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Steering growth with rising risks

Owing to double-digit inflation, currency depreciation, interest rate hikes and higher import bill, the prime minister’s finance advisor Shaukat Tarin says there are uncertainties in the market.

The record imports in November dragged the rupee to a historical low, share prices crashed and forex reserves fell to $16 billion on December 2 from $20.146bn on August 27.

The economy is in slumpflation where output is slowly growing along with accelerated inflation, says Dr Fahd Rehman, assistant professor of economics at Lahore University of Management Sciences.

Despite the current recovery, the overall domestic production is still below the pre-pandemic level.

However, the profits of the corporate sector are growing on the back of stimuli as well as inflation especially of those firms which can manage to sell their goods at higher prices.

And Prime Minister Imran Khan says growth this year would be 1 per cent higher than that in 2020-21.

“There is no need to worry, look at the fundamentals of the economy,” says Mr Tarin, adding that “the only permanent is that the economy is growing.” He assured the people and the market that the difficulties would subside in a few months.

The share of economic activities in overall tax revenues is less than the windfall from inflation

The State Bank of Pakistan (SBP) has however recently started to hike its policy rate with more frequent planned periodical reviews of its monetary policy.

The SBP has already taken some steps and the government is planning to take regulatory measures to curb ‘non-essential’ imports while trying to protect the growth trend.

The short-term regulatory measures taken in the first two years of the PTI government and the State Bank’s tight monetary policy did reduce trade and current account deficits by suppressing domestic demand and economic growth.

But this did not bring structural changes in the deep-seated foreign trade pattern in an import-oriented, debt-driven and heavily subsidised economy. During July-November, spending on imports soared to $33bn as against the much slower-moving export earnings of $12.4bn.

An International Monetary Fund’s (IMF) empirical study in 2011 suggested that fragmented countries with a high degree of political instability need to address root causes. Only then they could have durable economic policies that can engender high economic growth.

That is perhaps the reason why the IMF is insisting that the PTI government should get the proposed State Bank autonomy bill passed by the parliament instead of issuing a presidential ordinance.

Mr Tarin says inflation and import bill were interconnected as domestic produce and perishable items had an inflationary rate of only 3-4pc. He was referring to the inflation rate of 11.53pc and the surge in the import bill to $7.75bn in November.

As the economy is growing, he says, taxes are not only growing because of imports but across the board. There is 32pc growth in income tax and a 16pc increase in the overall tax collection during the first five months of this fiscal year.

However, the Federal Board of Revenue figures show nearly 54pc of the total tax revenue was raised at the import stage. Sales tax contributed 80pc while it was negative at the domestic stage. And the share of economic activities in overall tax revenues was less than the windfall from inflation.

Under the IMF deal, the government is required to impose Rs525bn worth of taxes on consumers, increase electricity charges and withdraw untargeted subsidies. Analysts say this would lead to another round of inflation.

Despite the rise in international commodity prices, more quantity of goods exported fetched fewer dollars because the value of the national currency has fallen below its real effective exchange rate. The growing adverse terms of foreign trade are further widening the trade deficit.

The government is however confident that rising exports and workers remittances would finance the trade deficit that it expects to come down to a manageable level as international prices of commodities, now beginning to fall, stabilise.

Here it may be noted that foreign debt repayments and debt servicing have increased to $13.4bn this year from $7.5bn in June 2018. Out of $31bn borrowed by the incumbent government, the bulk was used to pay interests on past loans but more than $5bn were procured to finance current expenditure.

In an article titled Economic aid: a curse?, independent researcher Ayaz Ahmed wrote that stagflation can’t be addressed by IMF’s loans and the Fund’s induced reforms.

A meeting convened by Mr Tarin to discuss the balance of payments position noted that the global prices of crude oil and coal had started falling which will reduce the import bill and import-related inflation. And there will be fewer imports of food items, furnace oil and vaccines. That may lead to a drop in inflation and strengthen the rupee.

But global commodity prices are unlikely to stabilise before June 2022, according to creditable research reports. In the United States, over half of the small businesses — the highest on record — plan to increase their prices over the next three months, according to a National Federation of Independent Business survey.

In America, there are two conflicting approaches to tackling inflation. Noting that inflation has hit its highest level since the 1990s, Noble prize winner Paul Krugman still argues that the call to the Federal Reserve to raise interest rates to cool the economy, ‘seems premature at best.’

In his opinion, “the overall demand hasn’t actually grown all that fast.” GDP is still below its pre-pandemic trend even though labour markets seem very tight, with high quit rates and rising wages.

(Under its dual mandate the US Fed is also obligated to maximise sustainable employment.)

There is growing evidence that supply chains are getting unkinked, which, Mr Krugman says, should provide some relief to the consumers. Inflation should come down as the economy adjusts. Matters would be different if we saw signs of a 1970s wage-price spiral. But so far we don’t.

The contrary view is: with the inflation rising to alarming levels, the Federal Reserve Bank should move to cool the economy, says Michel R. Strain, director, economic policy studies, at the American Enterprise Institute.

“If the Fed doesn’t, it risks inviting a sluggish economy — or even a recession — in the coming years.”

Published in Dawn, The Business and Finance Weekly, December 13th, 2021

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