If you are deeply concerned at the way the Pakistani rupee is losing value and how your bills are continuing to rise, you are not alone. If it is any relief, at least some in the top echelons of policymaking share your concern.

Growing numbers of people are feeling a rising tide of anxiety, as they watch their incomes erode and hear continuing news of further hikes in power and gas tariffs on the way, after the recent massive hike in petrol prices by nine rupees in the month of September, and the rupee crossing 170 to the dollar. And now we hear from reputable global ratings agencies like Fitch that the dollar could touch 180 rupees later in 2022.

On top of this, there is swirling talk of further power tariff hikes as well as continuing food price inflation. It is impossible to say how far these trends are going to go. And even for those who have been lucky enough to see an increment in their salaries this year, ranging between six to 10 percent, the bad news is that the economy is swivelling in a direction that will more than wipe these gains away. Keeping your head above water is going to remain challenging in the months ahead.

Power tariffs were hiked in early 2021 but, given the International Monetary Fund (IMF) pressure, more is to come. Fuel prices have also seen a record hike and it seems the worst is yet to come, given that global prices are continuing to rise and the government is preparing to activate further taxes on petrol as a means to shore up its fiscal position. The exchange rate remains under pressure and the situation will continue to worsen as the import bill rises.

Despite PM Imran Khan’s assurances that things will soon get better, Pakistanis are looking with great trepidation and anxiety at the economic situation around them. With sharp hikes in fuel prices, rising inflation and the rupee consistently losing value, most Pakistanis are struggling and worried. Everyone wants to know what is going on and what the future holds. Is worse yet to come?

Amid all this bad news there is some good news, however, for those willing to see it: we have been here before and lived to tell the tale. This article tells the tale for those who don’t follow economics, but want to understand what is happening and learn how to read the signs.

BEHIND THE EXCHANGE RATE

On top of the list of troubles that lie ahead is the exchange rate. It is not possible to say at what level it will eventually settle — though one global rating agency is putting the rupee at 180 by next year — but it is easy to see that it will remain under pressure for a while longer. The basic reason for this pressure is surging imports, which drain dollars out of the economy unless exports are able to keep pace.

The difference between exports and imports describes this situation the best. When this government came into power, this trade deficit — exports minus imports — hit a peak of 37 billion dollars, which was the largest the country had ever seen. Since it had been rising steeply for at least four years, the foreign exchange reserves of the country were depleted to a level where they were barely adequate to cover one month of imports.

That is when the new government began undertaking measures to curb the trade deficit and prevent this drain of dollars to the outside world through growing imports. Those measures yielded some results, and the deficit fell to 32 billion dollars in the next year, when the country entered an IMF programme, and then fell sharply to 24 billion dollars, slightly above the level it was at five years ago in 2016. By the end of fiscal year 2021, it jumped back up to 30 billion dollars again, and is climbing faster and faster every month, registering near record highs in the month of August, with September looking just as intense. Just in the first quarter of the current fiscal year, the trade deficit widened to nearly 12 billion dollars, double what it was at the same time last year.

In a sense, the country is drifting back to the same position it was at in 2018, when the government came into power. Except that, so far, the foreign exchange reserves are not falling as sharply, so the sense of crisis is not there. But a sharp fall in the reserves cannot be ruled out, should the drift continue unabated. This is the principal reason why the exchange rate has been falling since May, when this deficit began to increase sharply on a month to month basis.

Fuel prices have also seen a record hike and it seems the worst is yet to come, given that global prices are continuing to rise and the government is preparing to activate further taxes on petrol as a means to shore up its fiscal position.

Whenever a country is faced with a trade deficit like this, it has a few options. One is to find a way to finance the deficit. This means it has to find another corresponding inflow of dollars from another source. If your exports cannot fetch foreign exchange in quantities sufficient to pay for your imports, you need an alternate source to compensate for the weakness.

In the case of Pakistan, one alternate source is from remittances or money sent back by overseas Pakistanis to their families in the country. So, last fiscal year when the trade deficit jumped to 30 billion dollars, the country received remittances in more or less the same amount, which helped significantly in easing the pressure.

Taken together, remittances and exports account for the bulk of what is called the current account, which is the account that measures all the foreign exchange the country earns (or loses) for itself. Given such a tight balance between remittances and the trade deficit in fiscal year 2021, there was very little room for any other outflow. And given some movement in a few minor heads, the current account landed in a deficit of 1.8 billion dollars in fiscal year 2021. This represents the amount of foreign exchange the country lost to the outside world in that fiscal year.

