IMF Necessary but Insufficient
A blue print for sustainable economic growth in Pakistan
Executive Summary
With the IMF board’s approval in late September of a new US$ 7 billion lending programme for Pakistan over the next three years, we have gone back to the Fund for the 25th time since becoming its member in 1950. It is therefore, undeniable, that without the IMF’s continuous support, Pakistan’s economy would not have remained externally solvent during this time. But if our national objective is, as it should be, to not just survive economically but achieve sustainable growth, will this latest dose of bail-out money do the trick?
The answer is no, of course. IMF structural adjustment programmes are simply not designed to generate economic growth. On the contrary, their purpose is to stabilise economies struggling to meet their external obligations, often coupled with wide domestic fiscal deficits. To be fair to both the Fund and the government, the economy has achieved stability over the last twelve months or so. Inflation is decelerating, the current account deficit has been contained, and the currency has been stable. However, this required taking painful fiscal measures, cutting development expenditure, and suppressing imports, leading to lower consumer purchasing power and overall growth.
A viscous cycle
This equilibrium of relative macroeconomic stability coupled with low growth can only be maintained in the short term, typically no more than two or three years, given the past sequence of Pakistan’s predictable business cycles. This is because as monetary policy eases and political pressure to allow growth increases, imports start growing faster than either exports or remittances, essentially because Pakistan’s economy is highly consumption-led and import-driven. In the absence of any significant foreign investment inflows, the result is always a ballooning of the trade and current account deficits, which runs down foreign reserves and leads to currency depreciation, finally kick-starting an inflationary spiral. At this point, Pakistan is back to square one, in need of yet another rescue by the global lender of last resort.
Breaking the habit
How can this cycle be broken? Ultimately, only by increasing the economy’s productive capacity, so that output generated for both domestic consumption and exports can grow fast enough to make the trade deficit manageable. A broad blue print that distinguishes between urgent short term measures and longer term productivity-enhancing structural policy shifts can be useful to frame this discourse.
Getting the state into shape
The immediate challenge is to unlock the public investment required to build productive economic capacity. This is hindered by the large and growing strain on the fiscal account, with the national debt-to-GDP ratio rising from 64% to 75% over just the last five years. To arrest this trend and create the necessary fiscal space, four key areas of public finance require urgent reform.
First, the financial bleeding from Pakistan’s state-owned enterprises must be stopped. All major loss-making enterprises should either be privatised or restructured. Electricity distribution companies are the major culprits, with the power sector accounting for 87% of all planned subsidies in the budget for 2024-25! Unfortunately, apart from some progress on privatising PIA, there are no visible signs yet that the government is serious about this issue.
Second, Pakistan’s fiscal policies can no longer remain hostage to special interest groups, causing both lost revenue and unwarranted expenditure. Tax breaks for real estate, income tax waivers for the landed aristocracy, and blanket subsidies for corporate oligopolies - all such elite privileges must go. A 2021 UNDP report estimated that these hand-outs combined constituted about 6% of GDP. For perspective, consider that the total planned federal development budget (PSDP) for 2024-25 amounts to a paltry 1.1% of GDP, while the amount that actually gets spent will likely be even smaller.
Third, there is an urgent need for the federal and provincial governments to devise a more rational revenue sharing formula. While the provinces have gained substantial legislative and administrative autonomy after the 18th constitutional amendment, they do not collect enough of their own revenue. Instead, they rely chiefly on transfers from the federal government, leaving it over-burdened. Under the NFC Award, almost half of gross federal revenues now go to the provinces, with the exact proportion in 2023-24 being 44.5%.
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The fourth near term action, to unlock new tax revenue, is the documentation of the economy. Recent estimates suggest that Pakistan’s informal economy is more than 50% larger than its formal part. This is an important, though not the only, reason for our very low tax-to-GDP ratio. To increase tax collection, a ruthless economy-wide documentation drive is necessary. Only when the tax net is cast wider can taxation rates begin to be lowered, without compromising on overall revenue collection.
No need to re-invent the wheel
After taking these measures, what then must be done to increase the economy’s long term productive potential, the second component of our blue print? The required reforms can be organised under three broad categories, based on common policies adopted by success stories like China, East Asia, and India, identified in the development economics literature.
Invest in people
The first set of policies must focus on improving the quality of human capital, without which sustained economic growth is impossible. Pakistan’s adult literacy rate is still horrifyingly low, estimated at 57% in 2020, compared with regional peers China (97%), India (76%), Bangladesh (76%), and Sri Lanka (92%). It is the same story with healthcare. Our infant mortality rate is 53 deaths per 1,000 live births, much higher than the South Asian average of 31. These statistics are well-explained by Pakistan’s comparatively low spending on education and health: its combined expenditure on both is about 3.5% of GDP, lower than every country in South Asia, except Bangladesh.
Pakistan requires an emergency ramp up of spending on education and health, by re-directing fiscal resources freed up through the short term measures described above. Contrary to popular opinion, the relative cheapness of the labour force is not the only factor that attracts capital. Econometric research has shown that the quality of the labour force, i.e. its average longevity, health, and skill level, is an equally, if not more, important determinant.
Waste not, want not
Capital brings us to the second group of policies necessary to enhance productivity and stimulate growth: saving and investment. In the seminal case of rapid economic growth, i.e. the East Asian “tiger” economies, productive social spending was coupled with very high savings rates, at times reaching 50% of GDP! This required significant sacrifices of consumption and leisure by the generation of the time, to accumulate the capital investments required for rapid growth and a higher future standard of living.
In stark comparison, Pakistan’s gross saving rate is amongst the lowest in the world, perennially hovering around 15% of GDP, reflecting its consumption-based economy and a failure to convert wealth into real investment. Higher public saving can be generated through the four short term fiscal reform measures outlined above. To promote private saving, documenting the economy along with deepening and broadening the financial sector can create incentives for households and businesses to transfer their savings from cash and physical assets to potentially higher yielding formal sector financial instruments such as insurance plans, pension funds, and equities. This will in turn increase the funds available to banks and other financial intermediaries that can be channelled into new investments.
Make your own luck
The third and final element of the productivity-enhancing policy set pertains to how and where these increased national savings are to be invested. The successful experiences of both East Asia and China show that while the market should play a leading role, the state has the important function of not only creating an enabling business environment but also directing investment towards higher value-added and dynamic economic sectors, while staying open to adapting its approach through continued experimentation.
Any state support to industry should of course be based on sound economic analysis, specific in nature, and linked to performance. For instance, instead of continuing to subsidize the export of raw commodities like sugar and an increasingly globally uncompetitive textiles industry, modern sectors with future growth potential such as information technology and services exports should be considered.
This broad macroeconomic framework for achieving higher and sustainable growth is ambitious yet based on decades of global empirical research on comparative development policies. Pakistan’s entrenched political, bureaucratic, and business elites will resist any movement in this direction, for obvious reasons. Nevertheless, given the severity of the latest economic crisis, averted only temporarily, there must be continuous advocacy for meaningful structural change.
About the author
Waqas A. Rana is a development economist and founding partner at Shared Pathways, an international development consulting and advisory firm. His core area of interest is the study of economic growth strategies for developing countries. Outside of work, he likes to read literature from around the world, lift weights, run, and hike. He can be reached at: waqas@sharedpathways.org