Pressure on rupee exposes Pakistan’s economic weakness-Financial Times

Pressure on rupee exposes Pakistan’s economic weakness

Looming currency crisis exposes consumer binge and debt service burden


YESTERDAY by Mohammad Zubair Khan
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It has only been a year since a $6.2bn International Monetary Fund programme in Pakistan was completed, and the markets are speculating about the timing of a substantial depreciation of the Pakistani rupee.

Gross foreign exchange reserves built up by borrowing heavily during the IMF programme are still over $14bn, worth three months of import cover, but speculation has been fired by the underlying weakness in foreign exchange earnings and rising foreign exchange liabilities.

Reserves are gradually declining now due partly to steadily declining exports, ballooning consumer goods imports and imports of investment goods for the China Pakistan Economic Corridor (CPEC). A burgeoning debt service, which is already 29 per cent of export earnings, is adding to the burden.

But the largest losses in reserves in recent months have resulted from central bank intervention to defend the untenable exchange rate of the rupee.

The continuing weakness in the balance of payments is a legacy of the weak IMF programme and flawed economic priorities of Nawaz Sharif’s government under finance minister Ishaq Dar. During that period, inflation was contained, helped by lower energy prices, and growth inched up but remained much below the 7 plus per cent achieved during Pakistan’s high-growth periods.

The feeble economic revival has been driven by consumption demand financed by an unprecedented surge in remittances, multilateral and bilateral donor support and expensive commercial borrowing. But the investment rate remained low despite increased government infrastructure spending as private investment in manufacturing shied away due to the uncompetitive economic environment, high cost of doing business and an excessive tax burden of a maximum 38 per cent corporate tax rate and GST rates ranging between 17 and 22 per cent.
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Like many democratic governments living and spending in the present while ignoring the medium term consequences of neglecting painful reforms and accumulating expensive debt, Mr Sharif’s government resisted calls for an exchange rate adjustment as the rupee appreciated nearly 20 per cent in real effective terms in the last four years and failed to undertake important reforms in the energy sector.

Instead it increased energy prices to cover losses of up to 30 per cent in power transmission due to inefficiencies and theft.

Conspicuously, government failure to reform the public sector enterprises, which have accumulated losses of nearly $8bn, continues to cost the budget. With the aim of raising revenue to fund high-profile spending programmes including expensive urban mass transit systems, transport and agriculture are burdened with sales tax and duties of more than 55 per cent.

In general, tax rates were raised each year for the few tax filers in the country while large segments of the population remained outside the net. In the frenzy to achieve unrealistic tax revenue targets as elections approach, the thin line between enforcement and victimisation has blurred as the Sharif government has doubled tax revenue but the number of tax filers have remained the same or declined.

Consequently, the competitiveness of the domestic economy has been adversely affected. It is not surprising that exports have declined for three consecutive years and imports surged to out-compete domestic industries, resulting in a record trade deficit of $22bn.

Industry closure is rife. The All Pakistan Textile Mills Association believes that nearly 35 per cent of textile sector units have closed down.

Agriculture production continues to fluctuate with the vagaries of weather and productivity is below a third of neighbouring countries.

Policy choices confronting the government are clear. One route is to follow the existing policy of borrowing more to finance consumption and remain on a spending binge to buy electoral victory whatever the consequences. An alternative would be to devalue the currency, improve competitiveness, reduce the cost of doing business, rationalise tax policy to invigorate its industry and reduce the country’s dependence on borrowing.

The time for making the policy choice is running out in the economic realm as next year’s debt service costs will increase to 7.5 per cent of GDP when the Paris Club rescheduled debt comes due. However, politically it is not the best of times, both because parliament approaches elections next year and because after the Supreme Court recently disqualified Mr Sharif on corruption charges, the new government is suffering political paralysis.

The new prime minister, Shahid Abbasi, who was handpicked by Mr Sharif, has not yet demonstrated his independence or his intentions to take on difficult decisions. Today both Mr Sharif and Mr Dar face corruption charges in courts but paradoxically Mr Dar continues as finance minster to ensure Mr Sharif’s control over political power and the continuity of his economic policies.

As he faces serious charges of corruption, Mr Sharif leaves behind the legacy of a heavily indebted and uncompetitive economy, beholden to western creditors. The latter will come to haunt Pakistan as it tries to realign its foreign policy away from the US.

Mohammad Zubair Khan, a former Pakistan minister of commerce, was formerly on the staff of the IMF