GDP growth: only way out of the mess

Let us give credit where credit is due. This government, during its tenure, was faced with an extremely difficult international economic environment, which included the most severe global recession in a century and a steep rise in commodity and fuel prices. The domestic circumstances are also acutely challenging with the threat of religious extremism, nationalist militancy in Balochistan and an ethnic war in Karachi. These fractures combined with two devastating floods. Yet, despite these unprecedented adverse circumstances, the government managed to gradually increase, albeit marginally, the GDP growth rate from a historic low of 2.2 per cent three years ago to 3.7 per cent this year. Despite the brave economic firefighting by an embattled government, let us face it: Pakistan’s economy continues to stagnate at a per capita income growth of less than one per cent, while the inflation rate remains high at 10.9 per cent.

The prospect of intensified pressures on the economy and society in the future flows out of this basic fact. The principal parameters of these pressures in the real economy are high and rising levels of poverty, unemployment and a large-scale manufacturing industry that is at a virtual standstill: a dismal 1.1 per cent growth compared to its historical trend rate of over 10 per cent. Agriculture growth, even though it has picked up, will not help prop up the crumbling financial edifice through tax revenues in the absence of an effective agriculture income tax. It will also have a limited role in supporting the balance of payments through export earnings, due to the present low value-added nature of exportables in this sector.

Stagnation in the real economy has generated a range of financial pressures, which in the absence of deft governance can trigger an economic meltdown. The shortage of revenues associated with slow GDP growth has induced the government into imprudent borrowing of a kind that has not only doubled the stock of debt over the last four years but has also changed its composition towards high cost short-term debt. It is self delusory to take comfort in the fact that debt as a percentage of GDP is only 60 per cent compared with 124 per cent in Greece. The key issue here is that the debt servicing cost is unbearable at 40 per cent of government revenue. These debt servicing pressures are pushing the government into a vicious cycle of short-term borrowing and rising budget deficits.

Rapidly rising current expenditures are fuelling this vicious cycle as the government tries to manage subsidies on electricity, widespread violence by armed militant groups and the ‘Draculas’ of public sector entities as they bite into the financial arteries of the state with Rs500 billion annual losses. Then, of course, there is the economic cost of maintaining political power in a rent based social order where state resources are handed out in myriad forms to various factions within the power structure.

To add to its financial woes, the government is continuing to confront its principal aid donors on the issue of an ambiguous security policy. This has not only reduced foreign aid inflows but has also increased Pakistan’s risk rating thereby making borrowing from the global capital markets more expensive.

Faced with fiscal pressures, the government, instead of reducing non-productive expenditures, has drastically reduced development expenditure. This has not only deprived the economy of much-needed stimulus, but has also constrained expenditure on electricity generation, gas production and improvements in irrigation efficiencies, which constitute physical constraints to economic growth.

The key issue to understand is that a growth policy and not economic contraction is the path to financial stability. It is through higher revenues which a higher GDP growth provides, that the budget deficit can be reduced. At the same time, what we need to worry about is, not the size of the budget deficit, but its composition. If a budget deficit of even seven per cent is being caused by productive expenditure that creates employment, incomes and a revenue stream in the future, it ought to be acceptable. But not if the budget deficit is derived from unproductive expenditure that only lines the pockets of the elite.

Published in The Express Tribune, June 4^th, 2012.