Crisis and bankruptcy

Pakistan is neither in crisis nor bankrupt. Unless immediate, forceful change in policy is brought about, we will be.

‘Crisis’ and ‘bankruptcy’ are two of the most overused words in Pakistan. Even sensible people, from diplomats to economists (who should know better because these are technical terms), use these two words with casual abandon. Is there any basis for this exuberant wordplay or is it just another example of our penchant for drama and crying wolf?

Based on available data, macroeconomic performance in the first four months of 2011-12 (July-October) presents a mixed picture. Following the peaks reached last year, exports and workers’ remittances continue to do well. But the external trade and current account deficit has widened appreciably because imports are rising too quickly. If the FBR is to be believed, tax revenue collections are doing surprisingly well. Yet government borrowing to finance the budget deficit is soaring, which suggests that spending is growing strongly and the fiscal deficit is increasing. Inflation is showing signs of easing, although some of that is a statistical illusion due to re-basing and changing some of the weights. Finally, M2 (or money supply) has fallen, which is good news for inflation but a look at the components of M2 reveals some disturbing trends. Government borrowing is up sharply (both for the budget and into that black hole which we call ‘public sector enterprises’) while credit to the private sector, the main engine of growth and jobs, has declined.

Still, the economy is neither in a crisis nor is it bankrupt. It is projected to expand by 3-4 per cent year-on-year notwithstanding the drag that is being imposed on it by crippling energy shortfalls which, as one estimate suggests, subtracts some 2-2.5 per cent from our annual growth rate. If we add the economic costs of the floods, circular debt, public enterprises losses, the security situation and political instability, a growth outcome at even the midpoint of the expected range would not be a trifling accomplishment. It would bear testimony to the economy’s resilience and its ability to bounce back and grow despite the turbulence being generated in the wake of numerous adverse domestic and external shocks. Nor could we be bankrupt, since the government continues to service its domestic and external debts on time and the total debt-to-GDP ratio, despite its unfavourable dynamics, is not excessive.

Having said that, there are no grounds for bravado and machismo. The authorities’ decision to part ways with the IMF despite an unfinished reform agenda suggests that not only has ‘adjustment fatigue’ set in, but that they are falling into the all-too-familiar trap of becoming complacent and arrogant, taking false comfort from a seemingly ‘comfortable’ cushion of foreign exchange reserves, even though history teaches us that this has been Pakistan’s undoing every time. Just as the economy evinces signs of a turn-around, prudence gives way to self-destructive populism.

The cold reality is that without an immediate and forceful change in policy direction, the immutable laws of economics will assert themselves. Domestically, absent a Letter of Comfort from the IMF to unlock some of the financing for the budget, financing will have to come from high-cost domestic non-bank borrowing, commercial banks and the printing press. This will push up domestic debt, accentuate the crowding-out of the private sector that is already in evidence and, after a lag, impart a fresh inflationary impulse into the economy.

The government (like all governments) had incorporated many fanciful assumptions which were supposed to fill a much smaller external financing gap at the time of the budget. However, none of them — reimbursements from the CSF, privatisation receipts, whether new or pertaining to PTCL, floating a Eurobond — appear to be anywhere near to fruition, while other autonomous private capital inflows are declining. If this is the case, financing the external accounts can only come from the proverbial ‘bottom line’: a drawdown of our stock of foreign exchange reserves. But this would be a course that is fraught with grave risks since a closely watched and highly visible reserve loss tends to be self-propagating via expectation-inducing effects that end in a death spiral. To many observers, it is not a matter of whether, but when, Pakistan will face another crisis and go bankrupt.

Published in The Express Tribune, November 29^th, 2011.