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Time for introspection

Pakistan has now nearly had a haul of half decade with a GDP growth rate of below 5%. During the year ended June 30, 2012, Pakistan grew less than 4% and now in the second half of this year the growth figures appear to be no better. Compare this growth with the average growth of about 6.50% during 2002 to 2007, and the change in country’s fortunes, strictly in terms of growth and development, unfortunately does not make a good read. The decline is even sharper if we compare the present growth trend to the peak of 7.50% during the five years mentioned above. While corruption and wrong prioritization of resources by the government are factors surely to be blamed, a part of this slowdown is also attributed to the simple paralysis in decision-making from which the government never really recovered in its five years term about to end in March 2013. The role of the government’s paralysis is corroborated by the sheer inaction on the energy front, which has resulted in a compounded slowdown in manufacturing. Manufacturing, as we know carries a highly elastic behavior vis-à-vis governmental decision-making. While there is no real data available on the growth of the SME (small and medium size enterprises) over the last five years, the LSM (large scale manufacturing) has been growing well below the GDP growth level, which means that in-effect it has been shrinking. Sadly for Pakistan the services sector, which in many ways is less directly dependent on governmental decision-making, also took a nose dive due to the prevailing concerns on security and the law and order situation in the country.

This being said, perhaps the greatest across-the-board negative impact on growth has originated in the severe monetary brakes applied on the private sector and this with either the collusion of the State Bank of Pakistan’s (SBP) or due to its sheer indifference in redressing the situation in a prudent and timely manner – Either way the action or the lack of it cannot be condoned. The story of the private sector being crowded out is well known, but less well known is the fact that the SBP has been injecting liquidity into the banking sector with a targeted purpose of raising governmental debt and that share of private sector borrowing from its peak in 2004-05 has been reduced to less than one fourth. Adequate monetary growth provides the grease that oils the forward movement of a growing economy. While too much of it can make the aggregate demand run ahead of real incomes, thus, fuel inflation, too little of it can arrest, even cripple, the forward movement. Historically, the SBP maintained a relatively steady (close to double-digit or double-digit) annual growth in the monetary base, which determines the availability of credit in the economy. However, in recent years the squeeze has mainly been put on the private sector which continues to hold since the government appetite for debt is growing, whereas, its revenue raising resources are failing to keep pace with its spending budgets. This credit crunch complemented by high fiscal deficits, has administered a double whammy on the private sector.

Traditionally, the SBP has set growth with macroeconomic stability as the objective of its policy. Lately, it has abandoned the growth objective altogether. And even with respect to the macroeconomic stability, it has chosen to focus (nearly obsessively) on just one, even if key, element in such stability: Inflation. Setting aside any exceptional year or a certain brief period in the history of Pakistan, inflation rates in Pakistan have never consistently been in the single digit range. Yet the SBP and the economic team dealing with the international lending institutions tend to tame inflation in the Pakistani economic context to levels that are neither realistic nor keeping in line with our past trends. Ironically, the SBP has had at best partial success in combating inflation due to its poor management in another key area: the external sector. In the early years from when Pakistan adopted the flexible exchange rates, the practice of the SBP was to intervene in the foreign-exchange market to smoothen out short-run fluctuations while leaning against excessive appreciation of the Pak Rupee in the longer term. That policy stance provided short-run exchange-rate stability while allowing the SBP to build up somewhat reasonable levels of foreign exchange reserves. However, every time a political dispensation has taken place (the current one being no exception) their actions have thrown caution to the wind and generally adopted a kind of hands-off exchange-rate policy that sadly saw huge devaluations in the Pak Rupee’s parity against the global currencies and a regular erosion of our dollar war chest from where we have not been able to recover.

These policies have not been without consequences for the economy. The gross external debt has rapidly climbed unprecedently in the last five years and now not only significantly exceeds the foreign exchange reserves, but in fact the gap is so huge that it seems that no real policy linkage can be established between the two figures. Or at least the government certainly does not believe in linking these two. Needless to say that this phenomenon of rising external debt, devaluing Pak Rupee and our failure to build up healthy foreign exchange reserves has left the Pak economy extremely vulnerable on the external front. In consequence, as things stand today, the ability of the SBP to credibly intervene in the foreign exchange market to stem Pak Rupee depreciation stands greatly compromised. So, the Pak Rupee has been going into this free fall with obvious consequences on inflation. A depreciating rupee means rising rupee prices of oil and other essential imports even if the world prices of those goods did not rise.

A fiscally-strapped government has had no choice but to pass on a large chunk of these price rises to the consumers or to the ordinary Pakistanis in an environment where they are already suffering in absence of any real growth and job creation in the economy. And unless there is change of heart at the SBP, this policy will take matters deeper into a vicious cycle as it leaves the SBP with only one option if it is to keep on insisting on single-mindedly clamping down on inflation: A yet greater squeeze on the monetary base of the private sector and a prolonging of the misery of the Pakistani people where they may be coming to an employable age, but sadly no jobs waiting for them in the market!

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