By itself, the figure was not alarming. In the first year of the Pakistan Tehreek-i-Insaf (PTI) government, for example, this figure was above 19 billion dollars — a massive drain of foreign exchange that the economy could not handle. The deficit fell sharply in subsequent years, hitting its lowest mark by June 2021, when it came in at 1.8 billion dollars.

But the troubling part was the underlying growth of the trade deficit which, if it continued, could easily outstrip the ability of remittances to finance it. This is more or less what has happened in the months of July, August and September. In those two months of the new fiscal year, the trade deficit has surged ahead to 7.4 billion dollars while remittances have risen to 5.4 billion dollars, yielding a current account deficit just beyond two billion dollars in these two months alone.

Rising deficits on the current account create demand for foreign exchange in the country’s money markets and with this rising demand come some hard choices. The central bank — the body which is the chief custodian of the country’s foreign exchange reserves — can either let the dollar rise against the rupee (which is what happens to the price of anything when demand begins to exceed supply) or it can meet this demand from its own reserves.

Either option has unpleasant consequences. As it turns out, the State Bank of Pakistan did a little bit of both in recent months as the trade deficit powered on. This is why the rupee has lost more than 10 percent of its value since the month of May and, if the trade deficit continues surging at the same pace, is likely to lose even more in the months to come.

If the past is any guide, the scale and scope of these measures will increase to include many other items as well but, ultimately, they will be forced to control this overheating economy the only way it has ever been achieved in the past: by extinguishing growth and focussing on deficit reduction as the primary task of economic management.

SURVIVING IN A COMPETITIVE GLOBAL MARKET

But why is the trade deficit surging in the first place?

The answer is simple: because the economy is growing. On the face of it, this might sound odd, since we are conditioned to think of economic growth as a good thing. But Pakistan has always had this problem. Whenever the economy grows, the demand for imports grows with it, and exports are unable to keep pace.

Nearly seven years ago, for example, Pakistan’s exports of goods totalled just above 25 billion dollars. Yet, last fiscal year that ended in June 2021, exports were 25.6 billion dollars — a meagre rise compared to imports that went from 41.7 billion dollars to 53.8 billion dollars in the same period. In the intervening years, the numbers may have fluctuated, but these two snapshots of the country’s trade position in two different years is enough to see that there is a deeper problem at play here.

Why is this the case? And why have Pakistan’s exports lagged so far behind its imports over the years?

The answer again is quite simple: because Pakistan’s economy has not changed much over the decades and relies, more or less, on the same products today as it did in the 1980s. Pakistan was primarily an exporter of cotton and cotton-based products back in the 1980s. To this day, cotton and cotton-based products remain the country’s chief exports.

Compare this to India for an example, which diversified its exports far more successfully. Between the decade of the 1980s and the early years of the 2000s, India’s exports grew rapidly in services, chemicals, pharmaceuticals and other products. So, if almost 68 percent of India’s exports in the late 1980s consisted of manufactured items, by the early 2000s this had increased to 75 percent. But, more significantly, the largest contributor to the increase were chemicals, pharmaceuticals and engineering goods, whereas more traditional manufacturing industries — such as readymade garments or textile yarn and fabrics — either held stagnant or declining shares in overall exports.

India is not the only country to manage such an economic transformation in this era. Many other countries followed suit, encouraging investments in industries of the future and orienting their economies towards meeting demand in global markets. Those who did so successfully powered on and overcame the weaknesses in their trade structure. Those who were unable to undertake such a transformation remained stuck in the same industries and fell behind as the world came together in a global marketplace, where competitiveness was the source of a country’s strength more than anything else.

Pakistan was among those that fell behind and the result is the inability of the Pakistani economy to grow without giving rise to imbalances that swamp its own dynamism. This is the cycle that has brought the country back to the IMF every few years since at least 1988, because every spurt of growth depletes the foreign exchange reserves as imports rise faster than any other indicator in the current account.

It is an inevitable outcome of having failed to reform the economy over the decades, with the result that the country has to export cotton and cotton-based products while importing machinery, auto-assembly kits, power generation and transmission equipment or armaments.

