Fiscal and monetary interdependance


As a rule, monetary policy must be complemented by a prudent fiscal policy. If the interest rate regime and money supply are left to control inflation and monetary expansion, they lose significance over time, as is presently the case in Pakistan. Not only is the fiscal side not taking basic steps to improve revenue generation, it has also failed to cut costs and check unnecessary leakages. The government’s fiscal space continues to be strained by billions lost through inefficient public sector enterprises and an improper subsidy structure.
Until the government completes the process of identifying those most in need of subsidies, and then initiating a program of carefully targetted subsidies, its burden will not lessen. It must also ensure rapid turnaround and strategic privatisation of all loss making public sector entities. The burden of sustaining these trends is simply too large for the national exchequer. Similarly, tax reforms must focus on netting groups with the ability to pay, ultimately freeing more fiscal elbow room for the government to maneuver, with multiple spill-over benefits.
On the one hand, greater fiscal strength frees the government from borrowing, leaving monetary policy to stimulate private sector investment. Being more efficient, the private sector invariably leads in job creation and ultimate overall growth. On the other hand, the government subsequently has increased funds to allocate to public sector development, with its own impact on eventual GDP growth. At the end of the day, the main focus should be on achieving equitable and sustainable growth.
In order to posture towards a long-term growth trajectory, and keep feeding the ever expanding job market of approximately six million annually, Pakistan needs a growth rate of 8-10 per cent over 15-20 years. For this, the starting point must be a prudent revamping of the fiscal policy as the monetary sector paves the way for increased private sector participation.
Unfortunately, in the absence of a realistic fiscal policy, the monetary sector has been left to shoulder the burden on its own, consistently losing in relevance. Now, numbers show currency in circulation has risen over the last 12 to 13 years, a trend contrary to regional economies like India, Bangladesh and Korea, all of whom have recorded reductions in currency in circulation. Also, there is disintermediation in the banking sector. Pakistan’s banking-GDP ratio has shrunk from 35 per cent in ’99 to 32 per cent now. In the same time-frame, the same ratio for India and Bangladesh increased from 38-65pc and 25-51pc respectively.
Whenever fiscal policy is divorced from monetary policy, crucial economic indicators are skewed. Relevant authorities must restore balance between the two policy arms. That is why the monetary board has representation from the federal government, so both policies can move in tandem. The way things currently stand, the fiscal side must urgently reorient crucial revenue generation avenues so it is in a position to effectively complement monetary policy. Already, the exercise of toggling the interest rate regime to first control inflation and then engineer private sector investment has been pretty much wasted due to the government’s compromised fiscal outlook. Again, the aim must be equitable and sustainable long term growth. For that, the private sector must be facilitated. When it expands, and foreign investment is also attracted, unemployment will ease, consumerism will be triggered and an eventual fillip will be provided to the growth curve.

The writer is a former finance minister