Budgeting with constraints – Journal
PAKISTAN has struggled with weak economic growth for three decades. Since 1990, real GDP growth has averaged 4.2 percent. By comparison, South Asia experienced an average economic growth of 6% over the same period. Over the past three years, Pakistan’s annual GDP growth rate has declined further, to an average of 1.9%, due to the combined effects of the 2018 balance of payments crisis and the Covid pandemic -19.
Therefore, it is absolutely necessary to put the economy on a high growth path that is sustainable in the long run. Growth is a necessary condition for many good things to happen not only for the economy, but also politically for the PTI ahead of the 2023 elections. For the first time in years, a budget has been presented, charged with incentives for industry, agriculture and SMEs, as well as potentially revolutionary documentation measures. Even its underlying fiscal stance is fairly realistic, with the revenue target not entirely implausible, and the budget deficit target largely achievable given the cushions available on the expenditure side.
Lily: The path the government plans to take next year is very risky
Not surprisingly, the federal budget was well received. Still, it has a potentially fatal flaw. The problem is that fiscal strategy, however appropriate in itself, cannot work in isolation. Constraints rooted in the economic environment cannot be ignored or dismissed, nor can the impact of economic growth on the balance of payments.
Pakistan has a low export base and relatively high income elasticity of imports. While various estimates published for the latter range from 0.5 to 3.2, it is relevant to note that since 2005, while real GDP growth has averaged 4.5%, the annual growth of imports in terms of value exceeded 11% on average. This gives a growth ratio of imports to GDP of 2.5x.
The fiscal strategy will generate growth but increase the risk of strains on the external accounts.
Using this ratio implies that for the projected growth rate of 5pc for the next fiscal year, import growth could be around 12.5pc. Therefore, imports next year could well be in the region of $ 63 billion to $ 65 billion. Exports are not as responsive to domestic growth and are expected to hover around $ 27 billion in 2021-2022. With workers’ remittances expected to peak around current levels, the gap between imports and exports forecast for next year results in a current account deficit of around $ 7 billion.
Taking into account the planned repayments of the external debt, Pakistan’s gross external financing requirement for 2021-2022 is thus estimated at 25 billion dollars. With an expected oil facility on Saudi Arabia’s deferred payments of around $ 2 billion, and other sources of external funding, next year will not be a problem. However, the problem could arise on current trends in 2022-2023 – the year of elections.
With GDP growth set to accelerate to nearly 6% in 2022-2023, imports could increase another 15-18%, on a high basis. Of course, international energy prices, among other factors, will have a great influence on the actual increase in the value of imports. However, with external debt repayments expected to remain high, a sharp increase in the current account deficit could create a difficult situation to manage.
The risks to Pakistan’s external account related to the global economy over this period are not negligible and are likely to be increasing. A commodity super-cycle is already playing out, which is expected to lead to sharp increases in the prices of commodities that Pakistan imports like petroleum products, RLNG, coal, palm oil, etc. the US Federal Reserve. With the Democrats’ tough spending plans increasing the risk of the US economy overheating, even a change of language by the US Fed could lead to a repeat of the ‘tantrum’ the markets experienced in 2013 and to a flight to security of global capital that could deprive countries like Pakistan of external financing.
The government is absolutely on the right track in focusing on removing constraints to economic growth imposed by the balance of payments. The finance minister rightly identified exports, agriculture and ICT as the engines of future growth, adding to the prime minister’s emphasis on tourism.
The problem is that these sectors have suffered from political neglect for years, or from active anti-growth policies as in the case of exports. The reforms needed to make these sectors engines of growth are not only structural in nature, but also involve very important institutional and governance elements. By definition, these reforms require several years of cohesive and consistent implementation before producing results.
The process cannot be bypassed, no matter how pressing the economic or political need to grow the economy. The extent to which the trade-off between growth and imports has been ignored in the budget is evident in the incentives given to small cars – an industry that depends on billions of dollars in imports every year. (There’s also a completely unnecessary stunt for a small group of stock speculators).
A second potential problem with fiscal strategy is the instrument used for stimulus. While a multitude of incentives and a few business-friendly changes to the tax code could have been enough to consolidate economic momentum, the federal budget includes a 43% increase in development spending. Despite conventional wisdom, the economic and political benefits of spending on muscle development are questionable.
First, PSDP / ADP spending suffers from large “internal” and “external” lags. Second, the efficiency of spending under the PSDP has declined considerably since the 1990s, as measured by the IMF’s Public Investment Efficiency Index, and its boost to growth as well as distribution. of the benefits is not applicable. Even politically, the strategy was deemed ineffective, as the PML-Q and PML-N governments discovered to their chagrin in 2008 and 2018 respectively.
All in all, the federal budget lays an excellent basis for short-term growth, but ignores the very real risks on the external accounts front.
The writer is a former member of the Prime Minister’s Economic Advisory Board and heads a macroeconomic consultancy based in Islamabad.
Posted in Dawn, le 18 June 2021