A matter of timing

There have been a number of comments in the papers recently urging the government to move from the present "stabilization phase" to a "growth phase" to stem the loss of jobs and arrest the troubling increase in poverty as growth slows.

While the suggestion is correct in theory, timing is everything and the time is not now. The economy has hardly stabilized. After all, it has been barely two months since stabilization measures were taken in the context of the government's adjustment program financed by the IMF. No economy can be turned around so quickly and Pakistan is no exception.

To begin with, the signs of stabilization are still very tentative. Our foreign exchange reserves have stabilized but, at $ 10 billion, the situation is still fragile. Some have suggested the reserves will fall unless there are offsetting capital inflows. This is a source of concern. The allegedly tight fiscal stance and firm monetary policy appears to be having an effect on reducing internal and external imbalances by restraining aggregate demand. Inflation is coming down nicely, in large part due to the reverse price shock from falling food and oil prices. How much of a contribution macroeconomic policies are making in reducing inflation is difficult to tell. The fall in inflation thus far may be due entirely to fortuitous exogenous, non-policy related factors. Manna from heaven.

There are reports that the fiscal deficit target has thus far been exceeded, and there has been no net borrowing from the central bank, the root cause of past inflation. While it is difficult to ascertain the correct position since the data is guarded closely, if true, this is certainly good news and the authorities deserve to be commended. However, once again the FBR has fallen short of its tax revenue target which suggests that the fiscal target has been met by cutting expenditures.

There is nothing wrong with cutting expenditures. Indeed, empirical evidence from other countries show that fiscal adjustment that is based on expenditure cuts, as opposed to revenue increases has a better change of success and is more lasting. However, it all depends on what you cut.

It is highly unfortunate that the cut in spending is being focused on the development side. This is exactly what the government should not be doing. By limiting releases of funds to both new and on-going projects and programs, the development program is being devastated, hurting all projects across the board without any respect for priorities. This includes projects which are viable and make an important contribution to growth, namely, projects relating to physical and social expenditure and poverty alleviation. By applying such indiscriminate cuts, we are killing the proverbial goose, or one of the gooses that lays the golden egg.

Development spending is cut because it is simply easy to do. You just pass an order. The government has control over releases and can stop projects dead in their tracks. Cutting spending elsewhere, in current spending and defence spending, is harder to do. While there have been some rumors to the effect that the government is tightening up on jaunts by all and sundry and holding the line on other wasteful expenditures, defence expenditures, as usual, remain unscathed.

In brief, I would submit that we are off to a good, if tentative, start on the path of economic adjustment. The time to relax policies will come and we need to be patient until stabilization is firmly established, macroeconomic imbalances have been reduced, reserves have been built up to more comfortable levels and inflation has come down further. Once inflation falls to more acceptable levels, there will be room to cut interest rates and thereby provide a boost to the economy. This would mark the classic transition from the stabilization phase to the growth phase.

However, this will only work of fiscal policy is held tight. Loosening monetary policy through a cut in interest rates and loosening fiscal policy by expanding the deficit at the same time would be a classic case of overkill and will quickly get us into trouble again. Too abrupt and too fast an easing of policy will merely bring back inflation and widen the imbalances that we would have worked so hard to correct. We would have lost all our hard-fought gains.

Our past experience shows that we have invariably succumbed to the temptation to ease the policy stance prematurely. This is understandable because the political pressure to do so on an elected government which wants to be seen to be sensitive to the aspirations of the people is intense and becomes harder as time goes by. Patience is exhausted and adjustment fatigue sets in. The voices of prudence and caution are drowned out in the cacophony of macroeconomic populism.

Maybe we will do the right thing this time around.