Navigating Turbulent Economic Waters | Political economics
Prime Minister Shahbaz Sharif’s first official statement on the national economy strikes a chord: “The country is awash in debt, but we have to bring the boat back to shore… We have to overcome the challenges of poverty, unemployment and of inflation. The previous government failed miserably in its fight against these difficulties.
Sharif’s assertion that Imran Khan’s economic policies were an absolute disaster may only be half the truth. Blaming Khan for all the economic woes of the country is dangerous as it could blind the fact that Khan inherited several structural problems from the PML-N government, just as the PML-N government had inherited many economic problems from the PPP and Musharraf eras .
Now that a new government has been installed, the challenge is to objectively take stock of the problems and seek a way forward. Here we discuss what went wrong with Imran Khan’s economic policies, the challenges for the government and how best to manage the economy.
Imran Khan inherited several complex economic problems. The situation worsened considerably under his watch. Khan’s failure fundamentally lies in the inability of his economic managers to understand, let alone address, macroeconomic challenges. The PTI government inherited the currency crisis but had no effective plan to stem the free fall of the rupee against the dollar. Under the PTI government, the focus has been on using familiar shortcuts: opening capital accounts for speculative portfolio investments, encouraging unproductive real estate investments, and subsidizing a rentier economy favoring the elite.
Foreign investment comes in many shades and shades, with different economic implications. For example, long-term foreign investment in manufacturing has a different effect on economic fundamentals than heavy investment in debt and equity markets. A country must ensure a stable political environment, a reliable law and order situation, predictability and continuity of economic policies and regime changes to attract long-term investment in the manufacturing sector.
On the other hand, attracting foreign investment to the debt and equity market requires little more than an adjustment of policy rates. When things got tough for the PTI government, Pakistan followed the latter policy. Among the other factors that explained an influx of “hot money” (short-term foreign investments in the capital markets), the raising of the key rate above 13% by the central bank in 2019 was an important factor. This resulted in $4.1 billion in foreign investment in the debt and equity markets, with a large share in treasury bills (often close to 50% of total portfolio investment).
Khan also inherited a deep structural problem of low investment rates, which essentially means preferring current consumption to the detriment of future growth. Pakistan invests about 15% of its production, which is grossly insufficient and low even by regional standards. Other South Asian economies invest around 30% of their production. A direct consequence of Pakistan’s historically low rate of investment is that its economic productivity has remained at a suboptimal level, leaving it limited space for innovation and diversification of its product mix. In a recent article published in the New York TimesAtif Mian noted that Pakistan’s total export volume remains at 2005 levels.
Imran Khan inherited complex economic problems. Under him, the situation worsened considerably. Its failure fundamentally lies in the inability of its economic managers to understand, let alone address, the macroeconomic challenges.
With double-digit inflation and unemployment rates still high during the first phase of Covid-19, the PTI government was under immense pressure to provide quick relief to the masses. With limited fiscal space and near absence of a team of expert economic managers to redress economic fundamentals, the PTI government chose the quick-fix approach of providing grants under its Ehsaas program. . However, the subsidies that angered the IMF were more recent (announced in February this year) and linked to fuel prices and electricity tariffs.
Other economic problems that haunted the PTI government were the massive devaluation of the rupee and the huge debt burden. The devaluation of the rupiah under the PTI regime was unprecedented in the history of Pakistan. The PTI government also added about $27 billion to foreign debt, far more than the PML-N government.
When the economic fundamentals are weak, the currency is still likely to be under pressure. But under the PTI government, the rupee has experienced unprecedented episodes of devaluation. As Pakistan’s oil and food import bills rose, the steadily rising import bill triggered an unprecedented trade deficit, further eroding the value of the rupee. The most recent drop was triggered by an uncertain political situation and a stalled IMF program.
Governments turn to the IMF only when they cannot solve their economic problems themselves. IMF programs are often painful for the masses and exact a heavy political toll.
The current situation is that the IMF has set a number of preconditions to relaunch its Extended Financing Facility. The Sharif government has been urged to, among other things, raise fuel and utility prices, scrap tax amnesty programs for industries, reduce circular debt and show progress on the fiscal front. In particular, he must cancel the rescue plan of February 28 to receive the next tranche of the loan.
Finance Minister Miftah Ismail recently traveled to Washington to renegotiate the EFF. The IMF has reportedly agreed in principle to increase the current EFF from $6 billion to $8 billion and extend it for another year to help Pakistan deal with its balance of payments and foreign exchange reserves problems. . A formal decision in this regard will depend on the success of the technical talks which are currently underway. It seems that the IMF will not budge from its request to withdraw the subsidies announced by the PTI government.
The government currently pays a subsidy of Rs 21 per liter on petrol, Rs 51.52 on diesel and Rs 5 per unit of electricity. The finance minister has hinted that the government will phase out subsidies. Making it palatable will be a big challenge.
Pakistan’s economy is in dire straits due to a combination of factors including Covid-19 and the erratic economic policies of the PTI government. Ordinary people have been hit by soaring commodity prices. Bringing relief to them will be a big challenge for the government, but the most crucial challenge will be securing basic rights. Correcting economic trajectory will require balancing the long-term economic recovery and helping those most in need in the short term. It’s easier said than done.
The task of the current regime risks becoming insoluble as there does not appear to be any easing of inflationary tendencies. According to FAO forecasts, world food prices will reach an all-time high this summer. This will further drive up food prices in Pakistan and threaten food security. It’s almost a truism that food security threats and social unrest go hand in hand.
An equally virulent challenge for the government lies elsewhere. Skilfully playing religious and nationalist cards and calling for new elections, Imran Khan will leave little room for the government to make the tough decisions needed for economic recovery.
The author is Associate Professor in Department of Economics, COMSATS University Islamabad, Lahore Campus