It is no hidden fact that the current state of the Pakistani economy is deplorable. The issue at hand, however, is how the new government will deal with the challenges of an economy that is almost on the brink of collapse and global default. Keeping in view the current political climate in the country, it is more than probable that the new parliament formed after the 2013 elections, will be a hung parliament, with no solid majority achieved by any single political party. Therefore, unpopular decisions regarding the economy will not be taken, even though such unpopular decisions will be the need of the hour.
Just to give an overview of things, it would be pertinent here to discuss what sort of economy will the new government, formed in the latter half of 2013, inherit. Currently, the government is running a fiscal budget deficit that is a whopping 8.5% of GDP, with foreign exchange reserves hovering around US $8.5 billion. The GDP itself has been growing at around 3-3.5%, just a few percentage points above the population growth rate. Therefore per capita GDP, in effect, has not increased. Thus poverty and unemployment have soared in the past few years. The central bank has been following a loose monetary policy since the past year, with consecutive and significant decreases in the discount rate in the hope of reducing the domestic debt levels of the government. The most dreadful aspect is that of the external debt level and its comparison with the depleting foreign exchange reserves of the country. With only US $8.5 billion in reserves, the country is anticipating a balance of payment deficit of around US $3.5 billion, and is expected to pay-off an installment worth US $ 3.7 billion of the IMF loan by the end of 2013.
Since unpopular decisions will not be taken due to a hung parliament, it would be safe to assume here that the fiscal deficit of the government will remain at dangerously high levels. If the State Bank decides to increase the discount rate in the hope of controlling the high amount of capital outflows currently taking place, the already sky-high level of domestic debt will balloon further. Even though this tightening of the monetary policy will be required to control capital flight and inflation, it would be detrimental for the government’s fiscal situation. However, such a decision could be taken by the State Bank if it acts as an independent entity, separate from the government, rather than as an extended arm of the Ministry of Finance (as it has been in the last five years). If the tightening of monetary policy is not implemented, capital outflows from the country will continue, putting further pressure on the already depleting value of the rupee.
The free-fall of the rupee will continue, although this free-fall could be slowed down. Either way, the rupee is bound to lose more value against international currencies in the coming year. This is because of a net outflow of capital, depleting reserves, the IMF loan repayment, and a continuously worsening balance of payment position. The country’s industrial export sectors will suffer since there will be no short solution to the shortages of electricity and gas, which have hit these industries hard. Thus industrial output will remain low, and so will the country’s exports. A weakening rupee will also lead to an increase in the import bill, further worsening the current account deficit. The net flow of capital will depend on the discount rate (set by the central bank) and more importantly the investment climate in the country. The latter cannot be improved within a few months, and will improve only gradually even if it is one of the top priorities of the next government. Add to that the country’s international reputation as an exporter of terrorism. Therefore, foreign investors will stay away from Pakistani markets even in the near future. Terrorism has already diverted investment that was supposed to come into Pakistan to countries such as Bangladesh, Sri Lanka, Vietnam and India. The IMF loan repayment will further deplete reserves, and any statement issued by the current government that the loan could be restructured or its payments delayed is an outright lie. The World Bank and IMF are preferred creditors, and therefore their loans can neither be restructured, nor their payments delayed.
The almost certain depreciation of the rupee will in turn lead to a price hike, especially in sectors that are dependent on imported inputs. The depreciation of the rupee will also increase the amount of foreign debt that is to be repaid. Since electricity/gas shortages and regular shutdowns due to the worsening law and order situation will keep industrial output low, the country will not be in a position to take benefit of this depreciation by increasing exports. Thus, the depreciation of the rupee will hit the already bruised and battered economy hard.
The global economy is projected to pick up during the next quarter. India’s economy is back on the road to expansion, and while China’s growth may have slowed down, it is still expanding at a decent rate. Other developing countries’ economies such as Bangladesh, Sri Lanka, Brazil and Argentina are also expanding. All of these factors will lead to an increase in the demand for crude oil, thereby increasing its price in the world market. Thus, Pakistan’s import bill will increase since crude oil import makes a huge chunk of it. Furthermore, rising fuel prices will further fan the fire on inflation. Lastly, the impact of rising crude oil prices in the world market will lead to further shortages in the power supply, since Pakistan relies heavily on thermal powered electricity plants.
Another task for the next government would be narrowing the budget deficit. In order to do that, some tools available with the policy makers would be to increase tax rates, increasing the number of people in the tax bracket and/or reducing overall expenditure. Since increasing tax rates appears to be an unpopular decision, it is unlikely to be taken. Taxing agricultural income would also be difficult because a large part of the land owning class would be sitting in the Parliament. In order to achieve the desired goal, the Federal Board of Revenue (FBR) requires structural reforms with regards to curtailing tax evasion. Considering the fact that powerful people in Pakistan are tax evaders, the move seems unlikely. Reducing expenditure has generally not been the strength of any past governments in Pakistan, and it would be safe to assume that expenditure levels will increase or in a better speculated state of the world, remain at existing levels. Given these factors, it is highly probable that the budget deficit will increase or at least remain at the current level. This directly implies further pressure on inflation and will also reduce credit for the private sector.
So to sum up, economic projections for the first few months of the next government are far from decent. A depleting rupee coupled with huge external debt levels could well lead the economy into global bankruptcy. Domestic debt levels too will rise, for reasons discussed above. These will leave little credit for the private sector, further strangling domestic industries that are already suffering due to power shortages and the law and order situation. Capital outflow will continue, whether it may be due to a bad investment climate, terrorism or a low discount rate. GDP growth will remain abysmal, and may even fall below the level of population growth, increasing unemployment and poverty. Inflation will remain high, due to rising fuel prices, a depleting rupee (leading to more expensive imported inputs) and a huge fiscal deficit. Pakistan will most probably have to request IMF for a bailout package. Foreign reserves could however increase and the depleting rupee situation could be avoided if foreign remittances rescue the economy, as they have done in the past. It is a fact to be accepted that the last five years have done significant and perhaps permanent damage to the economy of Pakistan, and the road to recovery will be a long and torturous one to say the least.
The writer is a staff member. The views expressed are his own.