‘Fixing current account key to GDP growth’

LSE report highlights urgent need for structural reforms, less dependency on imports, loans

LAHORE:

The newly elected government’s first policy challenge will be to raise GDP growth, which is expected to remain at 2.71% for FY-24. However, the new country’s financial managers have to break the hysteresis that appears to have become embedded in the economy since FY23, and persists into FY24, said a recent research report launched by Lahore School of Economics.

The report highlights that Pakistan’s economy is highly import dependent, especially in large-scale manufacturing. A high growth rate of GDP verging on 6% over FY22 required import levels of $90 billion. Over FY23, these import levels dropped to $67 billion, and over FY24, this import constraint still appears to bite. Prior to the import constraint, in FY22, the level of imports required per month topped $7 billion, the report said.

Over FY23, this import level has dropped to $5.5 billion per month. Over the first quarter (Q1) of FY24, this import level has persisted at $5.5 billion per month. The import constraint has continued from FY23 to FY24 because its causal factors have also continued from the said period. These have been observed to be a persistent deficit in the current account (CA), a rapidly depreciating exchange rate, and weak reserves of foreign exchange, said the report.

All three causal factors make it difficult to pay a high import bill, which is needed for higher GDP growth.

The report added that the crisis for the economy is largely a current account crisis, and the government’s agreement with the International Monetary Fund (IMF) for the short-term Service Level Agreement loan of $3 billion can only be palliative at best, as twenty-three agreements with recourse to IMF loans only serve to sharpen this policy lesson.

The report further said that the economy’s main vulnerability is on its current account, and no domestic restructuring of the economy will fix the CA issue. “Only restructuring the current account will fix the current account.” High inflation too appears to have become embedded in the economy over FY23 and as observed in the first quarter (Q1) of FY24. Inflation has raged, approximating 30%.

The three main causal factors for such high inflation, estimated by our model, are rapid depreciation of the exchange rate, a large budgetary deficit, and an increase in energy prices. Government policy, in allowing a depreciation of the exchange rate or running a high budget deficit, does not have the objective of raising consumer prices. It is an inadvertent result. However, GOP’s policy, in raising energy prices, does have the objective of raising consumer prices, the report added.

Further, the report estimates that nearly two-thirds of the increase in the prices of the six main sources of energy are not to recoup an increase in suppliers’ prices but to raise the GOP’s tax. Here GOP policy must be prudent. GOP needs to reduce its budget deficit by raising taxes. But raising ad valorem taxes on energy is very inflationary, as observed; however, raising income taxes will not be inflationary and will also be more progressive and serve the purpose of fixing the current account deficit of the country.

Published in The Express Tribune, February 25^th, 2024.

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