The economy is slowing down and some real dangers lurk behind the corner which may push it over the brink

The pinch is already here: ask anyone shopping for food and this is what you get. Many analysts point out that continuously rising food prices are not the only problem with the economy. Growth is slowing down, budget deficit is widening, current account is running in the red and both our foreign exchange reserves and the rupee’s exchange rate are under pressure.

Are we already on the brink? How real are the fears that an economic meltdown is just around the corner? People in the government believe the situation is still quite far from being scary. “Nothing is wrong with the economy,” says Dr Ashfaque Hasan Khan, special secretary with the finance ministry in Islamabad and one of the key architects of the current economic strategy. “[The economy] is only cooling down a bit as part of the business cycle which is nothing but normal,” he tells the Herald. “This does not mean that we are facing an economic crisis or a recession,” he says. “Far from it, we are still expected to grow at 6.5 per cent this year. How many countries are growing at this pace? Only a few,” he observes.

According to Khan, Pakistan has grown at an average rate of seven per cent for five consecutive years, approximating at a nine per cent growth in the year 2004-2005. “What’s the big deal if the economy is now slowing down a bit? We’ve spent a lifetime at two to three per cent growth rates,” Khan adds.

Asad Omar, the chief executive of a fertiliser company, is also upbeat. He says that macroeconomic fundamentals remain more or less strong and there is little to fear about economic degeneration.

But these reassurances are bound not to soothe many. The almost lost official battle against spiralling food prices, persisting flour shortages, long power breakdowns and cuts in gas supply continues to have a negative impact on the people’s perception of the economy’s strengths. “[Technically] we are far from approaching a recession or an acute economic crisis. But a sombre feeling about the state of economy is certainly here,” says Dr A.R. Kamal, a former chief economist with the Islamabad-based Planning Commission of Pakistan.

This feeling is accentuated by the statistics about the performance of the economy in the first half of the current fiscal year — 2007-2008. Pakistan’s deficit in foreign trade has grown to more than eight billion dollars from 6.4 billion dollars since the closure of the last fiscal year in June 2007. It may widen to more than five per cent of the gross domestic product (GDP) by the end of this fiscal year. Headline inflation soared to just below nine per cent in December 2007. Food inflation is constantly running in the double digit, reaching above 14 per cent in October 2007 before dropping to around 12 per cent in December 2007. The rupee has depreciated by almost four per cent against the dollar and the government is forced to borrow heavily from the central bank to finance the budget deficit because it is reluctant to pass on the global oil prices to domestic consumers ahead of this month’s elections.

Foreign exchange reserves have been under pressure for some months now – because of the expanding external account gap mainly due to high oil and commodity prices – and have declined to slightly above 15 billion dollars after peaking to over 16 billion dollars in October 2007. Inflow of money from abroad necessary to finance external account deficit is down by about seven per cent. Global financial crunch caused by American troubles on sub-prime loans and political uncertainty at home seem to have restricted our ability to mobilise financial resources from the global capital markets.

The report by the State Bank of Pakistan on the performance of the economy in the first quarter of the current fiscal year predicts a slower than expected growth and higher than expected inflation unless the government corrects the growing fiscal imbalances and curtails its borrowing to finance the ballooning fiscal deficit. Multilateral donors and global investment funds and consultants have brought down their growth outlook for 2008 to something between 6.5 per cent and seven per cent – against the target of 7.2 per cent – while inflation will mount to 7.5 per cent against the target of 6.5 per cent.

Some critics of the official economic policies are already saying the slowdown will continue bringing the growth rate down to less than six per cent. They foresee harder times for the economy after the current fiscal year. Uncertainty about the country’s political future has caused the Karachi Stock Exchange to crash twice in two months (first after the imposition of emergency on November 3, 2007 and later after the assassination of Benazir Bhutto on December 27, 2007). This also heightens fears about the course that the economy may take if the elections fail to produce a stable political environment.

Omar says this uncertainty exists because “we have always been saying that the current growth rate is unsustainable.” He, therefore, advocates the need to slow down the economy and sees nothing wrong in revising the growth rate downwards.

For Kamal, the talk about growth being unsustainable stems from how and where the growth comes from. “Unless you invest in industry and agriculture, you are bound to face such problems as we have at our hands now,” he explains. “We need to change the pattern of growth and focus more on domestic industry and agriculture production rather than on importing growth,” he says.

There is a general consensus among experts and businessmen that the economic policies during the last six to eight years allowed consumer spending to expand and provided the services sector, particularly telecommunications, banking and construction, a bigger helping hand than what was necessary.

