Is the economy recovering?
By Shahid Javed Burki
Monday, 04 May, 2009
THE economy seems to be on the road to recovery. At least that is the impression one gets from reading the latest macroeconomic data and the reaction of the IMF. Several other observers have reached the same conclusion.
‘Pakistan is one of the few countries that enjoys more macroeconomic stability today than it did on September 14, the day before the bankruptcy of Lehman Brothers turned the world upside down. In those prelapsarian days, Pakistan’s currency was tumbling; its foreign exchange reserves covered barely two months of imports; and the cost of insuring its sovereign debt against default was almost 1000 basis points (10 per cent ),’ wrote The Economist in its issue of April 25.
The situation has improved considerably since those very difficult days. Foreign exchange reserves (with the State Bank of Pakistan) have climbed significantly, recovering from a low of $3.5 billion on October 31, 2008 to $7.8billion on April 17, 2009.
Fiscal deficit was brought under control although not by raising revenues from inside the country but by drastically cutting development expenditure. Some structural reforms were put in place by removing subsidies on energy. Prices of agricultural products that are still fixed (support price) by the government were raised thus providing incentives to the producers but also reducing the burden on the state.
One consequence of this may be a bumper wheat crop this year. If that happens, the rate of GDP increase may not plunge to the level feared a few months ago. But is this trend sustainable? Will the recovery result in a significant revival of growth, increased employment, particularly for the poor; and, perhaps most important, return in investor confidence?
The answers to these two questions depend upon four factors: continuous availability of external finance, pace of recovery in the global economy, strategic moves by Islamabad to address some of the structural problems the country faces, and the government’s ability to bring the rise of extremism under control.
The Pakistani economic and finance team met with the Fund officials during the recently concluded spring meetings involving the IMF and the World Bank. The Fund, satisfied by the progress Islamabad had made in stabilising the economy, agreed to release the second tranche of its $7.6 billion assistance programme. The programme is to run for two years. There was some indication that the amount available to Pakistan could be increased somewhat if the country continues to proceed on the track it has been following.
Both the World Bank and the Asian Development Bank are interested in expanding their programmes, prepared to provide fast disturbing money as well as project aid. The successful outcome of the Tokyo meeting may provide the country with some additional resources from bilateral sources. However, the real issue over here is Pakistan’s ability to implement the programmes and execute the projects which interest the donors. This will need considerable amount of emphasis on building state institutions.
This brings me to the second question: Would the country’s economic recovery be helped by the recovery in the global economy? There are some faint signs that the global economy may have begun to recover and the recession may be bottoming out.
Pakistan’s economic problems were more the result of internal developments than the cause of the global downturn. That notwithstanding, sharp deterioration in the global economy had an unexpected impact on Pakistan. Most other emerging economies were hurt by the contraction in international trade. Pakistan, with a very small share in global trade, was not as deeply affected. But it was hurt in a different way. The credit squeeze that followed the problems in the banking sector resulted in a sharp decline in external capital flows to emerging markets.
In the case of Pakistan a significant amount of money came into the stock markets. Not only did the flow dry up, the investments that were made were liquidated and capital flew out of the country. Islamabad responded by putting a floor under the prices of individual scrips. This had the effect of suspending trading and further eroded the confidence of foreign players in the markets. It will take a long time for confidence to return.
There are a number of signs that suggest that improvements are taking place. The Economist, the British news magazine, tracks 42 stock markets and in the past six weeks their value has improved by 20 per cent. The slump in global manufacturing seems to be ending and some of the major economies are showing unexpected strength.
The Chinese economy has begun to respond to the large stimulus provided by the state by a sharp increase in infrastructure spending. The German industrial output appears to be reviving. Perhaps by far the most important development is the seeming revival of consumer confidence in America. In the data released on April 28, the index of consumer confidence in the United States touched an unexpected high level. The American consumer is important for the global economy, in particular for global trade.
Sounding less terrified than they were when they met six months ago at the annual meetings of the World Bank and the IMF, finance ministers representing the world’s richest countries, the G7, saw ‘signs of stabilisation’ in the global economy.
This time they had gathered for the spring meetings of the two institutions. According to Timothy F. Geithner, the US Treasury Secretary, ‘there are signs that the pace of deterioration in economic activity and trade flows has eased. These are encouraging signs, but it’s too early to say that the risks have receded.’ In a joint statement the G7 went further and predicted that economic activity should begin to edge up later in 2009, but it is too early to say that the risks have receded.
If Pakistan continues to recover, if the international environment continues to improve, would this set in an attitude of complacency that has overtaken the policymakers in the past whenever the end of a particular crisis became visible?
Foreign capital flows can only provide temporary relief. Foreign direct investment will only come back once foreign players develop confidence that the state has been able to establish its control over all parts of the population and all parts of the country. Sustainable growth can only be achieved if the country begins to raise resources from within the economy. This will need a significant increase in domestic savings rates and a sharp rise – by as much as 50 per cent – in the tax— to— GDP ratio. Both changes will happen only with the adoption of the right set of public policies.
As mentioned above, domestic and foreign investment will return only when there is confidence that the state has established control over extremist forces who, albeit, not very large in number, have managed to scare not only the people of Pakistan but the entire world. For that to happen Islamabad will need to show a combination of resolve as well as imagination. Resolve should aim at reestablishing the writ of the state in all parts of the country. Imagination should be directed at persuading people that the government will do what needs to be done in order for them to develop confidence in their future.
The worst may be over for the economy but sustaining the trend will need a great deal of hard work by the state. The political leadership will have to convince a worried and nervous population that it is up to the difficult task.