From Economic Crisis to Collapse

Dr Muhammad Yaqub,

Former Governor to the State Bank

In her article on the economy in the August 24 issue of The News, Dr Maleeha Lodhi has sounded a serious and timely warning about the looming economic crisis. The message conveyed in her article was that the real threat to the survival of the country was not from India, the US or from terrorism, but from an economic collapse that may be closer than people think if certain policy actions are not taken. She has competently used key macroeconomic indicators to establish that the country is heading towards a train wreck but somehow the government, the opposition and other stake holders continue to ignore the warning signals.

Let me summarise in simple terms the main trigger points of the economy:

The commodity producing sectors are showing low growth. The rate of inflation is much higher than what the official statistics show. The budgetary situation is much worse than what the budget documents reveal or the Ministry of Finance projects. Budget subsidies are substantial and going to the wrong people. Several public-sector enterprises are bankrupt.

The balance sheets of banks are loaded with lending to the government and its bankrupt enterprises on the invalid assumption that sovereign debt cannot be in danger of default. The State Bank of Pakistan (SBP) has no control on its own balance sheet, which is being driven by government borrowing, and it has no autonomy in practice to formulate an independent monetary policy even when the revised SBP Act provides for it.

The private sector is dormant and capital flight is at an all time high. There is no plan for water management to promote agricultural output and the industry is suffering from a shortage of gas and electricity. The underground economy is expanding relative to the recorded economy. The medium term balance of payment situation is much more precarious than what the foreign exchange reserve position reflects.

The state of governance is very poor. In spite of relentless efforts by the judiciary, corruption and pilferage are on the rise. The government is barely functioning and the country’s finance minister has no effectiveness in the chaotic political system. Even with a parliamentary system of government, the prime minister is just a figurehead and the president, having no statutory powers, is in effect running the government. The army is engaged in fighting militancy and seems to have no interest or influence to help stabilise the sinking economic ship. The judiciary is being defied by the executive with impunity. In these chaotic governance conditions, nobody is paying any attention to the real threat to the existence of the country that is emanating from a collapsing economy. The underlying depressing economic trends are being covered up by slogan mongering, false promises, window dressing and statistical jugglery by the government.

While Dr Lodhi has used several macroeconomic indicators to point to the precarious state of the economy, I will focus on two major threatening economic storms that are brewing and that she has already mentioned. On the domestic front, the country is headed towards runaway inflation. On the external front, debt default is a real possibility. Both of these crises will have serious economic, social and political implications and once in progress will be difficult to manage and control.

For the last several years the country is in the grip of sharply rising prices and is headed towards the stage of hyper inflation. A part of high inflation is attributable to supply shortages reflecting lopsided economic performance, slow growth of commodity producing sectors and the effects of natural calamities like floods but it is mainly driven by demand pressures from unbridled printing of notes by the State Bank, which is supposed to be the custodian of monetary stability. Unmindful of the consequences, the government continues to use inflationary sources of financing the budget, fearing the public reaction to imposition of taxes or curtailment of expenditure. People are losing confidence in the country’s currency and dollarisation and real estate holdings are being used as hedge against inflation. If the government does not change its method of financing the budget and bankrupt public-sector enterprises, hyper inflation is just around the corner.

Inflation is the cruelest form of taxation hitting the poorest segments of society the hardest and creating social and political unrest. It hurts growth, adds to poverty and economic crimes and generates a dual society that will ultimately promote a class war and social and political disorder. The government has little awareness that in using inflationary methods of budget financing it is on a slippery and dangerous slope.

The second area of vulnerability mentioned by Dr Lodhi is possible external debt default with enormous consequences for the country and its future. With export volume stagnating and imports rising, and remittances and bilateral foreign assistance likely to dry up, and with no prospect of a meaningful and sustainable stabilisation programme with the IMF, very soon foreign exchange reserves will begin to get hit by heavy payments for imports and debt servicing, including large repayments to the IMF. Once reserves begin to decline, market psychology will turn negative and accelerate the process of depletion of foreign exchange reserves. The fear of external debt default or actual default will adversely affect international trade, the exchange rate, remittance inflows and private investment and lead to commodity shortages and a sharp rise in prices. External debt default or even an eminent threat of it will set in motion an economic chaos that would threaten the very existence of the country.

Time is running out for the government and the country. The government needs to act, and act now. It must undertake major economic reforms to stabilise the economy and avoid hyper-inflation on the domestic side and breakdown of the balance of payment on the external front.

Dr Lodhi’s warnings should be taken seriously and not brushed aside as a usual dooms day scenario of a pessimist. It may be pointed out that she very optimistically edited a book recently entitled “Pakistan: Beyond the Crisis State” and predicted that “the country may yet escape its difficult first sixty-three years, resolve its problems and re-imagine its future. But doing so will need a capable leadership with the vision and determination to chart a new course.”

We all are waiting for the beginning of that period of vision and determination by a capable leadership that would create hope and promise for the country.




This article appeared in The News International on September 8th, 2011