Macro economic stability is a pre-requisite to growth without which countries that seek to maintain sustained levels of economic growth inevitably struggle. It needs to be understood that fluctuations in the price level, exchange rate, interest rate or increasing tax burden on the consumers, go on to serve as a major deterrent to investment that is the fundamental driver for growth.
However, one thing that has emerged in this fast globalising world is that high inflation is incredibly damaging to investment and growth in a country’s economy. The dilemma that is then faced by the economic managers is the fact that bringing inflation down is both costly and eventually leads to lost output and employment. Therefore, what economic managers need to sit down and decide upon is how high is dangerous? It is pertinent to mention that inflation, more often, than not accompanies economic growth. Some countries across the world including Pakistan, from the early 2000’s till 2008 achieved sustained levels of economic growth however; growth was accompanied by persistent inflation. Historically, several countries across the globe have witnessed sustained levels of growth that have been accompanied by inflation of 15-30 per cent. However, given the changing global scenarios where countries are targeting to cut down on the inflation threshold both in the US, Europe and emerging economies, this threshold seems rather excessive. What though, has been unanimously agreed upon is the fact that inflation should be maintained in single digits. However, there still remains some ambiguity over the benefits of bringing inflation down to very low levels.
What has been unanimously agreed upon by financial managers across the globe is that it is best to allow the central banks to fight inflation by giving them a certain level of autonomy and insulation from the short sighted and immature behaviour of politicians who may want the central bank to relax its grip on inflation especially, before an electoral campaign in order to gain access to funds and bankroll their extravagant spending plans. Unfortunately, in the curious case of Pakistan’s economy while the interest rates have been cut down by the State Bank of Pakistan, and the inflation index revised politicians and the authorities continue with their borrowing binge that is severely harming the central banks’ attempts to rein in inflation. This is mainly due to the fact that despite remaining in power for the last four years the government has not made sincere efforts to widen the tax base to generate revenues. Furthermore, they have allowed the circular debt to balloon that has contributed to deteriorating the fiscal deficit of the country. Agreed, that the circular debt has been carried forward from the previous government however, this particular plague could have been dealt with had timely action been taken and funds been provided for to resolve this particular issue.
With a revised inflation index, the government has now received a greater cushion to continue unprecedented borrowings from the State Bank of Pakistan. In the last 60 years of Pakistan’s existence, the combined total public debt was Rs4.8 trillion and with the advent of the current PPP government this public debt in only a time span of four years has expanded to more than Rs10.5 trillion, growing by a gargantuan Rs5.7 trillion in the last four years. One is then compelled to wonder, if so much money was printed what has been the direct impact for that on the economy. Borrowing can be justified when it is being utilised to finance productive developmental projects, but when the same borrowing is used to finance unproductive projects, it leads to a catastrophe. That is exactly what has been happening in the case of Pakistan. A simple, economic phenomenon is known as the quantity theory of money that argues in very simple terms that the supply of money has a direct and proportional relationship with the price level. In simpler terms, when you increase the money supply in an economy, inflation rises.
Given this simplistic argument we can access the damage that has been caused by unprecedented borrowings by the government from the State Bank of Pakistan. While on the one hand a contractionary monetary policy has been employed by keeping interest rates high to rein in inflationary pressure, on the other the government has been borrowing vulgar amounts of money from the central bank. This situation is quite a paradox since it signifies that the contractionary monetary policy is effectively rendered redundant due to short sighted policies of the powers that be. Furthermore, the recent rate cut denotes that now, since the government has plans to borrow even more money from the central bank of the country, their borrowing costs will decrease significantly that will give them a cushion for borrowing. Yes, a rate cut has its positives as well, it helps boost business activity and increases liquidity in the market however this paradoxical situation simply sheds light on the government’s sincerity to address serious concerns.
In order to achieve high levels of economic growth, there must be a focus on increasing the market share of exports in the global economy along with a rapid integration with world economies. This process is heavily dependant on exchange rates, interest rates, and inflation. Therefore, the decision of the central banks in all three core areas mentioned above, bear significance on the effective implementation of growth strategies. A balance is required in this regard so that both the needs of autonomy of the central bank and the need for coherence are not compromised.
While government borrowing can be justified in cases where it is spent correctly on development projects, the fundamental aspect that needs to be taken into account is the fact that debt isn’t always bad if debt to GDP ratio is being maintained. However in the absence of real GDP growth in Pakistan, the growing public debt is a cancer that can debilitate the very foundations of our economy. In the case of rapid GDP growth, governments can afford big deficits by maintaining debt to GDP ratios. Furthermore, there is a need for the government to also relieve infrastructure bottlenecks to facilitate economic growth. In the absence of this, growth may falter.
While government borrowing can be justified in cases where it is spent correctly on development projects, the fundamental aspect that needs to be taken into account is the fact that debt isn’t always bad if debt to GDP ratio is being maintained. However in the absence of real GDP growth in Pakistan, the growing public debt is a cancer that can debilitate the very foundations of our economy. In the case of rapid GDP growth, governments can afford big deficits by maintaining debt to GDP ratios. Furthermore, there is a need for the government to also relieve infrastructure bottlenecks to facilitate economic growth. In the absence of this, growth may falter.
Very educated observation.
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