Between the hammer and the anvil | Political economics


The national economy is in troubled waters. The fact that analogies are drawn between Pakistan and Sri Lanka should give pause to all Pakistanis. Conventional wisdom suggests that when economies run into trouble, the respective stock markets are the first to react. By this standard, the recent collapse of the Pakistan Stock Exchange (a 2.23% drop in the KSE-100 index in a single day) is an unmistakable indicator that there is something fundamentally wrong with the Pakistani economy.

In a related development, the rupee was in a virtual free fall. On Thursday, the US Dollar traded at an all-time high of Rs 192.20. A high debt level, a sharp increase in world commodity prices and a widening trade deficit which has hit the Pakistani economy hard are closely linked to these developments.

So what went wrong with Pakistan’s economy? Apparently, there is no simple explanation. A complex set of deep-rooted structural issues has plagued Pakistan’s economy for some time. Although there is a lot of overlap in the factors influencing the economy, we can analyze some of these factors in isolation without much loss of generality.

The most crucial question is why the Pakistani rupee has been in free fall for four years and if it is possible to stop the trend. To begin with, the value of a currency is intrinsically linked to the size of foreign exchange reserves and the gap between exports and imports. In the recent past, Pakistan has been in a difficult situation in terms of foreign exchange reserves.

The State Bank’s foreign exchange reserves fell to around $10 billion and the current account deficit reached $13 billion. According to another estimate, Pakistan’s trade deficit crossed $39 billion in the first ten months of the current fiscal year and the volume of imports grew at twice the growth rate of exports. A combination of depleted foreign exchange reserves and widening trade deficit put the national currency under pressure, fueling inflation and forcing the government to raise interest rates to halt inflationary trends.

External factors greatly aggravate Pakistan’s economic problems. The slowdown in several major economies and the rise in oil prices resulting from the Russian invasion of Ukraine also contributed to higher global commodity prices and hence to higher inflation and devaluation. of the Pakistani rupee against the dollar.

A high degree of indebtedness has also shaken the Pakistani economy. Pakistan’s external debt averaged $65.223 billion from 2002 to 2021, reaching a record high of $130.632 billion in the fourth quarter of 2021. In relative terms, Pakistan’s external debt was around 26% of its GDP in 2014, dropping to 23.5% in 2016 and increasing to 26.7% in 2018. It climbed to 33% in 2019 and peaked at 37.6% in 2020.

Political demands are at the heart of government dithering. Every rise in commodity prices will fuel Imran Khan’s campaign for snap elections. Staying the course, on the other hand, will further increase the budget deficit, which will lead to higher debt..

There are conflicting arguments regarding the impact of public debt. One of the arguments is that indebtedness makes Pakistan extremely vulnerable to economic shocks, weakens it vis à vis external lenders and has seriously compromised its ability to invest in education and health. Another view is that the debt-to-GDP ratio may be irrelevant to economic stability requirements. Recent estimates show interesting patterns in debt-to-GDP ratios around the world. According to the most recent data, the debt-to-GDP ratio is 117% in Australia, 161% in Austria, 204% in Finland and 685% in Ireland. On the other hand, even low debt-to-GDP ratios can overwhelm some economies.

It is almost a truism that the burden of inflation is unevenly distributed among different wealth groups. The poor bear the brunt of inflation. Worryingly, poor and vulnerable population groups in Pakistan are expected to continue to suffer as there does not appear to be any immediate easing in inflationary trends, with the trade deficit expected to reach $50 billion by the end of this fiscal year.

Another factor that is hurting the economy is the widening budget deficit. It has exploded recently, especially in the first three quarters of the current fiscal year, mainly due to the chosen revenue generation model.

Pakistan collects revenue in two forms: tax and non-tax. The RBF is primarily responsible for tax revenue collection and has been relatively successful in meeting its revenue collection target, registering a growth rate of 28% in the first three quarters of the current fiscal year. However, it will be difficult to sustain growth as the government is under pressure to limit imports.

Against an increase in tax revenue, there has been a significant decline in non-tax revenue. Oil royalties have traditionally been a large part of the non-tax revenue pie. Only 20% of the Rs 620 billion target was collected in the first nine months of the current financial year, with little hope for significant growth in the final quarter. Consequently, the economy will be more stressed.

It can be instructive to see how politics affects the economy and vice versa. The current government is inherently unstable. The political situation has left the incumbent regime with little clarity as to how long it will be in power. Uncertainty is hampering the process of economic recovery. The government is faced with a proverbial dilemma: “to call or not to call an election right away”. A miscalculation can prove fatal for the coalition.

The way the government has conducted its business has also troubled the economy. After a brief period of optimism about the ability of the PML-N-led coalition to turn around the economy, the emerging view is that the current regime is clueless. He was unable to pull himself together and take the necessary steps to avoid an economic collapse. In the meantime, the former Prime Minister has given him a formidable political challenge.

The fact that the regime also suffers from internal contradictions has not helped. The International Monetary Fund wants the government to roll back fuel subsidies and tax exemptions. The government sees the subsidies announced by the previous government as “landmines” deliberately planted after the former prime minister saw the writing on the wall.

However, the government itself has no clear vision. According to some reports, Ishaq Dar, the former finance minister, strongly opposed the IMF conditions. When clarity about who makes decisions and where accountability ends is lacking, the economy suffers. This is especially true because financial support from “brother Islamic countries” and other “friendly” countries does not seem to arrive without IMF approval. Moreover, investor confidence is eroding. Significant capital flight will further complicate Pakistan’s situation.

Political demands are at the heart of the dithering. Every rise in commodity prices will fuel Imran Khan’s campaign for snap elections. On the other hand, staying the course will increase the budget deficit, leading to higher debt, higher interest rates and more economic chaos. The government seems to be between a rock and a hard place. It could be forced to phase out energy subsidies to guard against a potential Sri Lanka-like default.

The author is Associate Professor in Department of Economics, COMSATS University Islamabad, Lahore Campus

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