January issue 2012

The federal government remains so embroiled in issues like President Zardari’s health, the Memogate scandal and its possible ramifications on the government’s own future, that nobody in the corridors of power seems to beconcerned about the rapidly deteriorating state of the economy.

The already sluggish economy began to take a downward turn before the general elections in early 2008, and at that time it was anticipated that the new political dispensation would focus on rejuvenating it. But, as the government moved from one political crisis to another, the economy never got the kind of attention it desired. In fact, a lack of political will, frequent changes in the team of economic managers, ill-conceived and short-sighted decisions and, above all, sheer mismanagement accelerated the downward economic slide.

As speculation about the future of this government mounted, an annual report issued by the State Bank of Pakistan late in December served as a stark reminder of the abysmal state of the economy. The central bank report is a ‘wake-up call’ for economic managers to take immediate remedial measures to avert an economic collapse ahead of the next general elections.

The country’s economy is carrying the heavy baggage of inaction of the last four years. All macroeconomic indicators present a gloomy scenario. The GDP growth rate is lethargic, inflation is still stubborn and in double digits, fiscal deficit is mounting and likely to stay at a whopping 6.5% of the GDP for the second consecutive year, and external account balance is worsening with every passing day, resulting in severe pressure on the fragile rupee and foreign exchange reserves. And that is not all. The energy shortage is resulting in crippling power and gas outages for the industry; ineffective administrative measures are jacking up prices of essential commodities and national institutions like PIA, the Pakistan Steel Mills and Pakistan Railways are costing the national exchequer hundreds of billions of rupees annually.

The State Bank’s annual report presents a threadbare analysis of the economic performance of the last fiscal year. It also provides an insight into the future outlook and suggests remedial steps that are required to improve the situation. This year’s report was no different. However, what was unusual was the inclusion of a special box on the issue of governance in the executive summary of the report.

“In the final analysis, all the economic problems can be traced back to poor governance,” the central bank observed and said that all policies would prove to be ineffective unless they were supported by strong institutions and were consistent with other government policies. “A cross-country comparison shows that institutional weakness at all levels of government, the judiciary, civil services, law enforcement agencies, regulatory bodies and agencies for oversight and accountability, are directly responsible for poor economic growth,” the report stated, adding that these institutions put together make up the governance structure of an economy.

The central bank also pointed out that most governance indicators for the country have weakened in recent years, quoting a recent World Bank study on the ease of doing business in any country. It said that Pakistan had slipped from 96 to 105, out of 183 countries evaluated in the World Bank study.

The core issue of poor governance, which has been boldly pointed out by the central bank, has taken centre stage in recent months. Economic experts and opposition political parties have been crying out loud about the need to improve governance, but the government seems to be unmoved, resulting in disastrous consequences for the economy.

Moving to macroeconomic performance, the State Bank report stated that the government is likely to miss key economic targets in the current 2011-12 fiscal year. It said that the real GDP growth this year is likely to hover between 3-4%, which is lower than the targeted 4.2%. The main reason behind this is the expected lower growthsluggish performance of the agriculture sector, which had been adversely affected by the floods in Sindh as nearly half of the area under cultivation in the province was destroyed by flash floods.

It also pointed out that retail prices increased because of supply-side factors, including the impact of floods and the rise in international commodity prices. “Food inflation was particularly hard hit, posting a sharp 21.3% year-on-year increase in September 2010, compared with 10.4% in the same month a year earlier — food inflation remained about 19% in the first half of FY11,” it said.

Although, the central bank resorted to monetary tightening with an increase in the policy rate from 12.5% in end-FY10, to 14 percent in November 2010, the likelihood of inflation falling to single digit is not likely. The State Bank said that inflation is expected to top 12.5% this year.

On the crucial external account front, the central bank said the current account balance also remains a source of concern, but it said it remained hopeful of some upside on strong worker remittances and a possible recession in the global economy. Although data for the first four months of FY12 shows a current account deficit of $1.6 billion, this is due to temporary events like bulky oil payments and a seasonal pause in remittances in September 2011, and an engineered shortage of hard currency in the parallel foreign exchange market.

“Going forward, we expect a current account deficit of 1.5-2.5% of the GDP, which is relatively small given our past performance. However, the financing of this current account deficit could be challenging,” the central bank maintained.

In the absence of any significant foreign direct investment and the lack of funding from multilateral donor agencies, including the International Monetary Fund, how the government will be able to finance the ballooning current account deficit, will remain the key focus area for financial markets in the next six months. Uncertainty on this front will continue to put pressure on the rupee as well as foreign exchange reserves. The rupee, which recently hit a record low of 90 to a dollar, is widely expected to depreciate further and it may hit 95 to a dollar before this fiscal year runs out in June 2012.

Overall, the economy is in a quagmire and there are no quick fixes to remedy the situation. However, if the government is serious about turning the economy around, it will have to take some immediate remedial steps.

Firstly, it should constitute a focus group to devise a short-to-medium term economic agenda to put the economy back on track. This agenda should be implemented on a war footing as there is no room for political expediency ahead of the general elections. The central bank has also called upon the government to formulate a fiscal reform ‘master plan.’

Concrete steps are required to broaden the tax base. This is essential to shore up government revenues to contain the budget deficit. The recent drive of the Federal Board of Revenue in this regard should not be stopped now that the IMF programme has ended prematurely. Removal of subsidies and bringing other productive sectors into the tax net can also help supplement government revenues.

Professional boards and managements are immediately required to be put in place at all the loss-making public sector enterprises, which are cumulatively costing the tax payers over 300 billion rupees a year. Although a quick turnaround of these enterprises is not expected, a professional management team would make efforts to stop the pilferage of funds thereby easing the burden on the national kitty.

The federal government must make efforts to get a letter of comfort (LoC) from the IMF and try to seek another stand-by programme. The IMF’s LoC will also make the government qualify for seeking additional funding from other donors like the World Bank and the Asian Development Bank. This funding is crucial to finance the current account deficit to go forward.

Last, but not the least, there is a need to put in place a cost-effective energy plan. This would be a long-term strategy, but the sooner the government starts working on it, the better it will be for the economy.

These are some of the corrective measures which the government can take immediately to begin the process of economic revival. Some of these measures may not be easy to take but they are all doable if there is a political will. And as the State Bank report puts it succinctly: “In the current state of Pakistan’s economy, there is no wiggle room left.”

This article was originally published in the Annual 2012 issue of Newsline under the headline “On the Edge.”