Daily Times

At a recent public event, PM Imran Khan claimed that 2020 would be a year of progress for Pakistan. He asserted that the economy had stabilised and the economic hardships were a thing of the past. Finance Minister Hafeez Sheikh was also singing the same tune; laying out all the positive indicators that, according to him, suggested the country was on a path to prosperity. There is no denying that certain macroeconomic indicators have improved, but the pertinent concern is: will Pakistan experience growth and prosperity that are sustainable?

Over the last few decades, Pakistan has seen a discernible boom and bust cycle. It enters into an IMF program; implements quantitative tightening; its macroeconomy stabilises. The country posts modest growth over a couple of years. Growth becomes unsustainable, and back to square one, where another IMF bailout is needed. It is important to diagnose the fundamental reasons that prevent our economy from fully taking off.

If we look at Pakistan’s budget for 2019-20, there is a fiscal account deficit of Rs 3,560 billion. Obviously, the deficit implies that government revenues are not sufficient to finance expenditures. Hence, external financing is needed to plug the gap. Looking at expenditures, debt servicing of Rs 3,986 billion takes a major chunk (around 47 per cent) of the fiscal expenditures. This is particularly problematic since the high cost of debt servicing eats into the financing available to fund important sectors of the economy.

Most notably, development expenditure is curtailed, which reduces the economic and productive capacity of the country.

One may ask: why do we rely so much on debt if debt servicing costs are too high? The answer is straightforward: fiscal revenues, which are mainly tax revenues, are not near sufficient to fund expenditures.

The PTI government has been trying to tackle this issue by raising taxes, mostly indirect in nature, but this strategy has a fatal flaw. It is trying to squeeze out more juice from an overly constrained section of society. It is no secret that Pakistan has a very narrow tax base, in terms of direct taxes. It is believed that less than one per cent of the population pays income tax. Unless the tax base is expanded, increasing indirect taxes will not reap any noticeable rewards. If anything, an increase in indirect taxes will stifle demand and decrease economic activity.

The incumbent government has tried to reach macroeconomic stability, primarily through import compression. The problem with this approach is that Pakistan’s economy is largely import-driven and curtailing imports, by making it more expensive, has hurt domestic businesses as their cost of doing business has increased significantly.

To compound matters, the central bank has kept interest rate to around 13 per cent, which is quite high. This has increased the cost of borrowing for businesses, hence, suppressing economic activity again. The central bank has suggested that interest rates have been increased to control high levels of inflation. Theoretically, that is the correct approach. But this approach has its shortcomings because Pakistan is experiencing cost-push inflation, which is caused by an increase in the cost of imported goods and services.

The PTI government has been trying to squeeze out more juice from an overly constrained section of society

Devaluation of the rupee has played a major part in causing cost-push inflation. Therefore, increasing the interest rate is not effective in countering Pakistan’s inflation. Interest rate is a viable tool for combating inflation if it is demand-pull in nature.

Once the economy stabilises, Pakistan is unable to properly profit because of the aforementioned issues. As the country enters a period of economic growth, imports substantially increase again, which in itself is not a problem. But it becomes an issue because the increase in imports has historically not translated into a corresponding increase in exports. Because most of the efforts of the government have been on short term measures to control imports, the export side of the economy takes a hit.

As of today, Pakistan lacks a competitive advantage in the global market to boost exports, which is why it experiences such a large trade deficit. It is alarming to note that Pakistan’s Export-to-GDP ratio is only 8.8 per cent, which is one of the lowest in the world. In fact, less than ten countries in the world experience Export-to-GDP ratio of less than 10 per cent. The government needs to focus more on the supply-side to boost production capacity in the country so that it can properly benefit from increased demand during phases of economic growth.

Despite the PTI-led government’s attempts to paint a rosy picture of the economy, nothing seems to have changed. The tax base remains narrow, debt servicing costs are still too high, and there appears to be no significant uptick in export activity. Foreign direct investment remains flat even though the government claims that there has been enhanced foreign capital inflows. The large chunk of foreign capital inflows, which the country has received recently, are short-term investments in treasury bills due to the higher rate of interest that the government is offering. Because of the short-term nature, these investments will not significantly increase economic activity in Pakistan.

The incumbent government needs to rethink its strategy and not make the same mistakes made by the previous governments. As things stand, our economy will keep on experiencing the boom and bust pattern. It is not long until we go knocking on IMF’s door again unless our tax base is broadened and there is a shift towards an export-oriented economy.

The writer can be reached at hamza.shah3@hotmail.com