DAWN.COM | Business | ADB report says Pakistan ?living beyond its means?
ADB report says Pakistan living beyond its means By Amin Ahmed
Wednesday, 03 Jun, 2009
Persistent inflation has plagued the country despite all efforts AP/File photo. Business
The city that never sleeps RAWALPINDI: The countrys burgeoning current account deficit indicates Pakistan was living beyond its means with excessive domestic demand boosting imports and fuelling the inflation which restrict exports, according to the Asian Development Bank in its latest report on the economic crisis of Pakistan.
This orthodox interpretation of the external financial situation of the country presumes the current account deficit must be financed by flows of foreign reserves, which for the most part must be attracted by high returns and a stable political, economic and social environment, says the report titled: A Reinterpretation of Pakistans Economic Crisis and Options for Policy Makers.
The worsening trade account implies that local Pakistani consumption became dependent on the whims of foreign lenders. Further, given its large budget deficit, the government is said to be increasingly dependent on the foreign purchases of its debt to supplement domestic savers purchases of government debt.
The report warns if Pakistan cannot attract these needed reserves, it must slow its growth to reduce imports; lowering prices and wages could also encourage exports.
Thus, both monetary and fiscal policy ought to be tightened to encourage such capital flows even as this reduces the need for them, the report suggests.
Summing up how Pakistans new government doing in dealing with the current crisis, and setting the economy on a sustainable course, the report says the national government was trying to implement a series of measures to stabilize the economy and in this way set the basis for a successful recovery. At the same time it was trying to deal with the inflation problem.
The report recommended that tax and spending reform should be formulated to accomplish economic, social, and political objectives rather than to hit a deficit target. The government will find it very difficult to achieve its budget deficit target even if it were to cut spending on social services like education, health, etc. and development expenditures drastically.
This is because such draconian cuts would likely throw the economy into a deep recession that would reduce tax revenues. If this were done, it would have serious repercussions for the countrys political stability and for its future. A better strategy would be to negotiate with multilateral agencies a programme that would allow the country to service its external debt, and gradually reduce its trade deficit until it reaches a more manageable level. During this time, the structure of spending should be analyzed, and a realistic development program should be devised.
While referring to the recent agreement with IMF, the report opine that that there was still latitude within the constrained policy environment to pursue more sustainable outcomes than those established by the limited horizons set by the IMF agreement. Further, says the report, the IMF programme does not correctly portray the source of the inflation pressures, or the constraints on economic development.
It says Pakistan needs to foster conditions that will reduce its dependence on imports. The growth and development path chosen will make a difference to the countrys capacity to import. However, the orthodox solution to a current account deficit will actually make it more difficult for Pakistan to reduce dependence on imports.
Giving its assessment of the current situation in Pakistan, the report says growth by itself is not an adequate goal given the needs of the country. Policy must be designed to pursue the goal of full employment, price stability, and equity. While Pakistans latest growth experience during 20042007 initially led to high growth, it has now become clear that this growth model failed to address the main problems afflicting the Pakistani economy.
A crisis of confidence in the government prevails that was unable to undertake strong economic measures, such as creating jobs, solving the power and water shortages, and relieving poverty. There is also an inability to keep inflation in check, a neglect of some important components of the supply side of the economy, perceived inability to address the increasing fiscal and current account deficits that are believed in many quarters to be undesirable, and inadequate response to security threats.
The report recommends Pakistan must continue to seek international funds, while negotiating for minimal conditionalities. It is highly likely that the IMF will continue to provide loans as needed, but with conditions that include fiscal restraint.
Unfortunately, this is a risky time for budget cuts, which would entail both economic and political repercussions. Significant budget cuts can only be made in areas of military spending, food and fuel subsidies, pensions, or development. For obvious reasons, cuts in all of these areas would be problematic.
The alternative is to raise taxes again a highly problematic policy for a nation whose growth was already slowing even before the global crisis generated recession throughout much of the world. The economic and political situation had not improved in the recent weeks and the government has requested further assistance from the international community.
The report points to a reduction domestic currency debt service or domestic debt relief. Debt service alone will likely absorb more than half of all government revenue. Cutting the SBPs target interest rate would free more revenue than is likely to be obtained either by draconian cuts to other spending or by huge increases to tax rates.
In the context of the immediate urgency imposed by the foreign currency reserve crisis that most likely will last at least through 20092010, the ADB recognizes the reality that short-term policy options will be heavily conditioned by the IMF arrangement. However, the Bank believes that there could be some room to consider elements of a debt relief strategy within the IMF arrangement, as well as pursuing a range of fruitful strategies even though the IMF agreement has been signed.
For the medium-term, the report suggests a package of policies that includes reorient emphasis towards employment-creating policies and away from growth for-its-own-sake policies; reformulate tax and transfer policy; address the external deficit and the fall in international reserves in a manner that does not lead to domestic stagnation, unemployment, and poverty.
The government should seek debt relief and especially gradual elimination of foreign-currency-denominated debt. The government should diversify the countrys export basket with a view to promoting those sectors that will lead to sustainable economic development in the long run.
A well-designed export-led growth strategy can play an important role in the countrys development. The aim of this development strategy is not to direct domestic resources toward production for external consumers instead of using them to produce for domestic consumption. The objective of this programme is to reduce import reliance and limit the external debt drains on foreign reserves, the report says.
