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Old Monday, June 04, 2007
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The economy Uneasy mix of gains and losses

By Dr Mushtaq Ahmad

The economy has continued its growth tempo initiated a couple of years ago but it is accompanied by resurgence of macroeconomic instability, posing tough challenges to the economic policy makers. Over the last many years, vast economic policy reforms have been implemented to promote global integration and export led growth strategy. The world economy has expanded smoothly in recent years and many emerging economies have reaped the gains through expansion in their exports and resultant productivity gains, and massive foreign direct investment inflows. In our region China and India have demonstrated around double digit GDP growth, coupled with parallel achievements in exports, foreign exchange reserves, price stability and productivity level. While planning for the current year, not only high GDP growth was envisaged but substantial improvements were targeted in all areas of macroeconomic stability in our plan and budget. At about close of the year, the profile of the prime aggregates now displays many targets have gone astray.

The GDP growth has been estimated at 7 percent and is predicated on record production of wheat and sugarcane, higher estimated growth of livestock and services sector. The growth of the large scale manufactures slipped from the last year level as well as from the target. Many other aggregates like investment, exports, tax revenues, poverty reduction and inflation are mutually interlinked with GDP growth. The developments realized in them are incongruent to their behavioural relationship with GDP.

Giving the growing global economy, the meagre export growth of 3.4 percent, reflecting surplus for sale in the global market lends no support to high growth. While State Bank claims the continuation of a tight monetary policy to stifle excess aggregate demand, the question arises why enhanced domestic production had not tamed inflation. The general public perception is that poverty is on the increase in the country.

Foreign direct investment has substantially increased over the last year. Its credit goes to the government policies. This is in fact coming into rent seeking activities and where the profit and producer prices are guaranteed. It may be having implications in some future years in terms of profit remittance outflow and some time repatriation of the investment as the national policies accommodate it. These days there is excess international liquidity. For example Japan has 0.5 percent interest and such situation fostered ‘carry’ trades. Home remittances have also shown good increase over the last year. This is partly attributed to relatively higher interest rate in Pakistan.

Budgetary deficit has already equalled the annual target during the first nine months of the year, and by the end of the year it is certainly to be breached. There was appreciable growth in tax revenues but it has been outpaced by the government expenditures. The tax policy is totally driven by revenues maximization and this has also been reckoned by the commerce minister who referred to it in explaining the fall in exports. Its obsession with only revenues maximization has made it oblivious to the fallout of the neglect of its other goals e.g. income distributional equity, price stability, investment and export promotion. It is completely devoid of efficiency principle. For example extraordinarily high protection provided to goods like cars inflects loss on the economy of welfare as reduction in consumer surplus. Keeping the budgetary expenditure much above the revenues level while keeping it on increase every once in a while continuously nurtures the aggregate demand. This fosters the inflationary forces. I find this phenomenon holds sway in recent years in our economy.

The government has also been driven to borrowing both from within the country and abroad. Within the country its resort to the State Bank has directly led to creation of money and that is inflationary and alternatively or simultaneously tapping the open financial market has led to the increase in the interest rate through its crowding out. Budgetary borrowings this year are twice that of last year and are far higher than the target. Rising interest rates have prompted cost push inflation. The protracted overall fiscal deficit has increased the debt liabilities.

The fiscal policy domain is intimately interfaced with that of monetary policy. Development on one side instantly permeates into the other. Breaching the budgetary borrowings targets has constrained credit for the private sector and its pace has slowed down from 20 percent to 13 percent during July –April 2007 and is far below the target. External borrowing by the government has increased the net foreign assets. Thus both these are largely factored in augmenting the aggregate money supply (M2) which has so far surpassed the last year level as well as the target. It is likely to touch a mark of 15.5 percent by year end. Given the past monetary over hang this will reinforce the existing strong underlying inflationary forces.

Expansion in net foreign assets is a healthy symbol of balance of payments but it is problematic for central monetary authorities. They often try to sterilize its impact while they are to ‘err on the side of the tight monetary policy’. In Pakistan the authorities have recognized its need but not much to show on the score board. This is indeed a difficult task to achieve, needing great skill and precision. In our case the policy tools like operation market operations, required reserves ratio etc when pressed into operation are likely to further increase interest rate and crowding out of the private sector, a tasteless and counterproductive alternative.

The government had undertaken a massive overhaul of tax and trade policy to foster global integration. The industry has heavily suffered form its fallout. The moral of the story is that the end has failed to justify the means. Our exports could increase only by 3.4 percent, a sharp dip in the trend and far less than the target. The trade deficit has already reached $ 9.5 billion in the first ten months of the year which would further rise by the time the year comes to close. Similarly the current account deficit estimate of 4.8 percent exceeds the last year’s level of 3.9 percent of GDP and 4.3 percent target. The real effective exchange rate has continued to experience creeping appreciation. This coupled with lack of any improvement in productivity has eroded the competitiveness of exports. The foreign exchange reserves at $13.7 billion, better than last year, have lost its relative parity with increased trade deficit, sometimes termed as safe limit.

There is excess liquidity in the global market and interest rates are relatively low in the developed countries. Any developing country disciplined under the World Bank and IMF charter realizes oversubscription of its sovereign bonds. The key thing to ensure is that the borrowing is kept within the some safe limits and does not impair the intergeneration equity.

Inflation has continued as a cause of concern both for the authorities and the consumer alike. Despite all official efforts including tight monetary stance it has not gone down to indicate a definite trend. The food inflation has touched double digit. This aggravates poverty and has also some implications in areas of the economy.

The continuing twin gaps in the budget and balance of payments are the basic reflection of the shortage of national resources. One fourth to one fifth of national investment, already at a low level, is financed through foreign loans. No significant developments in this area have recently been witnessed, and in casually addressing the issue, the foreign exchange reserves are being construed as obverse of the national resources and savings for investment. Progress in human capital development is ‘business as usual’ because of limited resources and long shopping list.
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