A chaotic adjustment
By Dr Meekal A Ahmed


The News, Sept. 26, 2011

It is interesting to observe that how virtually all writers in the media reacted negatively and with disappointment to the government’s decision not to seek the resumption of the moribund 2008 IMF stand-by arrangement or go for a new programme. No one has claimed this as a brave and bold step and there is no rejoicing over “breaking the begging bowl.” Perhaps, it is because the government’s decision does not surprise. Once again, when faced with a challenge and the opportunity to demonstrate sound economic judgment, the government has taken the easy way out. Now shorn of any constraints on the economic decision-making and with no economic framework to adhere to, there is the gnawing fear that an economy that is already vulnerable and weak will unravel quickly and could, as some have suggested, even face the specter of hyperinflation.

It would have been different if the economy’s starting conditions had been more propitious. A robust fiscal position with inflation under some semblance of control would have allowed room for maneuver and scope for a counter-cyclical fiscal policy stance to boost growth. But that is not the case. The fiscal side is already under strain and we are now in the fourth year of ruinous double-digit inflation. The strong headwinds being created by power outages, the circular debt, the security situation and public enterprise losses show no signs of diminishing anytime soon and continue to trim some 2-3 percent off the economy’s growth rate each year resulting in a staggering loss of economic activity.

The global economic environment is also darkening with the growth in Pakistan’s key export markets slowing sharply and risks of a “double-dip” recession and financial turmoil rising against a backdrop of policy-gridlock in the United States and grudging incrementalism in solving Europe’s sovereign debt problem, respectively. Given these unpropitious starting conditions, parting ways with the only force of discipline on policy-making in Pakistan -- even if the weight of that force is somewhat exaggerated -- one cannot but feel deeply apprehensive about what lies ahead.

The government’s argument is that the external side, invariably the harbinger of economic distress, is “comfortable” with gross reserves providing a cover of about 5.7 months’ of projected imports. It is easy to see how one can be misled into coming to such a conclusion. Given the present trajectory of the economy and assuming unchanged policies, that sense of comfort could prove to be fleeting and we could be heading towards a repeat of the cataclysmic events of 2008. The question that needs to be asked is to what extent the good balance of payments performance in 2010-11 was due to the one-off and transitory factors as opposed to structural or permanent factors? Have our exports, which set a record last year in terms of value, suggest a structural break of some kind that can be sustained? The evidence is not reassuring. Coming off such a high base, exports are unlikely to grow by much, if at all, in value terms in 2011-12 with the global growth slowing and world prices for Pakistan’s major exports reverting to historical levels. Imports on the other hand appear to be rising quickly reflecting the high price of food and oil imports. It is unclear if this upward trend will abate anytime soon as aggregate demand pressures in the economy remain strong.

Furthermore, no one would be prepared to place a wager on the future growth of workers’ remittances. While these inflows are sharply up again in the first two months of 2011-12 defying yet again all expectations, they still represent a phenomenon that is difficult to explain. Much speculation abounds as to what is driving these inflows. They range from the plausible such as the success of the “Remittance Initiative” to the more sinister which includes money laundering and “hot money” inflows into the stock market and the real estate sector -- taking advantage of section 111(4)of the income tax act wherein any inflows that come in though “normal” banking channels is free of questions as to source and tax -- as investors seek the much higher returns that can be earned in Pakistan, even allowing for exchange rate risk, compared to the extraordinarily low-interest rate environment presently prevailing in the west. Despite difficulties facing the US economy, the yield on a ten-year US treasury bill is still below 2 percent.

Given the difficulties of making accurate forecasts of how the external side will evolve, the government is taking a hugely calculated risk, even as one may question the sanity of the ‘calculators.’ Alternatively, this could simply be a reckless, politically-driven decision whose catastrophically negative effects on the economy have either not been spelt-out, or worse, glossed over with an air of haughty arrogance that has got us into trouble so many times before. Even a small exogenous domestic or external shock to the economy will cause the best forecast to veer sharply off-track. With the “IMF net” entry in the external accounts turning negative as repayments to them start, absent other off-setting inflows such as privatisation receipts, convertible bonds or resurgent foreign direct investment and portfolio inflows, the balance of payments will start to come under pressure. This will unnerve markets, possibly lead to a rating downgrade, trigger capital flight and culminate in a self-feeding downward spiral eerily similar to three years ago. The absence of an IMF program will also mean that other flows that were supposed to be “catalyzed” from multilateral and bilateral donors to support the budget and the balance of payments will not come in. This will create an ex-ante “financing gap” that needs to be filled ex-post. Will the ex-post adjustment be done in a carefully calibrated manner or in a muddled, chaotic and frenzied one?

The government has suggested, rather disingenuously, that while there is to be no IMF program at present, there could be one next year. It seems highly unlikely that the government will engage with the IMF or even start to implement the strictures of a new IMF program against the backdrop of up-coming elections or in the midst of one. Clearly, it is the government’s hope that they will manage to get by without the distraction of a burgeoning economic crisis. However, with no formal macroeconomic framework to adhere to, the new ever-changing targets for key economic variables that have no anchor, and no growth-enhancing structural reforms, the odds that the government can forestall a full-blown crisis would seem to be stacked heavily against it. The IMF staff’s recommendations as contained in the annual Article IV consultation report -- which authorities have so far refused to undertake as per their obligations under the agreement -- no matter how harsh and strident will have no impact because of the absence an IMF programme.
With impeccable timing, there should be a new and more “cooperative” Governor at the helm in the State Bank tasked not with the job of up-holding the integrity and autonomy of the high office he holds but with winning an election. Reflecting this mandate, we could see an aggressive and damagingly premature relaxation of monetary policy which would make the folly of the recent 0.5 percent cut in the policy rate pale in comparison.

A loose monetary policy will be superimposed on a loose and ever-loosening fiscal stance as the budget is increasingly burdened with tax cuts, subsidies, another salary increase and other populist, election-related spending in the vain hope that this will produce a chimera of growth. Yet, as past experience suggests, all this will lead to a progressive loss of control. Now unconstrained, government borrowing needs will soar and firmly shut out the private sector. Inflation will take-off, become more deeply-entrenched and will be propelled forward by “second-round” effects. Surely the people of Pakistan, especially the poor and the vulnerable, deserve better than to be put through yet another agonising nightmare born of feckless policy-making and political expedience?

In conclusion, let me end with a quote from Thomas Jefferson:” I tremble for my country when I reflect that God is just.”

The writer has worked in the Planning Commission and the IMF. He lives in Virginia, USA.
Meekalahmed2@aol.com