Pakistan’s moment of truth

Despite an encouraging start talks between government and opposition teams to evolve a bipartisan reform agenda have yet to make the progress needed to address Pakistan’s deteriorating economic situation. The fiscal deficit crisis is like a runaway train hurtling towards derailment that can be averted only by prompt and bold corrective actions.

The recent visit to Islamabad by an IMF team and a senior economic adviser of President Barack Obama saw similar   messages being delivered to the government: that time was running out on the economy and on patience in Washington. Without necessary reforms, which the PPP-led coalition   committed and retreated from, there could be no revival of the IMF programme or prospect of help from donors.

The top political leadership still seemed to harbour the hope that the IMF would consider releasing the sixth tranche of an $11 billion standby arrangement. The visiting officials went away with no clear indication of what action plan the government was prepared to implement to enable the IMF to review Pakistan’s request for disbursement of the next tranche ahead of the budget. Progress on previously agreed performance criteria will have to be demonstrated before the Fund programme can be resuscitated or a fresh one negotiated.

Nevertheless five rounds of talks between the government and PML-N teams seemed to indicate common recognition of the seriousness of the problem and the need to do something. But negotiations began with a disadvantage: policy reversals by the government – on the reformed general sales tax and fuel price increase – that signalled its weak political will.

The urgency warranted by a worsening economy is not yet translating into talks being able to prioritise areas for immediate action. This is worrying, as both sides know what needs to be done and why action must be taken quickly. Without new measures the gap between the government’s expenditure and income will widen further, even push the budget deficit to a record 8 per cent of GDP this fiscal year. With no additional internal or external resources available to fund this at a time when the oil import bill is rising, resort will – as at present – be made to borrowing from the State Bank.

This will fuel more inflationary pressures on the economy at a time of falling growth and produce ‘stagflation’ which can generate conditions for social instability. More borrowing will also start depleting foreign exchange reserves, put pressure on the exchange rate and erode confidence in the country’s currency.

Without structural reforms on both the revenue and expenditure side the economic slide cannot be halted. This requires a minimum consensus on urgent steps in three core areas.

One, agreement on domestic resource mobilisation and specific tax measures. But people will only accept additional taxation if credible steps are taken upfront to reduce inessential expenditure, impose official austerity, stop tax leakages through corruption and improve collection from the existing regime.

But there is no getting away from attacking the source of all fiscal problems: Pakistan’s appallingly low tax to GDP ratio. Unless the present 9 per cent of GDP is increased by 3-4 per cent, reliance on bank borrowing, with all its pernicious effects on the economy, cannot be ended.

Agreeing on tax actions is a challenge as the two sides have differing proposals and priorities. Consensus has to be mobilised to enforce the reformed general sales tax and the flood tax legislation that was put on hold in the National Assembly. Removal of hundreds of tax exemptions (which cost the economy billions of rupees) revival of the wealth tax and commitments by provincial governments to institute an agricultural income tax should all be part of a package deal to accommodate the demands of all stakeholders.

The second point of consensus has to be on expenditure control. The PML-N’s demand for a 30 per cent cut in spending has to meet the test of practicality because after the substantial slashing of the development budget, debt servicing and defence are what are left, and the limitations here are obvious.

The third area that needs immediate agreement is the most politically difficult: elimination of general subsidies. Ostensibly aimed to help the less well off, subsidies are untargeted and a budget liability irrespective of what product they are for. They add to the fiscal deficit and are financed by additional government borrowing. This produces more inflation – the most insidious tax on the poor.

A structural reform agenda to attain sustainable economic stability will have to go beyond agreement on just these policy measures. A debt management strategy has to be evolved. Restructuring of public sector enterprises needs to be urgently undertaken to stem the losses that are such a heavy drain on the national exchequer.

While strategies to deal with longer-term problems have to be put in place the immediate priority is to forge agreement on what is absolutely essential to deal with the spiralling budget deficit. The aim should not simply be to qualify for another IMF tranche but to find durable solutions to the economy’s underlying problems. Both the government and opposition must learn to share the pain of adjustment.

This is a moment of truth for Pakistan’s political leaders: a test of whether they can subordinate their political and partisan interests to the goal of saving the economy. The country’s very stability depends on whether economics can take precedence over politics –  Khaleejtimes