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Economic Peril: Choose Restructuring Over Stop-Gaps

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Ijaz Nabi
Executive Director, Consortium for Development Policy Research, Country Director (Pakistan) International Growth Centre

Pakistan needs to undertake structural reform before any macroeconomic dividends can come through. This needs stepping back from political confrontation, and incentivising powerful elites to switch to investment patterns consistent with a more productive, export-oriented gameplan. This will also require the judiciary to mitigate legal challenges that enable a structural shift; embedding sustainable economic growth in national security frameworks; and, complementing these initiatives with an informed public debate on the needed change.

Between 2000 and 2022, the Pakistani rupee fell from 52 against the US dollar to 227 – with the market rate now crossing 260. Concurrently, manufacturing and exports have stagnated, investment fell, real wages remained flat, and debt (largely domestic) has spiked.  A growing proportion of public resources are now needed for debt servicing, leaving little room for physical infrastructure overhauls, education, healthcare, and climate change preparedness.

While all this paints a grim picture, Pakistan’s macro-fiscal problem is not complex – technically speaking. The economic management challenge is at two levels. The first – reducing the current account deficit and building up reserves to stabilise the exchange rate, both targets of IMF programmes – is relatively easy. However, at the structural level, addressing frequent spikes in the current account deficit will remain a key challenge for 2023. To make any substantive progress on this will require tackling the twin deficits in trade and fiscal accounts.

Pakistan’s persistent trade deficit reflects stagnant manufacturing and poor export competitiveness due to low investment and modest technological innovation. Meanwhile, large inflows of remittances have sustained overvaluation of the rupee for long periods, skewing relative prices in favour of imports. Apart from undoing the dependency on remittances, addressing this deficit will require adopting productivity-enhancing technology to make domestic production more competitive.

As for the persistent fiscal deficit, this will need addressing long-recognised fragilities in public expenditure management and revenue collection. On public expenditure, correcting the poorly targeted subsidies should be a start. The energy subsidy is the chunkiest, with residential consumers receiving a larger subsidy than industry. On the revenue side, low taxes on agriculture, retail and wholesale trade compared to manufacturing needs to be corrected. Investors’ sectoral choices should be based on productivity growth, not tax advantage.

Moving forward, as Pakistan negotiates and navigates new conditionalities with IMF for its next tranche, and simultaneously looks towards its lenders for concession and more relief, it is pertinent to realise these will serve no more than stop gap measures. The challenge for 2023 is one of building consensus among major political and non-political stakeholders for an uninterrupted structural reform of the economy.

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