No doubt, the current account deficit has tremendously narrowed down at the back of a drastic decline in imports. That allows built-up of reserves and so does the increase in portfolio investment that is seeing an upward trend over the last few months, at the back of high policy rate for many months now. Another reason for keeping interest rate high is to induce savings rate in the country, which is otherwise on the lower side. Moreover, tight monetary policy stance is overall being persisted with to check inflation, with an aim to constrain aggregate demand.
Exchange rate determination is mostly market-determined and only slightly being managed floated. At the same time, high food inflation is being checked mainly by establishing reduced prices of essential commodities, mainly through the provision of subsidy of Rs. 10 billion over five months (Rs. 2 billion per month) to utility stores, by increasing their numbers significantly across the country, and by envisaging a plan to curb cartels that influence prices artificially.
At the same time, institutional reforms- incentive and governance structure reforms mainly- in the external and real sectors would have allowed both enhancing exports volume, improved supply chain domestically
The government and the State Bank of Pakistan (SBP) say the above are all important steps to stabilize the economy, which they rightly point out was in dire straits when this government took office roughly around one-and-a-half years ago. Having said, in dealing with economic issues, as in life generally, there are certain necessary steps that need to be taken, mainly to deal with the immediate aspects of the problem.
Yet, there are at times competing ways to reach the same goal, with opportunity cost associated with each policy option. Hence, a wise government chooses those necessary steps with least opportunity cost associated. At the same time, sustained fixes to economic issues require addressing root causes, and they hold the promise of meeting the sufficient conditions of policy response.
In this regard, have the government and the SBP come true on meeting the best of necessary conditions, and after the government being in office for quite a considerable time has it made any reasonable strides towards meeting the sufficient conditions? Let’s analyze.
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Firstly, Pakistan is a net importer of oil, and overall imports contribute significantly to economic growth in the manufacturing and agricultural sectors. It was not the best option than to narrow down current account deficit at the back of virtually market-determined exchange rate, because this led to the huge impact of import-related pass-through on inflation, significantly reduced imports of machinery and other related commodities, in turn severely dampening growth in the manufacturing and agricultural sectors. At the same time, keeping a high policy rate for many months also meant that the cost of borrowing loanable funds increased substantially, whereby little working capital was left with importers.
On the other hand, high-interest rate meant substantial increase in domestic debt repayments for the government (where it remained the major borrower of loanable funds) that in turn pushed the fiscal deficit overall; causing curtailment of development expenditure, and the ballooning of deficit at the back of this and bailing out the energy sector (where circular debt has reached great heights of Rs. 1.7 trillion) and state-owned enterprises, resulted in greater push to not reduce the burden of taxes on domestic consumers, importers and exporters, especially the proportion of indirect taxes/levies in petroleum products and energy tariffs; even the pass-through of falling crude oil prices globally have been delayed.
Given the high incidence of income inequality in the country, disposable income after taxes and high inflation does not allow much space for savings therefore
Hence, while it was ‘necessary’ to reduce the current account deficit, it was also necessary to not do this at the cost of severely affecting growth in the real sector. Another way to do the necessary was to take a middle way, whereby exchange rate was managed floated to the extent as not to bring out the sharpest blade of stabilization for this narrow end of deficit curtailment.
Rather, domestic production should have been encouraged by reasonable a) depreciation of exchange rate, and b) policy rate hike, which also rationalized to this end, at the back of both government and SBP showing an understanding that Pakistan being a developing country, inflation was equally a fiscal phenomenon.
This approach would have allowed exports to be boosted at the back of reasonably ample domestic production, which with a lower cost of production would have been more competitive exports; not to mention the lowering of the otherwise significant cost-push element in the overall high inflation levels being faced.
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At the same time, institutional reforms- incentive and governance structure reforms mainly- in the external and real sectors would have allowed both enhancing exports volume, improved supply chain domestically, and produced sustainable positive consequences for reaching reduced inflation, and greater growth prospects for the manufacturing and agricultural sectors; with brighter outcomes for the employment situation, equity and poverty concerns.
