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Economic growth and political instability

Economic growth and political instability

Pakistan’s economic situation has attracted a wide range of commentary from analysts. The signs of economic meltdown and the rather candid report released recently by the State Bank have caused much alarm about structural issues as well as economic management. Another school of thought articulates that our understanding of what drives the economy is under-researched and, therefore, predictions of an economic collapse are far fetched. It is also important to remind ourselves that political instability directly affects the economic performance of a country and Pakistan is no exception to this well-known constraint.
Throughout 2011, Pakistan remained hostage to political developments that bred uncertainty and affected decision-making as the government kept itself busy with surviving in office than focusing on ‘policy’. As the State Bank of Pakistan’s report noted:

“Economic slowdown, high inflation, volatile movement in some key commodity prices, high cost of war on terror and its severely negative consequences like considerable internal displacement, have acted as negative shocks for the economy”.   
Pakistan’s economy managed to grow by 2.4%  during the fiscal year 2010-11. According to the State Bank, the government will again miss the 4% fiscal deficit target in FY12, with doubts on both expenditure and revenue targets. The floods in Sindh and a prolonged wave of dengue fever in Punjab, caused a rather heavy fiscal burden. Given that this is the election year, provincial and federal governments will indulge in massive public spending. The economy is likely to grow between 3 to 4%.
The foreign exchange reserves, stood at $18.3 billion in July, fell to $16.7 billion in the last week of December. In the early months of 2012, the current level of foreign exchange reserves is likely to decrease further due to reasons more than one. The State Bank also projects that inflation will remain within a band of 11.5-12.5% during 2011-12.
The State Bank also says that government’s domestic debt for budgetary borrowing has reached to almost unmanageable level of nearly Rs 900 billion. Given the trend, it might reach Rs1.5 trillion in next six months. The interest payments account for 32-33% of government revenues. Debt management is an area where most governments are found lacking.
It is also anticipated that due to the fiscal crunch, a sharp decline in development spending would continue affecting the fixed investment and future growth prospects. The most worrying aspect is that the federal subsidies to perennially sick public sector enterprises were three times higher than what had been envisaged in the budget. Pakistan Railways, PIA and Pakistan Steel are the key examples of mismanagement, which causes financial drain; and increased budgetary deficit.
On the trade front, there are reasons to worry as well. With the global recession, the possibility of a slowdown in our exports has arisen. The US and EU are the primary destination for Pakistani goods. However, the State Bank report has allayed such fears by citing the historical trend: Given our track record of precarious external deficits, market participants tend to expect the worst.
It should be noted that Pakistan’s current account balance in Fiscal Year 2010-11 was positive for the first time in six years, and import coverage extends to 26.6 weeks. The trade deficit narrowed to US$ 10.5 billion, which was largely financed by strong growth in worker remittances that reached a record US$ 11.2 billion.
Nearly 73 million Pakistanis live below the poverty line as the poverty ratio increased to 40% during the last fiscal year 2010 while it stayed at 36.1%  in 2009. The people living below the poverty line are more vulnerable to economic shocks than any other segment of society and may fall further in the abyss of abject poverty. Worse, food inflation, energy shortages etc are affecting the lives of the poor and fixed-income groups.
The state of formal economy looks dismal. However, that is just a partial story. Pakistan’s informal economy is believed to have grown to more than half the formal economy, which yields a GDP of $166 billion. One report suggested that that the size of informal economy stands at $83 billion and that it could yield the national exchequer revenue of $8 billion if taxed at 10% (Pakistan Today, Nov 5, 2011).
The 2010 study conducted by the State Bank of Pakistan showed that the informal economy was around 30% of the total economy in Pakistan. The report was cautious in saying that the informal economy has grown with almost the same rate as the recorded economy.
Earlier a study by M. Ali Kemal (Pakistan Institute of Development Economics, 2007), says that in the long run, underground economy and official economy are positively associated. Kemal (2007) estimated that the black economy ranged between Rs 2.91 trillion and Rs 3.34 trillion (54.6% of GDP to 62.8% of GDP respectively) in 2005. Underground economy and tax evasion were increasing very rapidly in the early 1980s but the rate of increase accelerated in the 1990s. It declined in 1999, but reverted to an increasing trend until 2003. According to Mian Abrar Ahmed, President, Karachi Chamber of Commerce and Industry (KCCI) Afghan Transit Trade is also a major source of informal economy.
We have yet to understand Pakistan’s economy. The conventional analysis on tracking the macroeconomic indicators is useful and vital but at best partial. The informal sector of Pakistan keeps the country going and it exists on the margins of the documented economy. What happens at the local level is a story yet to be captured and fully understood. At the same time, we cannot be oblivious to the fact that Pakistan’s investment rate was only 13.4% in FY 2010-11, which is the lowest since 1974 according to the State Bank of Pakistan.  Similarly the Bank fears that poverty is going to rise for a multitude of factors unless the policy priorities of the civilian coalition are reset.
The State Bank rightly notes that “institutional” weaknesses are directly responsible for poor economic growth in the country. “Both domestic and global factors are responsible”, says the Bank adding, “domestic issues are more decisive and chronic. These include the collapse of fixed investment, acute energy shortages, urban violence and lawlessness, poor physical infrastructure and institutional fragility.”
The real challenge is how can Pakistan move towards a policy framework that promotes equitable economic growth and provides more jobs for the unemployed whose numbers are rising by the day. The informal sector is linked to the formal economy and growth in both the areas is vital to absorb new entrants into the job market especially the youth who will soon become the largest population group in the country. For this to happen, there has to be semblance of political stability; and Pakistan at least in the short term is poised to face more uncertainty.
As the State Bank of Pakistan says:

“the growth outlook will be shaped by policy responses to several key domestic challenges: (1) energy shortages, which are restricting growth; (2) the high fiscal deficit whose financing has become difficult — partly owing to the backlog arising from the non-recognition of power sector subsidies of earlier years as reflected in the circular debt; (3) build-up of domestic debt, raising concerns for macro stability; and (4) inflationary pressures which are not receding readily.”
All these issues require a political consensus that is missing; and there is a popular clamour for return of authoritarian rule as the ‘economy’ hold many pundits functions better under technocrats when the politicians are ousted. This fallacy based on the higher growth rates with extraordinary aid inflows under military regimes needs to put into a perspective. As Dr Ishrat Husain, in one of his papers, The Role of Politics in Pakistan’s Economy (Journal of International Affairs, Columbia 2009) has rightly pointed out:

“Democracy, with such flaws and shortcomings as corruption and patronage, may cause economic disruptions and slow down development in the short-term. But it should be allowed to run its course as the inherent process of fresh leadership and governmental accountability through new elections provides a built-in stability to the system that eventually brings the economy back to equilibrium. Interruptions to the democratic process in the name of economic efficiency have created more problems than solutions in Pakistan.”

Pakistan’s unstable democratic system and the ongoing tussle between elected and unelected institutions are costing the economy a great deal. The primacy of ‘national security’ at the expense of development, growth and rights remains unchecked; and there can be no guarantees that a sudden regime change will bring improve economic indicators. Instead, the political actors must work together to address the huge challenge at hand.

A version of this article appeared in The News on Sunday Jan 8, 2012

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