- Borrowing still remains the better option for financing deficit
- Keenness on export, foreign ventures is the best support for forex reserves
Interview with Dr. Ayub Mehar — an eminent economist
PAGE: Tell me something about yourself, please:
Dr. Ayub Mehar: I have been serving as ‘Economic Advisor’ of the Economic Cooperation Organization (ECO) Chamber of Commerce for 3 years and also ‘Director General’ in the Federation of Pakistan Chambers of Commerce and Industry (FPCCI) for 7 years.
I have completed and worked on various research assignments for Asian Development Bank Institute Tokyo, including ‘Measuring Impacts and Financing Infrastructure Development’, ‘Economic Integration among CAREC Member Countries, and ‘Environmental, Social, and Governance Investment: Opportunities and Risks for Asia’. Development Financing, Macroeconomic Policies, International Trade and Finance are areas of my interest. I have completed several policy research studies on strategic issues including, ‘Bridge Financing and Fiscal Policies during COVID-19 Pandemic Crisis’, ‘Ineffectiveness of ESG Policies and Incentives: Impact of GSP Plus on Central and South Asian Countries’, ‘Infrastructure Development and Public Private Partnership: Measuring Impacts of Fiscal Policy in Pakistan’, ‘Economic Integration in CAREC Member Countries: Financing Economic Corridors and Sovereign Bonds Market’, ‘Infrastructure Development by Liberalizing Economic Policies: The Straight Path of Economic Prosperity’, ‘Financial Cooperation in South Asia: Recent Development and Challenges, and ‘FDI, Infrastructure Development and CPEC: Is There a Connection?’ for various national and international institutions including World Bank, Asian Development Bank Institute, Friedrich Naumann Stiftung (Fur Die Freiheit), SAARC Chamber of Commerce and Industry, and ECO Chamber of Commerce and Industry.
The Technology Policy and Assessment Center at Georgia Institute of Technology acknowledged my membership in the distinguished panel of international experts for Indicators of Technology-based Competitiveness, which is a project of the US National Science Foundation, United States Government.
I am also alumni of the IAL Gummerbach Germany, where I got training in Public Finance. Recently, I completed a study on “COVID-19, Digital Transactions and Economic Activities: Puzzling Nexus of Wealth Enhancement, Trade and Financial Technology” for a project on “Fintech and Covid19” jointly launched by Asian Development Bank Institute Tokyo and Cambridge Center for Alternative Finance at the University of Cambridge. Currently, I am associated as an ‘Economic Advisor’ with the Employers’ Federation of Pakistan and serving as a ‘Professor’ at Iqra University Karachi.
PAGE: What is your perspective on the economic outlook of Pakistan in 2023?
Dr. Ayub Mehar: What will be the economic positioning of Pakistan in the global scenario and how it can be compared with the historical economic trends, it can be assessed in the light of macroeconomic and social indicators in present circumstances. It is a known fact that the targeted economic growth rate set by the present government was 4.5 percent which has been downgraded to 2 percent because of the damages in the agriculture sector after floods and heavy rainfall. Obviously, it will affect all economic activities including the services sector and industries. Inflation and particularly food inflation will be further accelerated. If we import wheat and other essential commodities, the effect will be transferred to foreign exchange reserves and ultimately further inflation will be added.
Here, it is notable that the rate of inflation was 3.9 percent in 2017-18 and 11.3 percent in 2021-22. Now, it has reached more than 18 percent. The rate of inflation based on the sensitive price index which measures the change in prices of essential commodities was 0.9 percent in 2017-18 and 17.3 percent in 2021-22, now it has crossed 20 percent. While food price inflation is much higher than CPI (Consumer price index) based inflation.
The most adverse side of inflation is not its rate, it is its patterns. The current trends show that the rate of inflation for basic commodities (based on the Sensitive Price Index –SPI) is much higher than for common commodities (based on Consumer Price Index – CPI). It implies that inflation for the poor class is much higher than inflation for the middle class. Similarly, the rate of inflation in rural areas is higher than the rate of inflation in urban areas. It is something unhistorical and irrational. These statistics indicate that lower-income households are badly victimized by economic policies.
The share of indirect taxes in total tax revenue, the depreciating Pakistani rupee in terms of other currencies and increasing costs of raw materials and overheads are the primary causes of accelerated inflation in Pakistan. These causes are directly or indirectly associated with economic policies.
Though every government has mentioned that it will focus on direct taxes but unfortunately the share of indirect taxes is increasing in the last 20 years. It is notable that the share of indirect taxes in total tax revenue is less than 40 percent in industrialized countries, while in Pakistan more than 60 percent of tax revenues are collected through taxation on goods and services which is one of the major causes of inflation.
Unfortunately, the strategies to control prices are creating more inflation. The measures which have been taken by the State Bank of Pakistan to control inflation belong to demand-pull inflation. The State Bank has increased policy interest rates to discourage consumer financing.
To control imports, the State Bank tightened domestic financing for importable items. All these steps are taken to control demand-pull inflation, while no step has been taken to control cost-push inflation. It is obvious that market prices are associated with the cost of production and subsidies.