“The economy’s movement into a slower gear would not have mattered much had the government not had a fixation for fast-track growth,” says a former president of the Lahore Chamber of Commerce and Industry, not wanting to be named. “The government’s policies have focused more on obtaining short-term growth over the last six to eight years than restructuring the economy – particularly its productive and real sector – on sounder footings,” remarks Dr Faisal Bari who teaches economics at the Lahore University of Management Sciences.

He believes the economic boom did not result from the official policies or the correct handling of the economy. “The boom conditions appeared in the economy primarily because of the foreign inflows of money received in the form of home remittances, which are expected to go up to six billion dollars or more this year from almost one billion dollars in 2001, foreign investment that peaked to more than eight billion dollars in 2007 from a few hundred million in the late 1990s, multilateral and bilateral aid and grants and bilateral debt rescheduling and loan write-offs in the wake of 9/11,” Bari says.

In all, Pakistan is estimated to have received 60 to 66 billion dollars since 9/11 through inflow of foreign money mainly because of its role in the global ‘war on terror’. “Most of the foreign inflows of money went into speculative investment – in stock market and real estate – or in import-based consumption,” says Shafqat Elahi, a former chairman of the All Pakistan Textile Mills Association. “Only a negligible portion of this money went into productive sectors — industry and agriculture,” he adds.

“Huge inflows of foreign money in the changed global environment flushed banks with liquidity and caused interest rates to dip to an all-time low. This enabled economic managers to adopt a loose monetary stance during 2003 and 2004 to boost consumer financing and spending, thus increasing the demand for cars, motorcycles, refrigerators, televisions, air conditioners, so on, and allowing local manufacturers to utilise their idle production capacities,” says Elahi. “Once the local production saturated, the rising demand was met through imports. We have even been importing tiles and sanitaryware from China to meet the needs of our construction industry,” he adds.

He laments an opportunity was missed when foreign inflows were not used to support, increase and diversify domestic industrial production in line with increasing demand. “Even the agriculture sector was neglected. Look at the cotton production: we are producing 10 million to 11 million bales against our textile industry’s requirement of 16 million,” he says.

For Khan, the government policies for encouraging consumer spending and the services sector for obtaining growth are anything but flawed. He claims that these policies expanded the GDP by 87 billion dollars in eight years, slashed joblessness to 5.3 per cent from 8.3 per cent and reduced poverty by more than 10 per cent.

He admits the government has not done much to modernise the agriculture sector but puts it down to growers’ fixation with higher prices for their crops. He, however, says the government has done all it can to encourage industry – especially the textile sector – through subsidies and other incentives. “But the industry has failed to come up to our expectations. It has failed to train its workers and improve productivity and competitiveness,” he notes and adds, “the industry needs to come out of their old protectionist mould now. The government can no longer save it from competition.”

Encouraging local investors is not the same as attracting foreign money. Bari says it is here that the government’s policies were lopsided, heavily favouring foreign investment in the services sector such as telecommunication, banking and insurance. “No foreign investor went into export-oriented industry or agriculture because of lower margins of profit and the failure of the government to encourage investment in the real sector, which is the actual converter and transformer of the economy. This is precisely why the growth achieved during all these years is unsustainable,” he says.

Dr Bari also feels the government has missed the opportunity to use the extended fiscal space afforded to it by the foreign inflows of money to reform and improve the performance of institutions such as the police, judiciary, law and other social sectors which are crucial for economic activity.

Others beg to differ. “It is unfair to blame the government alone for the current economic situation. Unprecedented escalation in the world commodity prices – especially of wheat and oil – has also contributed substantially to our economic woes. Oil price, which peaked to 100 dollars a barrel several weeks ago, continues to be a major source of widening external account deficit and price hike,” says a Lahore-based foreign banker.

Some in the government immediately concur. “Food and oil prices have played havoc with the central bank’s efforts to contain price inflation despite a tight monetary policy being pursued since 2005,” says a bank official in Lahore. The government, he says, is borrowing excessively from the State Bank to financially cover the revenue shortfall resulting from official efforts to keep domestic oil prices in check. It has already borrowed 237 billion rupees, far exceeding its ceiling for the year, and hence added significantly to the inflationary pressure in the economy by expanding supply of money far above the target of 13.7 per cent.

Khan insists all economic ills are so visible only because of one factor: rising global oil prices. “Oil is 76 per cent more expensive today than it was in January 2007, when we last revised the domestic prices and froze them at that level. If we do not allow the oil prices to pass on, we will be in serious trouble,” he adds. The government, it seems, does not want to squander its little political capital on raising oil prices, a move bound to lose it a lot of votes in the coming elections.