Achieving economic stability

By Dr Ashfaque H Khan

Dr Abdul Hafeez Sheikh is the fourth person appointed by the present government in two years to look after the ministry of finance. Finance is the only portfolio which witnessed changes in faces in quick succession which speaks volume about the importance given to the economy by the present regime.

Dr Sheikh has inherited an extremely fragile economy which was badly handled for the last two years by those who had little understanding of the subject. Adverse internal and external developments of an extraordinary nature apart, the inept handling of the economy for over two years has brought miseries and pain for the people of Pakistan. Pakistan’s economic growth has slowed; the economy’s capacity to create jobs has shrunk, unemployment and poverty have risen; persistence of higher double-digit inflation has hurt the poor and the fixed income group the most; senseless borrowing coupled with sharp depreciation of exchange rate has drowned the country into debt (thanks to Shaukat Tarin); the country’s monetary policy has become subservient to fiscal slippages; power shortages and the persistence of circular debt have had crippling effects on the economy; and the confidence of the private sector is at all time low. Dr Sheikh does not have the capacity to address all the challenges simultaneously. He needs to prioritise these challenges and address the core issue first.

Restoring macroeconomic stability in a reasonable time frame should be the top most priority of Dr Sheikh. Empirical evidences suggest that macroeconomic instability has generally been associated with poor growth and a consequent rise in unemployment and poverty. Hence, growth cannot be revived on sustained basis without achieving macroeconomic stability. Thus, macroeconomic stability is sine quo non for achieving higher economic growth and poverty alleviation.

How can we achieve macroeconomic stability? Reducing fiscal deficit by mobilising more resources, rationalising current expenditure and prioritising development expenditure are some of the critical steps that are needed in order to achieve macroeconomic stability. Dr Sheikh must ensure that fiscal deficit remains at 5.1 per cent of the GDP in the current fiscal year. For the next fiscal year (2010-11), budget deficit target should be fixed at 4.0 per cent of the GDP for which he needs the total support of the prime minister.

Budget deficit is the mother of economic problems. It gives birth to many economic ills and hence creates macroeconomic instability. Reduction in budget deficit would reduce the borrowing needs of the government, slow the pace of accumulation of public debt, release pressure on interest rate, would enable the SBP to reduce discount rate which in turn would encourage the private sector to undertake new investments. Reduction in budget deficit would also help improve current account balance.

Bringing inflation down to a single-digit level is also needed for macroeconomic stability. Keeping the budget deficit low, maintaining stability in exchange rate, pursuance of tight monetary policy and freezing the support price of wheat for two more years will help bring inflation down to a single-digit level.

Restoring investors’ confidence should be the second most priority of Dr Sheikh. Establishing a channel of communication with the stakeholders should be the first step in this direction. Dr Sheikh is not communicating either with the print and electronic media or with the private sector and hence the uncertainty on economic policy continues to prevail. He must talk to a select group of economic journalists and TV channels and explain the government’s position on the economy. He must visit the leading chambers of both domestic and foreign investors; talk to the leading industrialists and address the president of the banks. Constant engagement with the private sector is vital for restoring their confidence on economic management.

Resource mobilisation through tax system and tax administration reforms should be the third most priority of Dr Sheikh. An issue at hand is the imposition of the Value Add Tax (VAT) with effect from July 1, 2010. The VAT has gained favour over traditional sales tax worldwide. The government has neither trained the tax collectors nor educated the tax payers about the VAT. As such, the VAT has not been properly understood by the tax payers and hence there is resistance from different quarters. If the VAT is implemented without proper homework, it will create chaos and will hurt the revenue generation efforts of the government.

Let me make a suggestion here. The government should impose VAT with budget 2010-11 but its implementation may take effect from July 1, 2011 instead of 2010. The government must use the time for training the tax collectors and educating the tax payers. The IMF must set some performance criteria regarding the education of the tax payers on quarterly basis. The World Bank must assist the government in educating the tax payers and training the tax collectors on the field. It must assure the IMF through highest level that the VAT will be effective from July 2011.

Addressing the challenges of power management should be the fourth priority of Dr Sheikh. Conservation and augmentation of power should be the guiding principals in addressing such a challenge. The government has already taken several measures to conserve power. On augmentation side, there are 50 power projects totaling 12,150MW in different stages of completion and will come into operation during October 2008 to December 2015. At least four of them have been completed and inaugurated by the prime minister. The government must ensure that these projects are completed in time.

Dr Sheikh has inherited a badly damaged economy. He has to take a pro-active approach to address the challenges. He will also have to take politically difficult decisions to restore macroeconomic stability for which he will need support from the prime minister.

The writer is director general and dean at NUST Business School, Islamabad.