Why Growth is Unlikely to Return Immediately

The most well-known aspect of Pakistan’s economy is that it is volatile. Growth has been aplenty in certain political eras, while it disappeared during other times. Political instability and policy inconsistency can be blamed for such erratic behavior of the economy.

Pakistan hasn’t really experienced a period of abnormally high growth but whenever the government attempted to chase growth, rates in excess of 5% were readily available and during most times, they were sustained for a few years. However, growth periods were often followed by periods of economic shrinkage – which many economists suggest occur due to the growth erstwhile achieved being made possible through excessive indulgence in debt. The repayment of the incurred debt that is often scheduled during the following electoral term leaves growth to alternate between political regimes. With the enormous focus on GDP growth as the most popular indicator of economic health and well-being, political parties that inherit periods which would not produce high levels of GDP growth are often subjected to public hatred. They cite progress in other development indicators and the conditionalities of the international financial institutions to justify the absence of growth.

The two Bretton Woods institutions, the World Bank and the IMF, insist upon attaining macroeconomic stability through structural reforms, even at the cost of forsaking any and all growth in the economy. Their standard prescriptions leave governments with a trade-off between growth and much-needed foreign exchange (read: dollar) reserves; acquiring the latter would imply that the government would have to take the difficult decision of compromising growth in exchange for dollars. This decision is, at the very least, brave and unpopular. Apart from the economic cost, it has political costs associated with it. For political parties, therefore, it is vital to calculate whether stabilization outcomes that such structural reforms would produce outweigh the political costs that they would have to incur to bring such reforms into place.

As we have seen in the past, political costs are too large for governments to persist with reforms. And so, they often succumb to the constancy of pressure exerted by the opposition and the public at large. Since inflation is one by-product of such reforms, they tend to become unpopular with the public much quicker than the time it takes for indicators that the reform promises to improve to begin showing results. In Pakistan’s current case, the dollar has somewhat stagnated at around Rs. 150 and the current account deficit has shrunk quite significantly to 1.1% of the GDP in FY2020 from its recent peak of 6.3% of the GDP in FY2018.  However, the double-digit inflation has done much to cloud these achievements of the government which, standing near the close of the third year of its term, feels politically compelled to change the course of its policy and begin to chase growth instead of stabilization.

Given the salary and pension commitments; the non-discretionary part of the budget and the slow progress on pensions reform, it will be interesting to see what the new Finance Minister will squeeze to propel development financing

The change of heart became visible at the Ministry of Finance, whose head was recently changed from someone who was seen as an agent of the IMF-prescribed stabilization policies to someone who promises to ease up the economy toward a more expansionary path; both monetarily and from a fiscal perspective. The members of the treasury have finally heaved a sigh of relief for once during these three years. They believe that they would finally have some growth numbers to silence the opposition and offer some relief on the inflation front to their disgruntled electorate. The Prime Minister has hinted at a reversal in policy to ensure high levels of economic growth. In his first press briefing, the newly incumbent Finance Minister also, quite unequivocally, made his intentions of adopting growth-centric policies clear.

While this may sound quite alluring at first, one must hope that the policy-makers do realize that – for the reasons that will follow – growth may not be achieved immediately.

Development expenditure had been scaled back gradually over the last two budgets. Some of the divestment from development had been used to increase the rate at which the government had historically serviced debt. However, Pakistan’s overall debt – despite large repayments –  has continued to increase, leaving the government little room to take development expenditure to the level from where it can begin to support growth rates in excess of 5% immediately. Given the salary and pension commitments; the non-discretionary part of the budget and the slow progress on pensions reform, it will be interesting to see what the new Finance Minister will squeeze to propel development financing. For now, it appears that development financing will only be increased gradually.

A disproportionately large part of the development expenditure is consumed by mega development projects that involve construction activity and have project completion life-cycles longer than one year. In fact, in many cases, this is longer than 3 years. Many ongoing projects with long gestation periods would still produce the very same growth outcomes that they would have produced prior to the policy change at the Ministry of Finance. Those who understand Pakistan’s cumbersome planning process know that it is difficult to make major changes to the design of such projects in the middle of the implementation phase – especially projects that stand at the cusp of maturity. Understandably, this leaves little flexibility in the largest part of the development budget, which may not be geared toward growth immediately.

If the government is able to channel resources toward growth, manage public finance effectively and make necessary adjustments to the development expenditure to ensure its multiplication, a gradual reversal in growth may start to begin in FY2022

Public finance economics lays great emphasis on something called the ‘multiplier effect’ which is the number of times each dollar spent by the government would be multiplied to become part of a country’s GDP. The multiplier varies from country to country, and is a good indicator to analyze how productively and effectively public finance is managed and governed. The estimates of Pakistan’s current level of the multiplier vary, however, with private investment declining to fall below 15% of the GDP, it will have to be seen how effectively any expected increase in the development expenditure can incentivize an increase in private investment. If growth expectations are not shouldered by the increase in private investment, one fears that the government alone would turn out to be an inadequate force to cause the growth turnaround that it foresees following a sudden adjustment in policy. Development is great multiplier in itself and can cause growth even without a large buy-in from the private sector; however, for development investment to multiply, it is critical that it is entrenched and channelized effectively. Provided that resources were channeled toward stabilization and not growth in the last few years, the entrenchment and channelization that would be instrumental in activating the multiplier effect cannot happen in the short-run.

The World Bank estimates Pakistan economy to grow by 1.3% in FY2021. Other estimates vary between 1.3% and 1.5% - staying well below the 2% which was the earlier projection, given a steady and quick recovery from COVID-19. Looking at the recent surge in COVID-19 cases in Pakistan, growth revisions could see projections decline further from 1.3%. If the government is able to channel resources toward growth, manage public finance effectively and make necessary adjustments to the development expenditure to ensure its multiplication, a gradual reversal in growth may start to begin in FY2022.

Even after such careful interventions, growth in excess of 5% may not be available during the last two years of the PTI government. It is critical that any promises that it makes to its electorate are sensitive to this contingency.

The writer is an economist and ex-Director of the Burki Institute of Public Policy (BIPP). He tweets at @AsadAijaz