Administrative measures to control the food and agriculture commodities may create rural-urban conflicts and lower the production of agricultural products.
The subsidy mechanism plays an important role to create competitiveness and control over prices throughout the world. More than 50 percent of current expenditures in industrialized countries belong to direct or indirect subsidies. This ratio is 44 percent in India and 34 percent in Bangladesh. This magnitude is less than 8 percent in Pakistan, which explains the causes of the high rate of inflation in the country. Despite these facts, IMF emphasizes on withdrawal of subsidies and the government has accepted this condition.
In the presence of higher interest rates, higher inflation, lower target of GDP growth, the declining inflow of foreign exchange, historically high indebtedness, growing trade deficit and declining tax collection what can be expected in 2023? Now, a structural change is required in the economic policies. This change requires some constitutional amendments to strengthen economic planning and policies without political intervention.
PAGE: What could be the impact of depleting foreign exchange reserves on the economy in 2023?
Dr. Ayub Mehar: Though I am sure that Pakistan will not face a default-like situation in international markets, however, its financial liabilities will create economic miseries for its common people and business community. The current account position of foreign exchange reserves, growing trade deficit and stagnancy in the inflow of foreign direct investment will create further problems for the government and economic stakeholders. This situation justifies the need for IMF funding and inflow of investment and borrowing from the countries in friendly circles of Pakistan.
No visible improvement in exports is expected in the near future as according to the medium-term strategic plan, the exports will remain at around 28 billion dollars in 2025 in the pessimistic scenario 34 billion dollars in doable and 37 in the optimistic scenario.
So, again we will have to depend on workers’ remittances. I have been mentioning again and again that creating export competitiveness and inducing foreign investment are the only options to provide a sustainable solution for building foreign exchange reserves. While sustainable foreign exchange reserves can ensure sustainable fiscal growth.
PAGE: How would you comment on the external loan of Pakistan?
Dr. Ayub Mehar: In the presence of a historically high level of outstanding debt, the government cannot afford further borrowing or the cost of interest on additional debts. Naturally, to discharge the debt liabilities, the government has to arrange more foreign exchange and have to collect more taxes. While the further increase in tax collection in the present scenario will damage industry and business activities. The more important point is not the magnitude of debt, it is the composition of debt. At present, 35 percent of total debt is external while more than 90% of external debt is long-term debt. Another astonishing aspect of external debt financing is that in the case of Pakistan almost the entire external long-term debt belongs to the public sector. It means further tax collection is required to repay the external debt.
According to official sources, the total debt and liabilities of the Government of Pakistan have arrived at more than 90 percent of the GDP, which is a dangerous point. The borrowing was accelerated during the last 5 years. Strangely, the federal government in the last 3 budgets has decided to borrow more than 1 trillion rupees per annum from external sources. It includes bilateral and multilateral loans and borrowing through bonds in international markets at a higher rate of interest. The loan from International Monetary Fund (IMF) is not included in this financing.
Similarly, more than 2 trillion rupees are financed by domestic borrowing from commercial banks. It is just the utilization of public savings to finance the fiscal debt which ultimately hampers investment in the private sector. The most important aspect from investors’ and industrialization points of view is deficit financing through domestic borrowing. It may adversely affect the domestic credit to the private sector. It will be much easier for commercial banks to provide lending facilities to the government at an attractive risk-free rate of interest in the present scenario.
In lending to the government, commercial banks can avoid risk-taking activities which is an integral part of every private business. While the redemption of this debt in the future by the government will add more burden on taxpayers. The shrinking of credit facilities to the private sector will certainly affect investment and industrialization. In the present global scenario, it is noteworthy that the world average of credit to the private sector as a percentage of GDP is 50 percent; it is 122 percent in middle-income countries. It is 55 percent in India and 45 percent in Bangladesh. Unfortunately, it is around 17 percent in Pakistan. These statistics tell the story behind the decline in investment and industrialization in the country.
PAGE: Your views on budget financing in 2023:
Dr. Ayub Mehar: Here, it is notable that ‘budget financing’ means ‘financing the fiscal deficit. The fiscal deficit is created if your total expenditures are higher than your total revenues including tax revenue. So, the first point should be to reduce the fiscal deficit either by curtailing expenditures or significantly improving revenue (or tax collection). In case of a failure in curtailing expenditures and improving revenue, a fiscal deficit will be created. The government has to depend on external borrowing, domestic borrowing, or the use of cash balance (borrowing from the central bank) to finance its fiscal deficit. Now, the autonomy of the State Bank of Pakistan has restricted the ability of the government to finance its fiscal deficit through the monetary system. To finance its deficit government has to rely on borrowing from commercial banks and debt markets at the prevailing interest rates.
In the present context of the global economic situation and negotiations with the International Monetary Fund (IMF) to maintain the required level of foreign exchange reserves, external borrowing has a difficult option. However, the utilization of public money for deficit financing will badly damage the investment and business activities in the country. Certainly, further increases in unemployment and level of poverty will be off-shoots of this policy. So, the government should avoid domestic borrowing. In a country with a lower growth rate and lack of industrialization, domestic borrowing to finance fiscal deficit will be a drastic option.