The history of economic policy in Pakistan shows that economic disasters
have befallen the hapless citizenry due to sins of commission as much
as by sins of omission. We will show in this article that there was a
time over a decade ago when incorrect sequencing of the Structural Adjustment
Programme led to disastrous economic consequences. That was a sin of commission.
Today we may be about to commit a sin of omission: The failure to translate
the over 10 billion dollars State Bank reserves into increased GDP growth
and poverty reduction could lead to continuing and unnecessary increase
in the misery of the people, and an erosion of the reserves themselves.
Successive governments stricken by the discreet charms of the IMF sought
to reduce the budget deficit, regardless of the cost in terms of rising
poverty and declining growth. That elusive symbol of economic health is
now at hand. After a decade of stringent restrictions on development expenditure
and more recently a sharp reduction in the debt-servicing burden (following
debt restructuring), the fiscal deficit as a percentage of GDP has fallen
from 8.8 percent in 1990-91 to 4.5 percent in 2002-03, while State Bank
reserves are at an all time high level of over 10 billion dollars. Two
questions emerge at such a juncture:
- What are the likely consequences of conserving this fiscal space
rather than utilizing it?
- Can this fiscal space be productively utilized for economic growth
and poverty alleviation?
Since both the above questions refer to the problem of sequencing economic
policy, let us begin by revealing a policy disaster that occurred in the
late 1980s because the government, the World Bank and the IMF got the
sequencing wrong. Dr. Rashid Amjad, an eminent Pakistani economist, has
shown in a recent paper how the government decision to sharply increase
interest rates in 1987-88 was part of the Structural Adjustment Programme
and a specific part of the financial sector reform programme associated
with the Banking Sector Adjustment loan from the World Bank. In terms
of economic logic it is clear that an increase in interest rates should
follow and not precede a reduction in the budget deficit, so that the
government would not have to borrow at extremely high interest rates.
Amjad argues that this incorrect sequencing of economic policy was a policy
“disaster”. It certainly was, because the resultant increase
in the government’s debt servicing burden forced such a sharp reduction
in development expenditure (to meet the IMF budget deficit reduction targets)
that GDP growth slowed down and poverty increased to historically unprecedented
levels. Development expenditure as a percentage of GDP, which was over
7 percent in the 1970s fell to less than 3 percent in the late 1990s.
Development expenditure has historically played a significant role in
generating GDP growth both directly as well as indirectly by stimulating
private sector investment. Thus GDP growth fell from a historical trend
rate of over 6 percent to about 3 percent in the late 1990s while poverty
doubled from 17% of the population in 1987-88 to about 34 percent by the
end of the 1990s.
The government policy in the late 1980s of increasing interest rates
before reducing the budget deficit was a monumental policy disaster. More
important the cost was paid by the poor in terms of untold suffering.
Every third household in Pakistan today is hungry; 65 percent of the poor
are suffering from disease; about 40 percent of the children are stunted
in body and mind due to mal nutrition and large numbers of parents unable
to bear such misery are committing suicide. Was any body held accountable
for this policy decision in the government, the IMF or the World Bank?
We shall not here engage in the debate on whether or not the Structural
Adjustment Programme was correctly designed. Economists like Nobel Laureate
Stiglitz have argued that it was not. The point here is that the human
cost in terms of hunger and disease could have been lesser if the IMF,
the World Bank and the government had managed the Programme better, and
sequenced its policy elements correctly.
Here we are today having finally achieved “macro economic stability”
at a terrible cost in human suffering. The government and multi lateral
agencies owe it to the people who have paid this cost to ponder on the
strategic policy choice that has now emerged. The choice is clear: (a)
Either the government at the behest of the IMF further reduces the budget
deficit from 4.5 percent today to 3.5 percent next year in the pursuit
of strengthening the “macro economic stability”, or (b) Use
the existing fiscal space to undertake bold new initiatives in the public
sector for poverty alleviation and accelerating growth. The increase in
the GDP growth rate must not be marginal but a quantum leap to a new growth
path of over 7.5%, which would make a substantial dent into the poverty
Economic analysis leads us to an important proposition in the context
of the above choice: If the government persists in simply conserving or
further enlarging the fiscal space, and does not use it immediately, then
this misplaced fiscal conservatism will lead to a loss of the fiscal space
itself in the foreseeable future. Consider. If the large State Bank reserves
do not get translated into high growth through public sector expenditure,
then Pakistan’s exchange rate would appreciate. In such a case,
ceteris paribus, export growth would slow down, with a consequent increase
in the balance of payments deficit, thereby leading to an erosion of State
Bank reserves. This is already beginning to happen in the Indian case
which is why the Vajpayee government in its election year is envisaging
a huge public sector development programme to stimulate their high growth
to even higher levels and to maintain the competitiveness of Indian exports
by preventing further appreciation in the exchange rate.
It is clear that fiscal conservatism in Pakistan in a situation of continuing
low levels of private sector fixed investment means, that GDP growth will
remain inadequate, poverty will increase and the very fiscal space that
the government seeks to conserve will be constricted.
Let us now consider the alternative policy option that is available.
The government can launch a set of major targeted programmes for the poor
aimed at generating employment through rural infrastructure development,
filling the food deficit gap of the poorest, providing safe drinking water
and preventive health care.
Such targeted programmes would change the nature of the policy challenge.
The issue would no more be, how to reduce the budget deficit further.
A new range of issues will then emerge: (a) How to undertake a civil service
reform. (b) How to improve the institutional efficiency of public sector
development programmes. (c) How to accurately identify the poorest of
the poor who are to be the beneficiaries of some of the targeted programmes.
(d) How to conduct impact analysis of the government’s poverty programmes,
and to independently monitor and evaluate these programmes. (e) How to
transfer resources to district governments, currently starved of finances.
(f) How to strengthen the institutional capability of local governments
to design, implement and monitor projects for income generation, infrastructure,
health and education.
Those in favour of fiscal conservatism point to the “limited absorptive
capacity” for development funds in Pakistan. The fact is that due
to over a decade of drastic cuts in development expenditure, there has
been an erosion of even the weak institutional structure for public sector
development that existed in the 1980s. It is only when a much higher order
of development expenditure is allocated, that the financing and the management
expertise necessary for reconstructing institutions, will come into play,
as an integral element of resource allocation.
The argument for utilizing the existing fiscal space and aiming for
high growth and poverty reduction does not mean losing macro economic
stability. On the contrary I would argue that Pakistan’s economy
is on a knife-edge. If the existing fiscal space is not quickly utilized
for catapulting the economy on to a growth path of over 7.5% and for making
its structure pro poor, then the economy will fall off the knife-edge.
In such an event the prospect of sustaining macro economic stability will
fall away as the economy slips into relatively slow growth and increased
poverty. Thus the very fiscal space that is sought to be preserved will
be lost. We cannot tarry too long on the knife-edge.