INTERVIEW – Dr Salman Shah: ‘Governance is at rock bottom’

PML-N’s economic wounds are self-inflicted

The economy is not as healthy as last time. And it’s definitely not as healthy as the government wants us to believe. So this upgrade, while a step in the right direction, is not a transformational moment, though it could become one if proper reforms are undertaken

 Dar sb’s happiness knows no end since the MSCI upgrade to emerging market status, even though it was in appreciation of the stock market’s performance and in no way a reflection on the finance ministry. Still, it’s not like he’s not ‘intervened’ in the money market before. He’s even, on occasion, announced interest rate changes ahead of time. So much for the central bank’s autonomy. And he’s always taken credit for the liberal monetary regime; and then, as a matter of habit, gone on to borrow even more from the local market even for the government’s day-to-day functions.

But it’s not like he doesn’t know the distinction. That he still chooses to give himself a pat on the back means he’s posturing – for political purposes, of course. This is the same kind of posturing that enables you to deliver a budget speech where you’ve missed the growth target by a percentage point as something of an achievement.

Nonetheless the stock market was the best performing in the region this year. This has happened while the real economy, despite the finance minister’s claims, has remained sluggish. Sure, the deficit eased a little more than a little, but Dar sb knows as well as anybody how that was an exogenous windfall, not policy-driven. Revenue was nowhere near the target, principally because there’s been no tax reform and there’s been no value addition in exports. Yes, inflation was low, but how long will that last, especially since Brent has started moving again?

To make sense of the real economy-capital market interplay DNA talked to Dr Salman Shah, former finance minister. It was in the early Shaukat Aziz days after all, when he was economic advisor, that the stock market really began its ‘stellar performance’. Growth remained high enough in the Shaukat days, so it was easy to sell a correlation of sorts. But no sooner than democracy came back did the decoupling start becoming apparent. And since then the market has outperformed, largely, while the economy has either tanked or struggled. What, then, does the upgrade mean in the present environment? And which way is the economy really headed?

Question: How big an achievement is the MSCI upgrade?

Salman Shah: It is a positive and welcome development, of course. But remember we have been here before. It was only after the ’07-08 mismanagement, when a floor was put under the market, that MSCI downgraded us to frontier market status. So the authorities should be mindful of the importance of maintaining market discipline this time.

It’s a positive development also because the market will attract greater liquidity. This means greater investment flow. There couldn’t be a better time for the government to initiate reforms in the real economy.

Q: Speaking of the real economy, the finance minister said the upgrade owed to reforms and fiscal discipline of the incumbent government. But wasn’t this a money market phenomenon?

SS: The finance minister is right to an extent. They did end the year with greater reserves, so he’ll naturally want to take credit for most things. But it is important to realise that these were not the result of any meaningful reforms. They did it largely by borrowing.

A few other things are also important to consider. When we were last an emerging market, in ’07, our investment-to-GDP ratio was 23.5 percent. According to the economic survey a day ahead of the budget, the same ratio in the outgoing fiscal was 15.5 percent.

That means the economy is not as healthy as last time. And it’s definitely not as healthy as the government wants us to believe. So this upgrade, while a step in the right direction, is not a transformational moment, though it could become one if proper reforms are undertaken.

Q: The government has clearly given up on tax and export reforms. Plus there’s not enough time left till the next election for results to show. What should we expect then?

SS: It’s not just broad macroeconomic reforms that are needed, but target action in a number of areas that the government just refuses to look into. We need tax reforms, FBR reform, civil service reforms, etc, if the investment and business climate is to be improved.

In ’08, we were in the 50-60 range in the Global Competitive Index. Now we’re at 90. That speaks volumes about our competitiveness.

We cannot be competitive unless energy price is reduced. Only if it settles in the 2.5-3 cent range can we begin the process of proper economic growth. Otherwise we’ll just struggle.

There is also an urgent need for power sector reforms. We produce the most expensive power in the world. How are we going to attract foreign investment in this climate? Currently our per unit cost is around 10 cents, while in the outside world it is in the 2.5-3 cents range.

We cannot be competitive unless energy price is reduced. Only if it settles in the 2.5-3 cent range can we begin the process of proper economic growth. Otherwise we’ll just struggle.

Q: What is the biggest risk to the economy at the moment?

SS: At the moment I’d say it’s a possible decline in remittances. If they drop, there’ll be more trouble. It’s still the main source of foreign exchange. We’ve made no progress in manufacturing sector reforms, which are urgently needed. The export and agriculture sector crises are also because of mismanagement.

Currently we have a bad energy policy and a bad water policy. There is no deregulation in the economy. There is no deregulation of the power sector. Governance is at rock bottom. A lot needs to be done.

Q: How do you think CPEC is progressing?

SS: Luckily there are two partners in this project; the other being the Chinese, of course. And they are very seriously committed to it, so they’ll make sure we keep meeting important deadlines.

Over here, the military is very interest in the success of this project as well, and wants it completed as soon as possible. But I don’t think the civilian government is very clear about how to handle this project. Special institutions, which were needed, have not been setup. They are approaching CPEC with the existing machinery. That is to say we have the hardware for this, but not the software. Unless we take the right steps now, this project will not go ahead as planned.

Plus, there’s a lot more to CPEC than infrastructure, etc. It will be successful if it raises Pak-China trade a hundred times, or increases bilateral investment substantially. There should be joint ventures, mergers, business to business contacts, etc.

CPEC requires a lot more homework than we are putting in.