South Asia’s policy dilemma
By Shahid Javed Burki

Both India and Pakistan are passing through delicate political times. India is getting ready to hold the next general election no later than the spring of next year when the term of the current government expires. Pakistan, having held elections in May 2013, has a new government in place. In both cases, the government that holds the reins of power will be tested in the field of economics. How the performance of the two governments will be judged is a question that is being debated in the two countries. The Indian government, under Prime Minister Dr Manmohan Singh, has concluded that its performance will essentially be determined by the prices people have to pay for the items of everyday consumption. Inflation has been relatively high in recent months. The new Pakistani government, headed by Prime Minister Nawaz Sharif, seems half-inclined to treat the level of prices as an important test for its ability to restore economic health to the country. In adopting these policy decisions, the two governments are making serious political mistakes. Their electoral appeal will be determined by the rates of growth of their economies and not by modest changes in the level of prices.
For the last several months, the South Asian currencies have been under a great deal of stress. The Indian rupee has lost 20 per cent of its value in terms of the American dollar since the beginning of this year. The Pakistani rupee lost close to 14 per cent of its value in the same period. Both governments have taken some steps to steady their currencies. Both have had some success. In both cases, the rupee has pulled back from the lows it reached. But, in focusing on the value of their respective currencies, they have made one big mistake that will prove to be politically costly. They have opted for stabilisation over growth. For this, they have been punished by the markets. The markets will continue to be sceptical for as long as the policymakers don’t change the long-term course they are taking and adopt policies that will take the rate of growth to a higher plane.
The only way to steady the markets, on both sides of the border, is to give a clear signal to them that the policymakers have a well thought out strategy in place to address the longer-term issues the two countries face. Here, India has greater degrees of freedom than those available to Pakistan. To some extent, the policymakers in Islamabad have their hands tied because of the programme they have signed with the International Monetary Fund (IMF). The choice they have to make is between growth and stability. Even though the IMF’s traditional focus on the latter, at the expense of the former, has been softened somewhat by its experience in the late 1990s during the Asian financial crisis, the institution has not significantly departed from its long-held philosophy. Then the countries receiving help from the institution had to drastically reduce public expenditure, curtail domestic demand by raising interest rates and open the economies to foreign trade. The strategy worked but at the expense of a sharp economic contraction, loss of jobs and increase in the incidence of poverty.
The approaches being followed by both India and Pakistan are less drastic but both countries are leaning towards achieving economic stability, even if it means reducing the rate of growth. Both are using the interest rate as an instrument for stabilising the economy. The policymakers fear inflation more than a slowdown in the rate of economic growth but they don’t have the political muscle to rein government expenditure. Not being able to use fiscal policy as a stabiliser, the policymakers are using monetary tools. That is a mistake. They should take some risk with inflation to get growth back on track. That approach will also create greater confidence in the markets and help with the exchange rate.
Growth versus price stabilisation is not a new debate. Nor is the debate about the most effective instrument for increasing the rate of economic growth. Liberal economists have always put growth before stabilisation. It is only with growth that the poorer segments of the population can be helped. There is a virtual consensus among policy analysts that interest rates are the most important tool available to governments for promoting growth. Economists use a formulation, called the Investment-Savings equation (IS curve), to show how interest rates can slow or increase the rate of economic growth. For economies such as those in South Asia, slight interest rate adjustments can produce telling results. With sharp declines in GDP growth in India over the last year and a half, the country needs to lower interests to reignite growth. With Pakistan’s economy stuck in a recession for the last six years, it is also the lowering of the interest rate that should be the policy of choice. In both cases, however, the currency markets have pushed the policymakers in the opposite direction. Sharp declines in the values of the two currencies have persuaded the managers in the two countries to increase interest rates. By doing so, they have stabilised their currencies — perhaps, only temporarily — but they have achieved that result by jeopardising growth.

Published in The Express Tribune, October 7th, 2013.