown an upward movement in recent months. We got a raw deal from the IMF; expensive and fraught with tough conditionalities. The IMF treated the crisis stricken countries of Eastern Europe more favorably. Just look at their latest deal with Greece, a country much worse economically than Pakistan.
While the world was reducing interest rates, massively injecting capital into banks encouraging them to lend, pumping huge sums of money into public sector and giving major tax breaks to restore their economies, we were doing just the opposite. We were increasing interest rates, cutting our public sector development by hundreds of billions of rupees and sweeping the credit in commercial banks for government and public sector companies’ use, thus totally drying-up credit for the private sector. The economic policy of this government, if there is one, fuelled inflation, suppressed growth and increased unemployment and poverty. We have seen economic models where inflation may be tolerated for some time if it is accompanied by high growth. But history is being made in Pakistan where inflation is high and resisting to come down and growth is virtually zero. Do we expect our people to fight inflation without jobs? In addition to destroying the private sector through excessively high interest rates and power outages, the only other “fiscal tool” that the federal government uses is to cut PSDP by hundreds of billions of rupees, thereby killing another source of jobs creation.
Government borrowing is at an all times high. This includes borrowing from the commercial banks as well as the State bank. By the time the government, the public sector enterprises and the RPPs are finished with the banks, there is virtually nothing left for the private sector. Pakistan incurred debt of Rs.1.3 trillion in 5 years from 2002 to 2007. Last year, in just one year, the government incurred new debt amounting to Rs.1.6 trillion.
We love to talk about exogenous shocks as if ours was the only country which faced them. Let us look at some countries in our region. Despite the exogenous shocks, China is growing at 9.5%, India at 7.5% and Bangladesh at 5.9%. Compared to the countries in our region, we have the lowest GDP growth rate, highest inflation, highest currency depreciation, highest interest rates, highest poverty, highest unemployment and the largest decline in output. From close to becoming an Asian Tiger just a few years back, we are at the bottom in our region.
We must get out of the IMF strait jacket and rely on ourself. The 23 months stand-by arrangement is coming to an end later this year. Lets thank them profoundly and move on ourselves. We need economic stability and growth. A balance needs to be struck between fiscal consolidation and revival of growth. Inflation must be brought down. Higher domestic food prices have been primarily responsible for sustaining high inflation. Cumulative increases in the prices of some essential food items have been over 100 percent. Adequate buffer stocks should be maintained to avoid food shortages. Freeze the support price of wheat. A ten percent increase in wheat support price increases overall inflation by three percent. Wheat prices have increased by 124 percent since 2007. The resulting atta price jumped from Rs.13 per kg to Rs.30. The price of wheat affects the prices of other food items too.
Improve the Tax to GDP Ratio. Tax the untaxed sectors like services and agriculture. Impose capital gains tax. All the stock market and real estate tycoons in this country and still untaxed. There is not much difference between VAT and Sales tax except for more documentation and more refunds. Pakistan has had Sales Tax regime since the early nineties. The main challenges were documentation and refunds. So how would imposition of VAT make it any different? We need a consumption tax, primarily because we let the privileged sectors of the economy go tax free. Impose VAT but introduce a lower rate of 12.5% and make the implementation gradual.
Cut non-productive expenditure by one third rather than cutting development expenditure. Development expenditure creates jobs. Don’t rely solely on imports contraction to improve the current account. Increase exports too, at least to cover oil, food and machinery imports. Encourage manufacturing for job creation. Give them electricity and credit. Government and Public Sector borrowing from banks must reduce. Monetary expansion should not be higher than GDP growth. Rupee must be kept stable.
With respect to social safety nets, rely less on cash transfers and more on skills development. Expand the scope of Bait-ul-Maal programs. Focus on Employment Guarantee, Universal Health and Unemployment Insurance programs for the poor.
Can we not do these things ourselves? This is Economics 101. We don’t need a headmaster in the shape of IMF to rap our knuckles to do that. Friends of Pakistan should help us though. After all we are taking the brunt of the war on terror, economically and in terms of massive civilian and military casualties.
The writer is the Secretary General of Pakistan Muslim League and a former Federal Minister.