We shall overcome

In a post flood Pakistan, there will be an immediate contraction in output and an up-turn of inflation.

As the floods sweep out to the south, the one question that seems to be on everyone's mind, apart from our collective anguish at the scale of human suffering, is what will happen to the economy? At this early stage one can only give a broad-brush sketch of likely outcomes.

There will be an immediate contraction in output and an up-turn of inflation. However, once the flood recedes and the actual task of reconstruction/replacement (RR) of damaged/destroyed infrastructure starts, there could be a significant boost to growth. The recovery could be ‘V’-shaped and the rebound quite vigorous and prolonged. Employment should also rise since RR is labour-intensive.

There are concerns on the fiscal side and the risks of unconstrained monetary accommodation unless external resources are timely and are of a magnitude that can finance the widening deficit. Whatever the domestic and external resource envelope, the government would be ill-advised to simply ‘add-on’ to the existing fiscal burden the huge costs of RR. The government must undertake off-setting spending cuts in non-essential non-interest current expenditures. Hints that the development programme will be curtailed sharply to contain the fiscal deficit are a classic example of throwing the baby out with the bath water. The development programme should be re-prioritised with implementation of good projects speeded up, not slowed. The provinces need to rein in their deficits by cutting current spending as well as trim their development programmes.

In this context, the much-touted NFC award is turning out to be a monumental financial disaster since the vast resources given to the provinces do not have any conditionality attached to them. At the very least, there should have been a condition that failure to mobilise resources would mean that the centre will withhold funding by the amount of provincial taxes not collected. On the central government tax revenue side, it would not surprise if the government does something foolish like offer an income tax holiday. Bereft of any other revenue-raising option, the government will probably take the easy route and impose a flood development surcharge at the easy-to-collect import stage. This would be inelegant, regressive and inflationary. There should not be a GOP-IMF programme — it should be kept in abeyance. The present level of foreign exchange reserves at around $16 billion would suggest that Pakistan does not have an immediate 'balance of payments need'. The IMF should offer Pakistan high-access under their low-conditionality emergency facility for natural disasters.

However, the Pakistani delegation presently in Washington DC for talks with the IMF seems to be moving in the direction of restarting the GOP-IMF standby arrangement programme after making suitable adjustments to it. There has been some talk of Pakistan asking for debt relief. While such an option raises issues of moral hazard, given the extenuating circumstances and the scale of the disaster, this may be the right thing to ask for.

The prophets of doom and gloom in Pakistan are only making a fragile situation worse. By churning out their doomsday scenarios they will only rattle markets, put investors in a ‘wait-and-see’ mode, lower our international credit rating, increase our borrowing spreads, diminish confidence and fuel capital flight. This will put pressure on the rupee. A depreciating currency will only add to inflation via imports and compound the woes of a population which is already reeling from the ravages of this massive flood. Both the government by its actions and the media need to 'talk-up' the market, foster confidence and demonstrate by their actions and words that the economy and the country shall prevail and overcome.

Published in The Express Tribune, August 30^th, 2010.