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Old Tuesday, March 27, 2012
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Which ‘fiscal deficit’?
March 27, 2012
Dr Meekal Ahmed

It is obvious that the government is in a pre-election mode, spending freely. Funds, including “discretionary” funds, are being released quickly for new “uplift” schemes. Even our “awam-dost” (“Friends of the People,” for the foreigners reading this) have received new money to spend; on what, no one seems to know. Yet we are hearing soothing words from the government that all is well, the fiscal deficit is “on-track,” “structural reforms” are being implemented and everything is under control. However, we are not being told which fiscal deficit the government is talking about. Is it only the federal government deficit? Does it include the provinces? Is their combined surplus promised at budget time close to materialisation? What about the circular debt and the losses of the public-sector enterprises? After all, these are all public-sector operations and therefore must be considered, definitionally and analytically, as part of the public-sector deficit which needs to be financed.

The fiscal deficit could therefore not be “on-track” if borrowing to finance it, plus borrowing for commodity operations, the circular debt and the public-sector enterprises is soaring and pre-empting some 84 percent of the total money and credit in the economy, with little left over for the private sector.

Lucky for us, however, this huge injection of borrowing/liquidity is not leading to an expansion in money supply (or M2). This is because the spectacular rise in domestic money and credit is being offset almost entirely by a similarly spectacular fall in our foreign-exchange reserves. so that M2 (the net effect of the two variables which are presently moving in opposite directions), has grown very slowly.

Whether this “offset” is by design or default is not clear. Either way, it is a dangerous game to play. The fall in our foreign-exchange reserves cannot endure for long before panic sets in. The external side, at some point which cannot be determined ex-ante, will go into a cumulative and self-reinforcing downward spiral punctuated by capital flight, a plummeting exchange rate, a rating downgrade and a stock-market crash. Then we will find ourselves right back to where we were in 2008, facing the prospect of a full-blown balance-of-payments crisis and debt-default.

This time, however, the IMF, that institution of “sinister omnipotence,” is unlikely to be easily conned into another bailout with a promise of some phoney reforms. Of course we like to think that all it would take is for Ambassador Sherry Rehman to make a call to Hillary Clinton and she makes a call to the new managing director of the IMF and they have a friendly woman-to-woman chat which ends with a nod and a wink. We grossly over-state the power and influence of the US. The US has a strong voice in the IMF but there are 23 other executive directors sitting on the IMF executive board who think they are just as important and who will vote on a new Pakistani programme. Some may reject it, as has happened many times before, a fact unknown to the public since the deliberations of the IMF executive board are confidential. And unfortunately for us, executive directors have long memories and look most disapprovingly at member-countries that take IMF money and cut and run.

It is possible that some of the assumed foreign financing comes in. This could stabilise the foreign-exchange reserve position or it may even start to build backup. But there are problems in that scenario too. The infusion of foreign reserves will add to the on-going excessive expansion in domestic money and credit (and not subtract from it as at present) and send M2 soaring. This would be the harbinger of sharply accelerating inflation down the road.

The government, it seems, is caught between a rock and a hard place. It has impaled itself on the horns of a dilemma and has two choices: sharply accelerating inflation or going bust. Possibly both. To be fair, it has not been easy going at home with many fatal distractions and the external environment remains unpropitious. Surging oil prices are likely to crimp global growth and stoke inflation while the growth in emerging markets which helped boost the global economy appears to be waning. All these factors impact adversely on Pakistan via trade and capital flows. But, having said that, Pakistan’s present plight is all about a fundamental disinclination to take the bull by the horns and alter course. You reap what you sow.

The writer has worked at the Planning Commission and the IMF. Email: meekalahmed2 @aol.com
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