Sunday, August 29, 2010

Pakistan's Troubles Magnified

The floods have wrought colossal damage. Nearly 20 million people have been affected, fifteen hundred perished and more than two thousand injured. The economic cost of the floods is estimated to be about $43 billion.

The devastation caused by the deluge would have been an enormous challenge for any government anywhere to meet. In case of Pakistan, the enormity of the challenge assumes even greater proportions in view of the country’s present predicament: the militancy, which is eating up the country’s most resources; the state of the economy, which would have crumbled but for the International Monetary Fund (IMF) credit; a laissez-faire ‘popular’ government, whose big bunch of ministers’ and advisors’ favourite pastime is to harp on their self-proclaimed sacrifices for democracy; the top political leadership, which commands but does not lead and whose credibility is close to naught both at home and abroad; the elected representatives, who are apathetic to the problems of those they represent; the state institutions, which are in decay and decadence; the system of governance, which is rotten to the core, the rule of law, which is trampled under the feet of the high and the mighty; the society which is becoming increasingly insensitive and cruel (the latest and the starkest example being the public beating to death of two young men in Sialkot); and the people, who are na├»ve enough to be deceived and duped by the same demagogues repeatedly.

The floods have magnified these ills of the polity, economy and society. We begin with the economy, which was in straits even before the floods had wrought the havoc. At the close of the fiscal year ending June 30, 2010 (FY10), the major economic indicators by and large presented a dismal picture. Fiscal deficit surpassed the 4.9 per cent target to reach 5.6 per cent of GDP despite drastic cuts in developmental spending (the PSDP was reduced from Rs 646 billion budgetary allocation to Rs 490 billion).

Inflationary pressures persisted with average CPI inflation of 12 per cent exceeding the nine per cent target. Investment-GDP ratio had gone down to 16.6 per cent from 19 per cent, while savings-GDP ratio had dropped to 10.1 per cent from 20.3 per cent a year ago. The unemployment rate had gone up to 5.5 per cent from 5.2 per cent largely due to the increase in urban unemployment to 7.1 per cent from 6.3 per cent.

The only good news was that the real GDP had grown by 4.1 per cent compared with the target of 3.3 per cent. However, that upward growth rate was made possible by a downward revised growth figure of 1.2 per cent for the preceding fiscal year.

To be fair, the economic predicament is not the making of the present government and can be ascribed to the three perennial constraints within which the economy of Pakistan operates: (a) the massive public debt, (b) the need to maintain a huge military establishment, and (c) the lack of tax culture together with the absence of political will to bring some holy cows (agriculture income for instance) within the tax net.

The first two constraints dictate that a large portion of the public expenditure is invariably allocated to debt servicing and defence, while the third constraint ensures that the public revenue, particularly from direct taxes, lags behind increase in government expenditure and growth of GDP. The result is not only increase in fiscal deficit but also misallocation of resources.

Hence, as per budgetary allocation for the current fiscal year, defence and debt servicing expenditure together account for about 66 per cent of current expenditure and 48 per cent of total expenditure. At present, the armed forces are engaged in putting down insurgency in the northwestern part of the country and therefore it is understandable that a sizeable part of the national pie is allocated to supporting that effort.

Scarcity of resources necessitates a trade-off among competing needs. If a country spends nearly half of its resources on mere defence and debt servicing, it will have too little to spend on promoting human capital and infrastructure development. Hence, not surprisingly collectively allocation for both health and education accounts for less than three per cent of the GDP, which is well below the desired level. Poverty alleviation and employment generation are among the basic policy objectives in a developing country like Pakistan. However, attaining this goal requires substantial investment in human capital development.

Although during last couple of years fiscal deficit has been substantially reduced from 7.6 per cent of GDP during FY08, the same has been done by curtailing developmental expenditure rather than by increasing tax-GDP ratio, which is stuck at nine per cent of GDP. Pakistan in fact has one of the lowest tax-GDP ratios in the world. Two options are available to the government to increase tax revenue: one, to broaden the tax net, for instance, by taxing agriculture income; two, to increase the existing taxes. For reasons political, the first option has not been exercised, with the result that those who already pay tax — the salaried class — are burdened with more taxes.

As the State Bank of Pakistan (SBP) has noted in one of its reports, a sharp cut in development spending is neither sustainable nor desirable, because the government is required to increase spending on human capital development and widening the social safety net as an effective antidote to extremism.

The floods will adversely affect the economy in several ways. One, to rehabilitate the victims and repair the infrastructure, the government will have to re-appropriate budgetary allocation. Given the political economy of Pakistan if any cuts are to be made, the same have to be on the head of development expenditure. Hence, the big chunk of the funds allocated to development will be diverted to repair and rehabilitation efforts.

Two, due partly to the colossal loss caused to agriculture and livestock and partly to diversion of resources, the growth of the economy will be retarded. The estimates are that at least one percentage point of the potential GDP growth will be washed away. When economic growth shrinks, investment level goes down, jobs are lost and incomes fall. Consequently, unemployment and poverty levels rise.

The rise in unemployment and poverty further reduces the aggregate demand, resulting into lower investment demand and thus slower GDP growth. Increased poverty and unemployment have enormous social cost, because the affected people can become a convenient tool in the hands of destabilising forces. This is particularly relevant to Pakistan, which is facing an insurgency in its northwestern part.

Three, the deluge devastation will make the economy more dependent on foreign credit at a time when developed countries are trying to recover from recession and hence official bilateral assistance is hard to come by. This makes credit from multilateral donors indispensable. Already Pakistan is under a 25-month $11.3 billion stand-by agreement (SBA) with the IMF effective since November 2008. Hence, the country will have to negotiate a fresh agreement with the IMF. The Asian Development Bank and the World Bank will also provide $2 billion and $950 million in credit respectively. Four, the loss to agriculture and livestock means Pakistan may be in throes of a food crisis in the days to come, which, inter alia, will strengthen inflationary pressures on the economy. The country will have to import food, which, together with fall in exports due to loss of the cotton crop, will push up the current account deficit and add to balance of payment problems.

The socio-political cost of the floods is equally, if not more, threatening. Hundreds of thousands of people have been deprived of their land and livestock, incomes and means of livelihood. Most of them will move to urban areas in search of work and a minimum standard of living. But urban areas, already facing large-scale unemployment and erosion of civic amenities, can hardly accommodate them. The resultant dejection and disappointment can be a fertile ground for anything ranging from unrest and riots to disorder and chaos.

The way the elected governments have handled the situation, the way they left the majority of the affected people to themselves, they way embankments in some places were breached to save the property of powerful politicians will strengthen the growing disenchantment with democracy. That Pakistan has had a sham democracy, there has never been much doubt about that. But the perception that the people’s governments have so abjectly surrendered the popular trust has shocked and shaken even the most vehement of their supporters.

Behind every calamity there is an opportunity and the federal finance minister believes that the havoc wrought by the floods can provide the impetus for taking some tough decisions. Only if the people in power woke up from their slumber, eschew narrow ethnic and political considerations, and put their heads together as to what went wrong and what can be done to avert another such calamity, that can be the redeeming feature of the floods.

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