Secondly, the deep stagflationary – both stagnation in economic growth and high inflation – situation in which the country finds itself as a consequence of lacking the government and SBP in making correct policy choices for appropriately reaching the best possible necessary conditions, and reforming effectively to yield any meaningful sufficient solutions, is moreover not going to be resolved with lukewarm solutions like providing subsidy to the utility stores and increasing the number of stores.
As a necessary condition here, a ‘price commission’ for rationalizing prices, needs to be formulated (details of which the writer provided in earlier columns here) to check the working of cartels and economic agents individually that are involved in setting prices to their advantage in both real and financial sectors; in turn not allowing true price signals to be reached.
Napoleon Bonaparte pointed out that Money has no motherland; financiers are without patriotism and without decency; their sole object is gain
At the same time, the sufficient solution, one that strengthens the institutions, underlying organizations and markets, is undertaking appropriate institutional reform so that an incentive and governance structure is evolved, which facilitates organizations and markets to not allow setting of artificial prices.
Thirdly, increasing the savings rate depends more on the correction in terms the first-two broad policy areas indicated above, because only when inflation is on the lower side, will the broad group of the people in the country will be able to save more. Given the high incidence of income inequality in the country, disposable income after taxes and high inflation does not allow much space for savings therefore.
Hence, a high-interest rate has not much of savings to induce anyways. This policy, if anything, allows only the minute rich class to save and invest more at these high-interest rates, and inflation levels, to in turn, perpetuate further their wealth, and influence over policy through conniving with political elites; for instance, through financing their election campaigns and sharing with them profits, earned through policy manipulated in favour of economic elites, and formulated by political elites.
Read more: Stagflation and it’s prevalence in Pakistan
Fourthly, the policy of attracting portfolio investment through keeping policy rate high is a policy that cannot bring sustained consequences for narrowing down the current account deficit, since high-interest rate causes cost-push inflation, reduce the volume of exports, dampens prospects of needed innovation, and overall makes them uncompetitive.
This ‘hot money’ is also very fluid and is likely to leave once eventually, the policy rate takes a downward turn. And recognition of this policy is not something new as well, as Napoleon Bonaparte pointed out that ‘Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.’
The PM says he is a student of history, and surely he would know the history of hot money. His friend Mahathir Mohamad, his government and his country even lived through the hard economic times of the late 1990s as a consequence of the fluidity of hot money leading to its quick flight out of their country.
One important step could be to include in his economic team policy makers of more recent education of economics, who are better versed in heterodox economics
He learnt something there and managed more aggressively the exchange rate accordingly for one. At the same time, does the PM not realize that since the global financial crisis of 2007-09, the limitedness of the role of the central bank in terms of their policy tools – mainly policy rate – have been vividly brought out by more and more economists and policy-makers globally?
Should he then not turn a new leaf in the economic policy of his government and give a greater role to fiscal and governance-related policies? Should he also not realize the exceedingly greater research literature bringing out the negative consequence of neoliberal mindset, and asks his economic team educated in mainstream economics influenced by this philosophy to revisit their beliefs about institutional reform, and the greater role of government in economic policy and markets, and to bring this wisdom on the table while holding policy negotiations with International Monetary Fund (IMF); which are also greatly influenced in their thought-process by the same neoliberal/Washington consensus styled policies?
Perhaps time has come for PM to take the bull by the horn, and not allow his economic team – primarily related with Ministry of Finance, and SBP – to a) hide behind each other, b) not challenge the IMF programme fundamentals in terms of more recent economic wisdom globally, and c) more broadly for the lack of reforms initiated in the real and financial sectors during the tenure of his government. One important step could be to include in his economic team policymakers of more recent education of economics, who are better versed in heterodox economics.
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Overall, the time for PM is over-ripe to correct the choices in terms of meeting necessary conditions of policy, and in increasing momentum and choosing better policy options for reaching sufficient solutions for the economy, and more broadly the quality democracy. The PM should also realize that growth in itself is not a necessary condition; rather the quality of growth is more important.
At the same time, the sufficient condition is not growth alone, but equitable growth and human well-being; for instance the wellbeing budget presented by the government of New Zealand last year. All economic policies should be geared overall with this aim in mind.
Dr. Omer Javed is an institutional political economist, who previously worked at International Monetary Fund, and holds Ph.D. in Economics from the University of Barcelona. He tweets at @omerjaved7. The article was first published in Business Recorder. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.