GROWING PAINS

The latest such growth spurt began, paradoxically enough, at the beginning of the Covid era last summer. Around the world, governments administered a massive stimulus to their economies to offset the adverse impact of the lockdowns and Pakistan followed suit. By July of last year, more than 2 trillion rupees’ worth of a stimulus was announced for the economy in various shapes, to be administered via the government and the State Bank.

This included 1.2 trillion rupees under the Prime Minister’s Covid-19 Relief Package, of which around two thirds was actually disbursed, coupled with a set of incentives for the construction industry, in what was said to be an effort at boosting job creation.

The largest boost was provided by the State Bank, totalling more than 1.6 trillion rupees, the majority of which was ultimately disbursed or has been approved and remains ready for disbursement in the days ahead. On top of this, the State Bank also slashed interest rates by a record six percentage points in a matter of two months — the sharpest rate cut on record in Pakistan.

An idea of how much money was thrown into the economy during those days can be gleaned from some data on the money supply in the country. Consider, for example, that in August 2018, when the PTI government came into power, the total amount of currency in circulation in the country was somewhere around 4.7 trillion rupees. In the 20 months till March 2020, when the Covid era began, this amount had risen to 5.6 trillion rupees, an increase of 900 billion rupees. This sort of growth is relatively normal for an economy such as Pakistan’s.

But in the ensuing months, once the stimulus began, it rose rapidly to cross 6 trillion rupees in early May of 2020 and crossed 7 trillion rupees by May of 2021. In just about 13 months, its growth surpassed that of the preceding 20 months.

A similar trend was seen in bank deposits, which stood at 11 trillion rupees in August 2018 and grew steadily to touch 13.5 trillion rupees by March of 2020. By June of that year, they crossed 14 trillion rupees. Then the State Bank’s interventions kicked in with full force, pushing them beyond 15 trillion rupees by December 2020, and rising relentlessly till they are close to 17 trillion rupees today.

In just over one year, the amount of money held in bank deposits grew by almost double the rate at which they had grown in the preceding 20 months. This was the total amount of money sloshing around within the system.

Most of this money did not go into the pockets of ordinary people, least of all the working poor. A few months after the stimulus began, for example, a number of industries began reporting record high profits, breathing new life into the stock market. As the growth continued unabated, the companies in the KSE 100 index of the stock exchange reported record high earnings of 875 billion rupees by the end of fiscal year 2021, according to a report put out by Arif Habib Securities, a securities brokerage, investment banking and research firm.

Alongside this, government borrowing from the banks increased rapidly. A report by Topline Securities, a brokerage house in Pakistan, looked specifically at the growth in the money supply in fiscal year 2020, and found that it “clocked in at 18 percent, compared to its preceding 5-year average of 12 percent. In absolute terms, increase in [money supply] was recorded at Rs3.4trn during the year 2020 — almost twice its preceding 5-year average of Rs1.7trn.”

This is stupendous growth in the country’s money supply and it was driven, in significant part, by the government pumping money into the economy through fiscal and monetary inducements under the garb of mitigating the impact of Covid.

Almost 70 percent of this growth was accounted for by government borrowing from banks, which rose by 41 percent, whereas private sector borrowing increased only by five percent, according to the Topline Securities report.

With so much excess money pumped into the economy, stocks and the property market rose and corporate cash flows swelled to the point where many businesses turned away bank loans and started using their own money for their working capital requirements by March of 2021.

Despite a low interest environment, many businesses chose to retire loans from their cash flows rather than rely on bank borrowing to finance their operations at the start of the year 2021. So the third quarter of the fiscal year 2021 saw credit offtake by private businesses fall by 20 percent, especially in those industries that were still seeing large growth, such as textiles, oil, fertiliser, cement and so on.

The combined effects of these stimulus measures imparted a massive boost to the economy that has few parallels in our history. It is hard to think of a time period when so many resources were thrown into the economy through so many different means in so short a period.

From an amnesty scheme in the construction package that mobilised more than 200 billion rupees, to subsidised loans for industry, to interest rate cuts and tax incentives and accelerated refunds — the combined impact of all these measures caused economic activity to jump start by August of 2020 and continue in a rapid spiral till today.

By April of 2021, the government started boosting the trend further by announcing further incentives for car purchases, and auto loans picked up to the point where the production of jeeps and cars jumped by 264 percent in June this year, compared to the same month last year, or 66 percent for the full year.

With all this activity in the economy, the pace of imports accelerated sharply, while exports were unable to keep pace.

