The present government will be presenting its second budget on June 13. Before one analyses the expected policy stance for the 2009-10 fiscal year, it is essential to review the current policy stance pursued by the government.
Pakistan’s balance of payments came under severe pressure during fiscal 2007-08 and in the first four months (July-October) of the current fiscal year owing, to the unprecedented rise in oil, food and other commodity prices as well as to the global financial turmoil. Absence of effective policy response during the political transition to a new government further accentuated the balance of payments difficulties. It is not surprising that Pakistan continued to lose its foreign exchange reserves at a much greater pace and by end-October 2008 they reached a dangerously low level. The rapid pace of the reserves’ depletion created doubts within and outside the country on the viability of the country’s balance of payments. How to prevent the rapid decline in foreign exchange reserve and save the country from defaulting on its external payment obligations became the single most important economic challenge for Pakistan. Pakistan approached the IMF for balance-of-payments support and received a $7.6-billion package spreading over seven quarters, ending in June 2010. One of the objectives of the IMF programme was to restore the confidence of domestic and foreign investors by addressing macroeconomic imbalances through tightening of fiscal and monetary policies.
Accordingly, Pakistan pursued tight fiscal and monetary policies during 2008-09. The budget deficit was targeted to decline from 7.4 percent of GDP in 2007-08 to 4.3 percent in 2008-09, and the current account deficit was targeted at 5.9 percent of GDP–down from 8.4 percent in 2007-08. Tight fiscal policy was needed to curtail aggregate demand and support improvement in current account deficit. A tight monetary policy was needed to restore confidence in the Pakistani rupee, help rebuild foreign exchange reserves, ensure domestic financing requirement of the government is met through market placements of government securities and sharing off aggregate demand by reducing import demand for which higher interest rates were needed.
It is important to note that while the rest of the world was pursuing easy monetary and fiscal policies Pakistan was pursing entirely opposite ones. This is because the rest of the world was facing the issue of lack of demand while Pakistan was facing the challenge of excessive demand as reflected through high fiscal and current account deficits. The rest of the world required policies that would create more demand while Pakistan needed policies that would result in reducing demand to minimise macroeconomic imbalances. Pakistan pursued right policies and succeeded in reducing both fiscal and current account deficits for which the government deserves commendation. Fiscal deficit is expected to be 4.3 percent of GDP-down from 7.4 percent and the current account deficit is likely to be 5.3 percent of GDP–down from 8.4 percent last year. Such a sharp reduction in macroeconomic imbalances in one year is not a mean achievement.
There are indications that the government is targeting a fiscal deficit of 4.6 percent of GDP in the Budget 2009-10 as opposed to 3.4 percent agreed earlier with the IMF. Given the current depressed global economic environment the IMF has advised member-countries, programmed countries in particular, to spend more. Accordingly, it has allowed Pakistan to increase its fiscal deficit from 3.4 percent of GDP to 4.6 percent. This has encouraged the government to increase spending–particularly development spending in the coming budget.
Why this expansionary fiscal policy stance is not advisable at this stage? Firstly, after successfully reducing budget deficit there is no point of reversing this trend so soon. This will send a wrong signal to the rating agencies and international financial institutions. Secondly, the budget deficit of 4.6 percent of GDP will amount to Rs680 billion, which will need to be financed from domestic and /or extern borrowing. Such a large borrowing would simply add to public debt which is already rising rapidly over the last two years; it will put pressure on interest rate and monetary policy will become hostage to expansionary fiscal policy. Today we may be able to spend more but going forward the bulk of resources will be consumed by debt servicing alone, leaving very little for social sector and infrastructure development.
Pakistan should take a different policy stance as it has done in the current fiscal year. The IMF may have allowed the rest of the world to purse expansionary fiscal policy to prop up demand. Pakistan’s fiscal position is still fragile and current account deficit is still unsustainable. Pursuing an expansionary fiscal policy in this environment is certainly not the type of policies we should be pursing. The hard-earned improvement in macroeconomic environment underpinned by fiscal discipline will come under threat. We need to be clear in our policy objective. Do we need to promote economic growth by pursuing expansionary fiscal policy and “possibly” easy monetary policy? Or we want further reduction in macroeconomic imbalances by pursuing tight monetary and fiscal policies? In choosing the former, we should keep in mind that the oil prices have started rising (since January 2009 it has increased by 66 percent). Pursuing expansionary fiscal policy in the midst of rising oil prices will aggravate balance of payment difficulties. My suggestion is that we keep the budget deficit at less than 4.0 borrowing of the GDP level and continue to purse a tight monetary policy for one more year and consolidate the gains. In other words, what we need is macroeconomic stability–low budget deficit, low current account deficit, and single-digit inflation. Growth will follow stability. In the meantime agriculture can contribute to growth; manufacturing and services will contribute to growth if we succeed in improving security environment and minimize power shortages. The present government will be presenting three more budgets during its tenure. One more year of tight monetary and fiscal policies will allow them to spend more in the remaining three budgets.
