Youth Awareness











{January 11, 2011}   When politics trumps the economy

Dr Maleeha Lodhi
The writer is a former envoy to the US and UK, and a former editor of The News.

 

 

 

 

 

By winning back the MQM’s support in parliament, the PPP-led coalition has managed to avert a potential collapse and ease a political crisis. But this has been secured at a heavy price – the abandonment of urgent reforms that have put the economy in serious jeopardy and will place the government in a bigger bind later.

When the MQM walked out of the ruling coalition the PPP saw itself confronted with a choice between saving the government and saving the economy. To no one’s surprise it opted for the first. Political expediency trumped the urgency to fix the economy.

The PPP government first announced the decision to reverse the fuel price increase that was to take effect from the start of the new year. This was followed by the deferment of legislation in parliament to enforce a reformed general sales tax – demanded by much of the opposition and the MQM.

These decisions won the government a political reprieve that may yet turn out to be temporary. But they entail serious repercussions for an economy in disarray especially if compensating actions are not taken to offset the impact on an unsustainable fiscal situation. And these will also not be politically easy to take.

The rollback of the petroleum price decision will involve an additional subsidy of at least Rs5 billion or $53.8 million a month. As an IMF spokesperson put it, the bulk of this subsidy’s benefit will go to higher income individuals and large companies. Most deleteriously it will add to a spiralling budget deficit, which will likely be financed by printing more currency notes. The inflationary impact of this will soon offset the ostensible ‘benefit of rolling back the fuel price’.

The government’s economic team hopes to limit the damage by persuading its political principles to remove the fuel subsidy after one month – when the political crisis begins to recede. But it is not clear how such a weak government will make another policy U turn especially when the political environment remains charged and its position so fragile.

If the government fails to reduce the burden of the subsidy, mobilize additional revenue and cut inessential expenditure, the fiscal deficit will soar to a record level – around eight per cent of GDP. Financing such a large deficit mainly by borrowing from the State Bank will accelerate inflation, begin to deplete foreign exchange reserves and put pressure on the exchange rate.

The external side could then rapidly deteriorate and the present ‘record’ level of foreign exchange reserves slip quite quickly (as there is no offsetting financing and the oil import bill is rising) despite the continued robust inflow of workers’ remittances. The government will then be compelled again to seek external funding.

As the programme with the IMF is off-track loan disbursement by the Fund remains suspended. This together with the oil price decision will make it harder to receive financing from other international financial institutions – the World Bank and the Asian Development Bank. Instead of phasing out subsidies and address the vexed circular debt problem the latest government move compounds it. In the absence of other action on energy sector reform this will further complicate management of the country’s crippling energy crisis.

In an imploding fiscal situation created by the failure to mobilize revenue, limit expenditure and stem the losses in public sector enterprises including the energy utilities the government has been resorting to printing more currency notes as a politically convenient way to cover the widening fiscal gap. In an environment of high inflation further borrowing from the central Bank will undermine public confidence in the country’s currency, fuel greater inflationary expectations, move the economy towards dollarization, and push it a step closer to a state of hyperinflation.

Thus the celebration over the government’s rollback of the fuel price increase and RGST by most political leaders and much of the media overlooks the grave implications of these decisions in contributing to a deepening fiscal crisis and the danger this poses for the country’s stability: the prospect of runaway inflation which is the most cruel tax on the poor, erosion of everyone’s real purchasing power, retarding sluggish growth, crowding out the private sector, deepening poverty and ultimately engendering civil strife, even political instability.

It has been left to finance minister Hafiz Sheikh to warn parliamentary leaders about the gravity of this situation and the inflationary impact of continuing general subsidies particularly at a time when domestic resource mobilization measures in the form of the RGST are stalled in parliament. Many leaders seemed to understand the heightening risks but are unable to square the economic imperative with their politics.

Little understood by many who virulently oppose the RGST is the fact that this is the single most effective instrument that can generate substantial revenue. This is not to suggest that a VAT-like measure can unilaterally solve the country’s fiscal problems but its ability to enhance tax revenue by 2-3 per cent of GDP in the medium term makes it a more important option relative to others.

The unstated presumption behind the lack of official resolve on reforms and a similar attitude among opposition politicians is that the US-led international community will prevail on the IMF to resume lending and prevent an economic collapse in a strategically vital country. The stream of messages sent by Islamabad to top officials of the Obama Administration to weigh in with the Fund indicates this.

These have so far got little traction. Instead, in a public rebuke, Secretary of State Hillary Clinton criticized the reversal of the petroleum price increase and described this as a mistake. Ministers of other development partners have been more blunt in stating that their country’s taxpayers cannot be expected to help when Pakistan cannot get its own taxpayers to pay up.

Government leaders and others may therefore be miscalculating that Washington can or will ask the Fund to bail Islamabad out. At a time when the IMF is participating in programmes that entail sharp adjustments in many cash-strapped European countries is it realistic to think that it will apply different performance criteria here?

Can IMF funding be expected to resume to Pakistan without any national revenue effort or correction of fiscal policy and an automatic, flexible mechanism for administrative price adjustments that is by some measure symmetric and fair? Absent structural reforms to deal with the haemorrhage in public sector enterprises and worsening circular debt as well as significant control of expenditure, can any rescue plan even work?

Irrespective of what the IMF does, the growing economic disarray in the country should concern all leaders in and out of government. An economy with no direction and no policy reforms to halt the slide and the spectre of dangerously high inflation should engage the attention of all public representatives.

Tough economic decisions will ultimately have to be taken but the longer they are postponed the greater the adjustment that will be required. The political pain of necessary reform will have to be shared if Pakistan is to be saved from an economic breakdown.

This means forging a political consensus on a set of reform measures needed to restore financial stability. This can only be achieved by an informed debate in parliament and the media and an agreement not to politicize economic problems on whose resolution rests the very future of the country.

In today’s strained political environment evolving consensus on a minimum reform agenda may seem a vain hope but the alternative – a descent into economic chaos – should serve as a reminder of what might happen if no policy correctives are implemented. This ought to urge different stakeholders to review their stance of putting short-term expediency before the country’s economic security. After all without such stability their political gamesmanship will be in vain.

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