The year ahead
By Shahid Javed Burki
Monday, 03 January, 2011
By Shahid Javed Burki
WILL 2011 be a better year for Pakistan? Probably yes. Will the little bit of recovery in the rate of economic growth expected in 2011 place the country on a sustainable path of development that will approach those of the other large economies in South Asia? The answer is probably ‘not’, unless Islamabad gets serious about reforming the economy.
Will the international community continue to support Pakistan, filling the gap between government revenues and expenditures and between export earnings and import outlays? The answer is probably ‘not’, but with one exception. The exception is the IMF which is now acting at least implicitly on behalf of the entire donor community.
All these answers require some explanation which is what I will now proceed to provide. My purpose will be to describe the domestic and external environment in which Pakistan will manage its economy in 2011 and how that will affect the rate of growth, the incidence of poverty and the relations between different regions and provinces of the country.
Pakistan has just finished what will be one of the worst years in its economic history. It will be a while before the final numbers come in but one thing is certain: there will not be any increase in the average income of the citizenry. Given the distribution in national income which is becoming increasingly skewed, per capita incomes of the bottom 60 per cent of the population will undoubtedly decline. The number of poor will increase with the proportion increasing to close to 40 per cent of the total.
If the 2011 population is 175 million, this means that some 70 million people will live in absolute poverty. Perhaps 40 per cent of the poor will live in large cities and small towns where the social structure is weaker than in the countryside. In other words, the options for the urban poor are fewer than those available to those living in villages. It is this group of people that are supplying recruits to the various extremist causes.
The poor performance of the economy in 2010 was caused by natural disaster – the floods in the summer of the year just past – and poor economic and financial management. There was also a lingering effect of the Great Recession of 2008-09 which constrained the markets for Pakistani exports although the country is not as well-linked with the world as is the case with many Asian states. How the economy fares in 2011 will depend upon a number of factors. By far the most important of these will be the ability of the government to keep its programme with the IMF on track. That is necessary since the donor community has made it clear to Islamabad that its much-needed help will need the Fund’s “good housekeeping seal of approval”. For decades, Pakistan has not paid much attention to the need to generate most of finance needed for public sector investment for development and for running its non-development operations. This has made the country excessively dependent on external capital flows. The economy performs well when external finance is available; it does poorly when the flow is constrained.
Since the flows from the outside that come in the form of “official development finance” will be constrained because of the delays in carrying out the IMF supported programme aimed at fiscal reforms, this will affect the availability of resources for the government. This constrained flow of official assistance will provoke two responses. The government will borrow more from the central bank or from the market.
In the case of the former, the State Bank will be reduced to printing money which, in turn, will cause the rate of inflation to increase. In the case of the latter, government borrowing will crowd out private investment and have an effect on investment and later on the rate of growth. Since the government is depending upon its friends in the foreign community of donors, in particular on the World Bank, to finance the provision of relief to the millions of people affected by the floods, the recovery from that particular disaster will also be delayed.
The only silver lining in this dark cloud is the promise of some relief to textile exporters in obtaining enhanced access to the markets in the European Union and the United States. There is some movement on this front and this relief may become available. If that leads to increased exports it might take some pressure off external balances and stop the haemorrhaging that will otherwise result because of the decision by the IMF to suspend payments. Since so much rides on the Fund, it will be useful to provide a bit more background to the country’s current programme with that institution, the latest of the many Pakistan has attempted, but mostly failed, to implement.
A 23-month Stand-by Agreement (SBA), in an amount equivalent to about $7.61 billion was originally approved on November 24, 2009. On August 7, 2009 the SBA was augmented to $10.66 billion and the period of disbursement was extended to December 30, 2010. The Fund reviewed the progress of its programme in May 2010 when its disbursements had reached $7.27 billion and concluded that the Pakistani authorities needed to do more work before further releases could be made.
The remaining amount was to be released upon the adoption of the Reformed General Sales Tax. But the RGST legislations failed to move through the Sindh assembly, the province from where a significant amount of additional resources will be collected. It was opposed by the MQM. Islamabad told the Fund that it needed more time to prepare the political ground for the imposition of this important tax.
As was to be expected, in spite of Islamabad’s failure to adopt the policies that would increase the pitifully low tax-to-GDP ratio – this is one of the conditions of the SBA with the IMF – the institution granted a nine month extension to Pakistan for disbursing the remaining amount. According to a press release issued by the Fund on December 27, the nine month “extension will provide time to the Pakistani authorities to levy the GST, implement measures to correct the course of fiscal policy and amend legislative framework for the financial sector”.
This extension could be treated by the authorities in two very different ways. They might convince themselves that Pakistan is too big and too important a country to be allowed to fail – a kind of Citibank in the troubled world.
According to one scenario, the IMF could allow the current programme to lapse while negotiating another one that did not have the RGST as an explicit condition. The other – and I hope that is the one the government will take – is to finally adopt the series of reforms that will put the economy on the track to recovery and sustained growth. For that to happen Islamabad will have to get serious about addressing both sides of its financial ledger – the resource mobilisation as well as the expenditure side.
The environment in which Pakistan must manage its economy in 2011 is a difficult one. There are no easy options. The country is in such an economic mess for the simple reason that it has always opted for the easier course in the belief that there is somebody out there ready to pull it back from falling into an abyss.
The donor community appears to have wised up to this way of doing business in Islamabad. It should keep the pressure on. It will be good for the country, its people and for the world around Pakistan.