Policy framework and structural change
The macroeconomic policy framework of successive regimes is composed of fiscal prudence and tight monetary policy to achieve low inflation rate. These so-called good macroeconomic fundamentals have hindered the desired structural change in the economy. These macroeconomic fundamentals have a great impact on the followings.
Tight fiscal and monetary policies give rise to an over-valued rupee vis-a-vis the US dollar. This over-valuation affects the competitiveness of exports. Since our export basket tilts in favour of textiles, their competitiveness is dented. That is the reason exporters are talking up the cost pressure.
These tight policies have an impact on the composition of the fiscal budget. Debt servicing has gobbled up a large chunk of federal expenditure and successive governments could not reduce the running expenditure owing to their inertial nature. Then development expenditure became the sacrificial goat.
On the revenue front, governments have to rely on regressive taxes to meet their targets. Under direct taxes, they have to rely on the withholding tax regime as there is a lack of voluntary compliance. On this basis, workers and managers in the formal sector are facing the brunt over the last couple of years. Hence, the composition of the fiscal budget restricts allocations for physical and human capital.
These policies also affect the external sector a great deal. The external account is composed of current account and capital/financial account. The economy has been experiencing trade deficit since long and these policies play a vital role in perpetuating this trend. As the current account is in deficit, the financial/capital account has to be in positive as per the international public accounting practice.
Since the financial account consists of foreign direct investment (FDI), portfolio investment and net international reserves, their composition also changes. In the event FDI is not forthcoming, the country has to rely on portfolio investment to some extent.
In addition, it has to shore up reserves through open market purchases. The State Bank of Pakistan (SBP) has bought dollars from the market to bolster its reserves in the last couple of years. So, these policies change the composition of the external account.
Owing to these stringent policies, the industrial structure could neither be adjusted to the international patterns of wants nor adjusted its export capacity. Export capacity remained dependent on import content. This dependence does not allow exports to grow fast while imports kept on increasing.
In other words, the volume of exports increased without a meaningful addition to the value-added sector. Hence, the value-added exports could not be increased to the desired level.
Terms of trade show the ratio of export prices to import ones. As far as the case of developing economies is concerned, there is a decline in the terms of trade over a period of time and Pakistan is not an exception in this regard.
As value-added exports command high prices and Pakistan's exporters could not acquire high value-added functions, our exports remained stuck in a low-to-medium value category and hence export prices remained range bound.
On the contrary, import prices kept on increasing as the economy requires expensive capital goods, intermediate inputs and raw materials. Being a net importer of oil, it has to consume precious dollars as and when international crude oil prices surpass $80 per barrel. Hence, the terms of trade decline, which is not good from the development perspective.
In a nutshell, a good macroeconomic policy framework inhibited the structural change required for the economy. Successive regimes have ignored traditional macroeconomic fundamentals such as high aggregate demand and a competitive real exchange rate. Therefore, the country is stuck with low value-added exports.
The writer is an independent economist and authored a book: Pakistan's Structural Economic Problems in the era of Financial Globalisation