SOUNDING THE ALARM

By March of 2021, at least one person in the government had realised that this could not continue. Then finance minister Hafeez Shaikh had restarted talks to resume the IMF programme that was suspended back in April of 2020 with the arrival of the pandemic and, in March, he successfully negotiated a new set of targets for the economy.

Development spending was to be cut back sharply, according to that document, to bring the government’s expenditures back under control and limit its recourse to bank borrowing. Taxes and power tariffs were to be increased, and the schemes for subsidised credit being run by the State Bank were not only going to be wound up, but the power to issue such schemes would be taken away from the central bank for good.

Not surprisingly, he was shown the door days after the programme was approved by the board and implementation was set to begin. Instead, the government announced Shaukat Tarin as its new finance minister, and told the Fund that they would like to renegotiate the programme altogether.

In the budget announced in June, the government sought to up the ante further. They announced a massive increase in the development budget along with the Kamyab Pakistan Programme, through which it sought to disburse almost 3.7 trillion rupees in the next three years through various schemes.

As the fiscal year opened in July, the government ramped up development spending so rapidly that close to 44 percent of the total development budget was spent in the first two months of the fiscal year, an amount slightly less than 400 billion rupees. This is an unprecedented speed of government spending and is bound to have an impact on economic growth.

But as the engines of the economy began to rev faster and faster under the impact of this stimulus, the imbalances grew in tandem. The result is a large spike in the GDP growth rate, which went from negative territory to four percent in one year. It is difficult to recall the last time when the GDP growth rate jumped by more than four percentage points in a single year. But with the growth in business and industrial activity came an equally impressive growth in imports that grew faster than exports, placing the current account under growing pressure.

From July till November 2020, the current account registered a surplus, which was much celebrated by the government as its signature achievement. For a few months it seemed as if the impossible had been achieved — the current account surpluses continued even as growth picked up. By December, Prime Minister Imran Khan was repeatedly telling the country that “the economy is moving in the right direction”, an odd statement from a leader of a country that had just opened talks with the IMF.

In December, however, the current account recorded a massive deficit and every succeeding month brought further deficits. The pace of these deficits grew so rapidly that, by July and August of 2021, the current account deficit in the month of August alone was only slightly less than what was recorded in 12 months of the preceding fiscal year combined.

As the deficit climbed every month, the exchange rate took a beating because, put simply, a rising current account deficit means a growing demand for dollars in currency markets. At the start of this year, the rupee was trading just above 160 to the dollar. Then the rupee’s value started rising, slowly but steadily, till it hit just above 152 to the dollar in early April and oscillated around this level till the last week of May. By end June its value hit 157, by end July it fell to 162, by end August it reached 166 and today it has breached the 170 level.

And then the State Bank sounded the alarm. On Monday, September 20, the central bank declared that the party is over, the stimulus must now end, the growth must now moderate and the government should focus on protecting the economy from the dangers posed by its growing imbalances, rather than simply pumping the growth engine. It raised interest rates by a nominal quarter of a percentage point, a move designed as a signal of intent rather than applying any actual brakes on economic activity and, for the first time, warned of “possible further gradual tapering of stimulus” in the months ahead.

This was the second time a voice emerged from within the government’s own circle of policymakers to warn of the dangers of continuing down the path of runaway growth unchecked. Following this, Finance Minister Shaukat Tarin has also grudgingly acknowledged that the imbalances are growing and imports will need to be curbed in the days ahead, and in doing so used a word that economists utter with dread when describing the direction in which an economy is moving: overheating.

That is where the economy is heading, towards overheating, if its current growth path continues unabated. To control imports they have already started applying some brakes, starting with imported cars. If the past is any guide, the scale and scope of these measures will increase to include many other items as well but, ultimately, they will be forced to control this overheating economy the only way it has ever been achieved in the past: by extinguishing growth and focussing on deficit reduction as the primary task of economic management.

That is the cul-de-sac to which Pakistan keeps returning after every growth spurt, mainly because the economy remains wedded to a primitive export base that is increasingly becoming uncompetitive in a globalised world, and because the state stands on a narrow tax base that cannot provide the revenue needs of a growing economy.

Until these underlying dysfunctions are fixed through a tough road of reform, this story will always have the same ending.

The writer is a business and economy journalist.

He tweets @KhurramHusain

Published in Dawn, EOS, October 10th, 2021