2
On March 20, 2018, the State Bank of Pakistan (SBP), through a press release, notified an adjustment in the rupee-dollar exchange rate. Reportedly the exchange rate movement was in-line with evolving fundamentals on the external front.
On March 06, 2018 the International Monetary Fund (IMF) published a report on its First Post-Programme Monitoring Discussions with Pakistan. The fund apprehends external front pressure and points out the expected fiscal and monetary slippage.
According to it, the rising current account deficit will limit Pakistan’s capacity to repay its external liabilities. The fund stresses the importance of greater exchange rate flexibility on a more permanent basis to improve competitiveness.
The IMF and the World Bank have, over the decades, advocated for supply-side ‘structural reforms’, adjustments in the exchange rate to jump-start exports, and cuts in government spending, partly in response to the fund’s inability to provide additional external resources.
Contrary to ‘priming the pump’, structuralist economists see growth due to disequilibria an inherent structural feature of an economy. ‘Structural reforms’ involve many interwoven steps which remain fruitless without political resolve and stability in the absence of larger public consensus on how fast we choose to change.
Much has been said about the dismal economic condition of the country, but as in everything else, there is a silver lining in this situation as well
Much has been said about the dismal economic condition of the country, but as in everything else, there is a silver lining in this situation as well.
The projected growth in Gross Domestic Product (GDP) for fiscal year 2017-18 is 5.6 per cent annually compared to 4.1pc in 2014-15 due to investment in China-Pakistan Economic Corridor (CPEC) related projects.
A Dutch consumer goods giant recently announced Foreign Direct Investment (FDI) of $120 million as an acknowledgement of the country’s growth; highlighting that Pakistan has long been on the radar of foreign investors.
The recent exchange rate movement is allegedly an orchestrated move; in-line with the IMF recommendation to increase export competitiveness.
Even though, despite the December 2017 foreign exchange adjustment, Pakistan is still struggling to increase its exports by providing greater incentives to exporters (the minimal increase in export performance was mainly due to the international price hike).
Meanwhile, CPEC-related infrastructure investment will make it viable for many investors to invest in new export opportunities.
A current account deficit is natural to developing countries and indicates faster growth.
In any economy goods and services can be either consumed, saved or invested. A country with a current account deficit indicates that it is investing more than it is saving, therefore a current account imbalance can simply be viewed as the difference between saving and investment.
Historically Pakistan has had a low savings and investment rate. High domestic investment is needed to accelerate GDP therefore if domestic saving is insufficient to finance domestic investment, it will be financed by investment from abroad.
These capital flows are a credit on the capital account and should be matched by a deficit on the current account. You may call it ‘Credit’ or ‘Loan’; similar to when someone makes an investment with borrowed money.
For Pakistan, CPEC is an investment in economic zones, railway, roads and ports that will create a huge space for FDI in the country’s export industries. Since the real driver of growth in an economy is labour and investment, and Pakistan has abundant labour, it needed seed investment to kick-start its potential growth.
Exchange rate adjustment along with tightening the monetary and fiscal policy is implied by the fund to correct the balance of payments disequilibria and for macroeconomic stabilisation.
In general, there is a consensus on macroeconomic stability. Excessive expansion of domestic demand or an exogenous shock worsens the current account deficit. In either case, if the situation is not self-correcting, and the increased current account deficit cannot be financed, the only way to restore the macroeconomic balance in the short run is to reduce aggregate demand and disrupt growth.
Investment related to CPEC is a major contributor to aggregate demand and the current account deficit. Scaling down the projects through a reduction in sovereign spending will reduce the mismatch between aggregate expenditure and production capacity.
Deceleration of aggregate expenditure through a tight fiscal policy and exchange rate downward adjustment has recognisable stagflationary outcomes with a disruption in the growth process.
Abrupt and frequent downward exchange rate adjustment; as the last adjustment was just four months back, will fuel inflation especially with the current hike in international oil prices. A sharp decline in real wages can push the economy into a destabilisation spiral if the most-handy tool (devaluation) is not used with prudence.
Pakistan has less one per cent of its GDP flowing in as FDI. Through better governance, simplifying the taxation system and introducing a value-added tax the government can attract more FDI; allowing the country to seize the opportunity without destabilising its growth trajectory.
The writer is an investment banker and a visiting faculty at PAF Kiet
Published in Dawn, The Business and Finance Weekly, March 26th, 2018
