The root cause of economic problems in Pakistan lies in its poor performance in exports, which are far below its potential and lead to substantial trade imbalances and a problem with the balance of payments. The deficit in the balance of payments leads to depreciation of the Pakistani rupee, which makes imported goods expensive. Since the depreciation increases the cost of consumable goods, it leads to cost-push inflation. Cost-push inflation should not be dealt with using demand management tools. The depreciation not only makes imported goods expensive, but it also increases the cost of raw materials used by local producers, which ultimately leads to an inflation in domestic goods as well.
In addition to this, the State Bank of Pakistan has responded to the rise in inflation in an inappropriate way. It has used the demand management tool of increasing interest rates to control inflation. Instead of affecting demand, the rise in interest rate increases the cost of production and makes domestic production more difficult and unattractive for local producers. Recently, the government has also increased the prices of petroleum products and electricity bills, and has levied a large number of taxes on electricity bills, making the use of electricity extremely expensive. The cumulative effect of all these factors makes local production non-competitive. This increases the reliance on imports further. The decrease in local production and further increase in imports leads to further deterioration in the balance of payment situation and depreciation of the rupee. This creates a spiral effect comprising continuous increase in costs of production and depreciation of Pakistani rupee.
It is clear that if the problem is emerging because of low production, the solution lies in increasing the production. If production is further discouraged, it will only worsen the situation. What was needed at this time was to reduce the cost of production so that local production was encouraged and that can be achieved by reduction in interest rate and costs of energy. But we are moving in exactly opposite direction. The PDM government under Ishaq Dar initially resisted to the conditions of the International Monetary Fund (IMF) and imposed restrictions on certain types of imports. Because of these initiatives, they had achieved a remarkable improvement in the current account balance. In the months before re-entering into the IMF agreement, the current account was close to a balance and it was possible to turn it into surplus with a little more effort.
The statistics reveals that there was a great potential for further improvements. For example, Pakistan imported agricultural products worth $8 billion in the last financial year. Pakistan is actually capable of producing all these goods locally and it was desirable to focus on producing these goods domestically. If this had happened, the current account might have turned into surplus and the surplus could have been sufficient to repay the instalments of external debt. Strong support was needed for the agriculture sector to turn the balance in favor of Pakistan and this support lies in reducing the interest rate and cost of production. However, Pakistan turned to the IMF again and all these gains were wiped out. The IMF emphasized removing the restrictions from imports and increasing the interest rate, which was exactly the opposite of what was needed at that time.
The IMF conditions compelled the government to increase energy costs and interest rates. These two factors added to the costs of production. Thus, the vicious spiral of reduced production and worse balance of trade started again.The higher interest rate, on the one hand, increases the cost of production. On the other hand, it increases the government’s liabilities in the form of markup payments. In the current fiscal budget, PKR 7303 billion have been allocated for the markup payments. This allocation is higher than the total of all other allocations, including defense, development, civil government, and all others.The heavy spending on markup payments compels the government to cut its spending and increase taxes and duties.
These taxes further add to the cost of production, making the situation even worse. The way out of the crisis lies in making production easier, and this can be done by doing exactly the opposite of what the government is currently doing. We need to reduce the interest rate and energy costs so that production can take a momentum. If local production is enhanced, it will reduce the trend of imports and will improve the exports. If this happens, the balance of trade will improve and the reverse spiral of improvement will start. Recent political developments, including the initiation of no-confidence motions and the formation of the PDM government, was the most stupid move in recent political history which has casted a long shadow of instability. Additionally, returning to the IMF’s fold, despite achieving a balance in the current account, poses a perilous specter for the economy. What Pakistan truly requires is a stable government singularly focused on fostering productivity. Until such a government takes the reins, the cherished goal of economic stability will remain elusive.
—The writer is Director, Kashmir Institute of Economics, Azad Jammu and Kashmir University.
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