THE consolidated federal and provincial fiscal operation document shows a quarterly budget deficit of 1.2pc of GDP for FY14-15, which is a positive for macroeconomic stabilisation.

Usually, lower inflation, reduced budget deficit and controlled money supply are considered good macroeconomic fundamentals, and Islamabad is scoring well on these points.

The by-products of this stabilisation programme are a lower level of aggregate demand, high positive real interest rates and overvalued exchange rates that impede the desired structural transformation. Hence, the very question is whether to go for good macroeconomic fundamentals or structural transformation?

Statistics reveal that macroeconomic stabilisation is having a big toll on development spending, and around 28pc of the development budget was spent till January 2. By cutting the annual development budget, the existing projects can get delayed and new projects cannot be started on schedule.

Scaling down development spending may achieve a short-term stabilisation gain at the cost of medium- to long-term structural transformation. The amount budgeted this year is even less than that of the previous year in nominal terms. The existing pace of low development expenditure would restrict the GDP growth rate to around 4pc in FY14-15.

The investment-to-GDP ratio is central for achieving higher economic growth. The remedy of lower investment calls for ‘development finance,’ which is implemented through development financial institutions. These institutions need to arrange long-term funding for strategic developmental projects.

Moreover, low real interest rates play an important role in promoting investment. Currently, we neither have developmental finance institutions nor low real interest rates to increase investment.

The private sector is not coming forward mainly due to low business confidence, high positive real interest rate, energy crisis and various other reasons. Pakistan has received a mere $600m in foreign direct investment in the first five months of this fiscal year.

In the absence of development financial institutions post-privatisation, the role of the state re-emerges. The current global and local economic circumstances require state-directed capitalism. Specifically, active state investment is required in education, healthcare, technology and infrastructure. However, macroeconomic stabilisation doesn’t provide the required space to spend money on these important activities.

An overvalued exchange rate affects the composition of exports. The low to medium value-added exportable products depend on the real exchange rate. As a consequence of the rupee’s appreciation, the value of merchandise exports declined around 5pc in the first five months of FY14-15. In addition, an overvalued exchange rate makes imports cheaper, affecting the domestic industrial structure. And imports grew 12.5pc from July to November 2014.

Macroeconomic stabilisation is pursued by sapping aggregate demand. The higher level of aggregate demand is a pre-condition for promoting a decent domestic industrial base. The stabilisation programme brings down inflation by curtailing the level of aggregate demand, which negatively affects the domestic industrial structure.

In a nutshell, the focus of the policymakers should be on economic development, which is both complicated and political and requires a broad and robust vision. An economic vision is anchored on a cost-benefit analysis as well as a holistic understanding of the complicated development process. The social returns should outweigh private returns, and projects with huge social benefits should be conceived and implemented without delay.

The writer is an assistant professor of economics at the Suleman Dawood School of Business, Lums, Lahore

Published in Dawn, Economic & Business, January 12th, 2015

On a mobile phone? Get the Dawn Mobile App: Apple Store | Google Play