State of denial

THERE seem to be two conflicting views about the state of the economy. The first shared by most independent economists and analysts is that worsening fiscal and balance of payments deficits warrant urgent corrective action otherwise the country will head inescapably into an economic crisis.

The second view held mainly by the government’s economic managers is that there is no near term risk to the economy or looming crisis and they can continue with business as usual. This helps to explain why in its last days in power, the government has gone on a pre-election spending binge, which will leave public finances in complete shambles.

Saleem Mandviwalla started his short stint as finance minister by making the astonishing claim that the country is “in a comfortable place” and there is no balance of payments problem – this, at a time when Pakistan is teetering on the edge of such a crisis. If the minister had cared to read the budget strategy paper that he presented to the cabinet last week he would have not have been so complacent. That document stated starkly that “the fundamental short-term risk” to Pakistan’s fragile economy “is sustainability of foreign exchange reserves”.

Mandviwalla’s claim at a subsequent press conference was even more disingenuous. He declared that his government was leaving the economy in “good shape”. These statements echoed earlier assertions by the Governor of the State Bank, Yaseen Anwar, that Pakistan faced no crisis of foreign exchange reserves that necessitated turning to the IMF for financing. He also said, without elaborating, that there were many strategies Pakistan could pursue that did not require the Fund’s help. The governor and finance minister have both chosen to downplay the threat posed to financial stability by the country’s critical balance of payments situation for which the evidence is overwhelming. Both insist Pakistan has enough foreign exchange reserves to meet its external debt obligations so there is little reason to worry, at least till the end of this fiscal year. It seems to escape both the governor and the minister that a crisis doesn’t wait to erupt when foreign exchange reserves fall to zero. It can happen when the reserve level dips so low as to spark panic in the market and send confidence plummeting.

Dr Maleeha Lodhi When panic spreads people start buying dollars and selling rupees. Pressure mounts on the State Bank to quickly run down reserves by using them to defend the currency. The inescapable dilemma for the central bank in this situation is that if reserves are not used, the rupee’s value risks going into a downward spiral.

This is not a hypothetical scenario. It unfolded not long ago in the 2008-09 balance of payments crisis. In fact at several points in the 1990s Pakistan was unable to meet its external financing requirements and repeatedly sought IMF help to avert external debt default. Is the finance minister unaware of this history when he proclaims Pakistan has never been in a situation where it could have defaulted on its external obligations?

The facts are clear about the present precarious situation. The country’s foreign exchange reserves have steadily eroded. Last week reserves held by the State Bank fell to $ 7.8 billion. This offers no assurance that the country can avoid a balance of payments crisis when capital inflows have dried up, foreign direct investment has plunged to the lowest ever level and debt payments loom. By June reserves will dwindle to under $6 billion as more repayments are made on external liabilities.

In the next fiscal year $6.2 billion in debt service payments will be due to the IMF and other creditors by which time reserves would have dipped below $6 billion and with the trade gap also needing to be financed. Confidence could vanish quite quickly when the market perceives that the country’s financial requirements far exceed its foreign exchange resources. No one can accurately predict when such an inflection point could be reached. But no responsible government would want to wait for that to first happen and then respond to a runaway crisis from which rescuing the economy would be exceedingly difficult. Wilfully letting a crisis occur so long as it is not on its political watch exemplifies economic mismanagement at its worst.

The finance minister also seems to think that in the next three months – or until election time – reserves can be shored up and pressure on the exchange rate mitigated by increasing overseas Pakistanis’ remittances from the present $13 billion (annually) to $20 billion. He believes this can be done by extending to money changers and exchange companies the rebate given to banks under the Pakistan Remittances Initiative. Apart from the feasibility of achieving this in such a short timeframe, the measure could be open to abuse for money laundering, and expose the country to greater international scrutiny. Moreover this BandAid, buy-another-month approach will do nothing to address the structural problem that lies at the heart of rising external imbalances.

To compound an explosive budgetary situation, the government has also gone on a no-holds-barred spending spree in its last days in power. This is reflected in a number of fiscally irresponsible decisions taken in recent weeks, mostly by the cabinet’s Economic Coordination Committee, which met four times in just over a fortnight – unprecedented in Pakistan’s economic history.

The decisions are too numerous to list. But the more egregious ones include: • Subsidy for sugar exports, which will cost the exchequer at least Rs3 billion a year – and benefit a politically powerful lobby.