The best myths are found in the media about the Pakistani economy and are told by bankers, chartered accounts and finance specialists. Let me run through some of the myths.

Stabilisation is not needed. This means that there is no need to cut aggregate demand by tightening of monetary and fiscal policy. Instead, what is needed today is an expansionary monetary policy. This will benefit citizens because it will lead to economic growth. The so-called “ground reality” is that other countries in the region, essentially India and China, are opting for expansionary fiscal and monetary policies.

An expansionary monetary policy is not required because the recent inflationary episode was entirely caused by rising food and fuel prices. That is, bad luck and not bad policies of the previous regime were to blame. Now that these prices have and are coming down, we need not worry about inflation and, instead, need to position ourselves for economic growth. The government has adopted an IMF programme – all stabilisation measures such as removing utility subsidies and increasing interest rates have only been taken to please the IMF.

And no country has come out of an IMF programme successfully.

The first three myths are interesting in that they challenge the very need for macroeconomic stabilisation.

If it is true that recent economic deterioration was bad luck, reflecting rising international prices, and not bad policies of the previous regime, it must be the case that (a) Pakistan’s inflation rate increased after the 2007 global price hike and (b) the trend rise in inflation rate must be in line with India’s during the same period.

Figure 1 shows the increasing trend in annual inflation rate by 2006, well before the global price hike. Notice India’s trend rate, during the same period, does not show anywhere near the same increase and remains flat even after the global price inflation. More than bad luck is needed to explain worsening inflationary performance relative to India. Inflation as an economic problem is much more severe in Pakistan than in India. The two cases are not quite comparable!

What caused the much larger increase in relative inflation rate? The two factors responsible are increasing fiscal deficits (figure 2) and its consequence an expansionary monetary policy. The important thing to glean from the trend lines of growth and fiscal deficits (figure 2) is that Pakistan created massive budget deficits during a period of high growth. That is, its fiscal deficits were pro-cyclical and were overheating the economy at a time when aggregate demand was already exceedingly high.

The Indian experience is the reverse that of Pakistan’s (Figure 3). India, for the first time, cut fiscal deficits during a period of high growth. India’s fiscal deficits were counter cyclical, which allows them greater fiscal space to manoeuvre now! This reinforces the earlier point that the two cases are not quite comparable. It also suggests that Pakistan’s relatively higher inflation rate is due to bad policies of the previous regime and not bad luck!

Coming to consequences, rising aggregate demand, due to expansionary fiscal and monetary policies, and increasing inflation resulted in the appreciation of the exchange rate. The State Bank and the government chose to keep the nominal value of the rupee stable which exacerbated the rise in the real effective exchange rate. The appreciation of the real exchange rate meant that our exports were becoming price uncompetitive (figure 4) and imports were made affordable and attractive. The net effect of these policies was the creation of a galloping current account deficit (Figure 5). It is a myth that export performance was buoyant during the Musharraf era; in actual fact our export performance remained stagnant and deteriorated rapidly after 2006, well before the global price escalation (Figure 4). Notice that during the same period India significantly improved its export performance. Unlike Pakistan, India was able to secure maximum returns from vibrant global growth!

Similarly, galloping current account deficit had reached unsustainable levels of over four per cent of GDP by 2006 well before the global price hike. As opposed to this, India’s current account deficit, albeit rising, remains at a manageable level of around 1.5 per cent. This means that an unsustainable current account deficit is a legacy of the post-2005 Musharraf regime and was caused by its choice of expansionary policies.

So what is the reality and why is it so different from mythology? The reality is that Pakistan’s economy is saddled with crippling inflation, an unsustainable fiscal deficit and a severe balance of payments crisis. The Indian economy is not suffering from these crises and hence it is not facing the crisis of depleting reserves, a fragile currency, external trade defaults and the possibility of large-scale capital flight.

Coming back to the myths! Is it wise to run an expansionary monetary policy and not stabilise? “No” because it would result in an increasing divergence between Pakistan’s inflation rate and that of economies such as India. This would exacerbate the current account deficit and lead to a further loss of confidence in the rupee.

In turn, an unstable and depreciating rupee will fuel further inflation and will be bad for growth, equity and living standards. There is no trade-off between inflation and ‘sustainable’ growth!

It is time to worry about both a fall in inflation and a reduction in Pakistan’s inflation rate relative to its competitors. For this, we need to control the policy-induced component of inflation. As a result, in the short-run there is a need to curb aggregate demand through contractionary monetary and fiscal policies.

What can be discussed is whether macroeconomic adjustment should place a greater weight on fiscal rather than severe monetary contraction. Whatever the political choice, it is important that the tradeoffs are transparent and debated publicly.

Could the government have stabilised without IMF assistance? It could have in principle; however, given the state of the current account deficit, the cost of a stabilisation programme without foreign inflows would have been extremely high. The IMF programme gives this buffer.

Another myth is whether a country has come out of an IMF programme successfully? I am not sure what the answer to this is. What I do know is that India went through an IMF funded stabilisation programme in 1992, which proved to be the turning point for the Indian economy.

What forced India into the stabilisation in 1992? Its current account deficit had touched three per cent of GDP; its exports were falling; its external debt to GDP ratio reached a new peak; it was confronted with extremely high fiscal deficits and a sharp rise in oil prices following the Gulf War. Sounds familiar!

The stabilisation saw a sharp devaluation of 18 per cent in the value of the Indian rupee; a policy that allowed the exchange rate to adjust; fiscal cuts backs; and the adoption of other structural measures. The Indian economy bounced back after two years and has not looked back since.

However, what made India turnaround is not only stabilisation but structural reforms aimed at boosting the growth potential of the economy. It also benefited from access to foreign capital and expatriate capital and skills.

Like India in 1992, Pakistan needs to stabilise the economy in the short-run by curbing inflation and resolving the balance of payments crisis. There is no way around it. Furthermore, no matter which way you cut it, stabilisation is going to hurt. The policy debate is really about how to share the burden of adjustment and who should bear it: government or business; poor or rich; producer or consumer?

However, it must be realised that stabilisation is a necessary but not a sufficient condition for economic recovery and sustained poverty reduction. Other conditions include: successfully completing the stabilisation phase and avoiding a political spending bonanza; using this space to design and implement structural reforms that increase the growth potential of the economy; ensuring that programmatic loans taken from multi- and bi-laterals are well designed and will increase the economic growth rate.

The hard questions that we need to pose are about growth recovery measures and about policies and interventions that make growth inclusive and sustainable and not about the inherent need for stabilisation!

These measures and policies need to be home-grown. The government needs to draw a distinction between seeking IMF assistance for the stabilisation phase and developing its own programme for economic recovery and for poverty reduction and growth expenditures during stabilisation.

The government must make a substantial allocation for social protection and poverty alleviation. This is because we will see a large escalation in poverty as a result of a slowdown in growth and unemployment.

Dr Ali Cheema is an Associate Professor of Economics with a joint appointment in Political Science at the Lahore University of Management Sciences