Pakistan’s balance of payments came under severe pressure during fiscal 2007-08 and in the first four months (July-October) of the current fiscal year owing, to the unprecedented rise in oil, food and other commodity prices as well as to the global financial turmoil. Absence of effective policy response during the political transition to a new government further accentuated the balance of payments difficulties. It is not surprising that Pakistan continued to lose its foreign exchange reserves at a much greater pace and by end-October 2008 they reached a dangerously low level. The rapid pace of the reserves’ depletion created doubts within and outside the country on the viability of the country’s balance of payments. How to prevent the rapid decline in foreign exchange reserve and save the country from defaulting on its external payment obligations became the single most important economic challenge for Pakistan. Pakistan approached the IMF for balance-of-payments support and received a $7.6-billion package spreading over seven quarters, ending in June 2010. One of the objectives of the IMF programme was to restore the confidence of domestic and foreign investors by addressing macroeconomic imbalances through tightening of fiscal and monetary policies.
Accordingly, Pakistan pursued tight fiscal and monetary policies during 2008-09. The budget deficit was targeted to decline from 7.4 percent of GDP in 2007-08 to 4.3 percent in 2008-09, and the current account deficit was targeted at 5.9 percent of GDP–down from 8.4 percent in 2007-08. Tight fiscal policy was needed to curtail aggregate demand and support improvement in current account deficit. A tight monetary policy was needed to restore confidence in the Pakistani rupee, help rebuild foreign exchange reserves, ensure domestic financing requirement of the government is met through market placements of government securities and sharing off aggregate demand by reducing import demand for which higher interest rates were needed.
It is important to note that while the rest of the world was pursuing easy monetary and fiscal policies Pakistan was pursing entirely opposite ones. This is because the rest of the world was facing the issue of lack of demand while Pakistan was facing the challenge of excessive demand as reflected through high fiscal and current account deficits. The rest of the world required policies that would create more demand while Pakistan needed policies that would result in reducing demand to minimise macroeconomic imbalances. Pakistan pursued right policies and succeeded in reducing both fiscal and current account deficits for which the government deserves commendation. Fiscal deficit is expected to be 4.3 percent of GDP-down from 7.4 percent and the current account deficit is likely to be 5.3 percent of GDP–down from 8.4 percent last year. Such a sharp reduction in macroeconomic imbalances in one year is not a mean achievement.
There are indications that the government is targeting a fiscal deficit of 4.6 percent of GDP in the Budget 2009-10 as opposed to 3.4 percent agreed earlier with the IMF. Given the current depressed global economic environment the IMF has advised member-countries, programmed countries in particular, to spend more. Accordingly, it has allowed Pakistan to increase its fiscal deficit from 3.4 percent of GDP to 4.6 percent. This has encouraged the government to increase spending–particularly development spending in the coming budget.
Why this expansionary fiscal policy stance is not advisable at this stage? Firstly, after successfully reducing budget deficit there is no point of reversing this trend so soon. This will send a wrong signal to the rating agencies and international financial institutions. Secondly, the budget deficit of 4.6 percent of GDP will amount to Rs680 billion, which will need to be financed from domestic and /or extern borrowing. Such a large borrowing would simply add to public debt which is already rising rapidly over the last two years; it will put pressure on interest rate and monetary policy will become hostage to expansionary fiscal policy. Today we may be able to spend more but going forward the bulk of resources will be consumed by debt servicing alone, leaving very little for social sector and infrastructure development.
Pakistan should take a different policy stance as it has done in the current fiscal year. The IMF may have allowed the rest of the world to purse expansionary fiscal policy to prop up demand. Pakistan’s fiscal position is still fragile and current account deficit is still unsustainable. Pursuing an expansionary fiscal policy in this environment is certainly not the type of policies we should be pursing. The hard-earned improvement in macroeconomic environment underpinned by fiscal discipline will come under threat. We need to be clear in our policy objective. Do we need to promote economic growth by pursuing expansionary fiscal policy and “possibly” easy monetary policy? Or we want further reduction in macroeconomic imbalances by pursuing tight monetary and fiscal policies? In choosing the former, we should keep in mind that the oil prices have started rising (since January 2009 it has increased by 66 percent). Pursuing expansionary fiscal policy in the midst of rising oil prices will aggravate balance of payment difficulties. My suggestion is that we keep the budget deficit at less than 4.0 borrowing of the GDP level and continue to purse a tight monetary policy for one more year and consolidate the gains. In other words, what we need is macroeconomic stability–low budget deficit, low current account deficit, and single-digit inflation. Growth will follow stability. In the meantime agriculture can contribute to growth; manufacturing and services will contribute to growth if we succeed in improving security environment and minimize power shortages. The present government will be presenting three more budgets during its tenure. One more year of tight monetary and fiscal policies will allow them to spend more in the remaining three budgets.