DAWN - Opinion; 03 February, 1998

Looking to foreign investors

Shahid Kardar

THE economic scene is cheerless, if not bleak, official pronouncements and hype notwithstanding. The uncomfortable reality of today is that the growth impulse in the productive sectors of the economy is weakening and the key economic indicators are pointing to the deepening of recessionary tendencies.

Combined with the compression in public sector expenditure and the reluctance of the banking system to improve credit delivery in the changed environment of prudential discipline, persistent deceleration in the rate of growth in industrial output, sluggish sales growth of the corporate sector in both nominal and physical terms, in many cases growing inventory build-up and reduced credit off-take (higher deposits are not being recycled in the form of commercial credit) all reflect the extension of recession. The lowering of the inflation rate is partly reflective of the poor demand conditions faced by the manufacturing sector.

In the same vein, much of the widely touted narrowing in the trade gap has also come not from the increase in exports but from the reduction in the growth of imports which confirms the levelling off of industrial production; although a decline in the international prices of oil, wheat and palm oil also contributed to a reduction in the import bill. Even the reduction in the historically large gap between domestic savings and investments has come from a decline in the rate of growth of investments. Add to all this the well publicised shortfall in the cotton crop and it becomes difficult to believe that the growth rate for the year will even cross 4.5%.

On the fiscal front the federal and provincial governments are close to insolvency. Partly as a result of the mindless populist slashing of tax rates revenues are Rs 14 to 15 billion short of the target for the first half of the year. Thus, the target for the remainder of the year looks like a pie in the sky. The huge shortfall in revenues at the end of fiscal 1997/98 stares the government in the face, notwithstanding the desperate attempts at window dressing of accounts through petty tricks like withholding duty drawback claims and by withholding releases for the PSDP (these have less than Rs 10 billion during the first half of the year compared with the programme size of Rs 90 billion for the year even ignoring the misplaced priorities of development expenditures almost wholly dedicated to the Motorway).

In fact, the odds should be good on a bet that tax revenues will barely finance the debt servicing costs for fiscal 1997/98, particularly after the recent devaluation. With such an outcome being a distinct possibility there are no prizes for guessing the true level of the budget deficit on June 30, 1998.

In this situation and with S.E. Asia still in turmoil one wonders how many of those who matter in the government believe that investors are queuing up to buy the assets we are trying to privatise. If domestic investors are simply not willing to invest, for whatever reasons, they must be asking themselves the obvious question why a foreigner would, given the large range of opportunities available to him practically anywhere in the world, would want to come here, unless, of course, we are prepared to sell these assets at throw-away prices (as this is what we will get for their present condition).

No wonder, people want to know how the government will finance its external debt, specially of the short-term variety, and that how real is the danger of default. From where will the resources come to purchase the electricity generated by the IPPs that will be functional by the close of the financial year? For how long can the increase in tariffs of electricity and gas be avoided and what will be the eventual increase that will have to be effected as a result of the postponement (which in turn is adding an additional 2.5% per month to the increase that will finally have to be put through)?

Given this state of affairs one question is frequently asked, can we suffer the same fate as the South East Asian economies? A fair answer must set out the differences between us and them, which should prevent the recurrence of that phenomenon here. We do not have portfolio investments of foreign institutional investors of the size found in S.E. Asia. The State Bank controls the expansion of credit through a fairly tight monetary policy and through a set of prudential regulations that govern credit provision by financial institutions, notwithstanding the huge portfolio of non-performing loans accumulated over the years.

Also, contrary to the situation in S.E. Asia, the bulk of our debt is public debt, and whose build-up has been somewhat controlled. Private external debt, which created the problem in S.E. Asia, is limited. Nor have asset/property prices been driven up in Pakistan by capital inflows and lax lending by banks for such purposes. Finally, speculative attacks on the rupee are relatively difficult because such attacks only succeed if high levels of leveraging are possible which enable speculators to hold assets in foreign currency and the liabilities in local currency, something not possible in the case of Pakistan. So much for the favourable aspects of the comparison. However, all the other key indicators seem to suggest that the economic imbalances in Pakistan are more worrying and that the rupee continues to be overvalued. Table 1 encapsulates the nature and the scale of the problem.

The country's foreign exchange reserves are woefully inadequate to prevent erosion of creditor confidence. It will no longer be that easy to get creditors to roll over of the short- term external debt. After S.E. Asia they would be unwilling to accept more exposure on Asia (and particularly on an economy whose credit rating has taken a severe beating because its balance of payments position is extremely shaky), except at a pretty heavy price. Hence, the future placements of swap funds brought in by foreign banks must be under pressure, not withstanding the recent attempt by the State Bank to retain such deposits by raising the yields on their investments in the Short Term Federal Bonds.

A temporary respite had come from the disbursement of the first tranche under ESAF. The government will again be looking to the IMF to give it a further lease of life by disbursing the second tranche, come March. Understandably, because of the urgency and desperate need for IMF's approbation of its performance, the government is seen to be clutching at straws to demonstrate fulfilment of IMF imposed targets. In any case, the government cannot be expected to aggravate the despondency and must put up a brave face despite the heavy odds.

Currently, the disbursement of the second tranche from the IMF lies in the realm of uncertainty. However, there are two schools of thought on whether the IMF will come to the government's rescue and help buy some time for it. One school argues that after S.E. Asia donors (afraid that it will not be possible to brush aside criticism for financing lax economic management) will take a hard-line and not accept any slippages on agreed targets.

The other school is of the view that compared with the billions required to bail out S.E. Asia, Pakistan will only get a paltry sum, a small price to keep a loyal lackey afloat. Therefore, despite the slippages, the Fund will release the second transche. And this certification of good housekeeping it will be for reasons other than good economic management, fulfilment of promises and achievement of agreed goals. The news making the rounds is that key players in government are sitting pretty smug, confident that this programme with the Fund will also not come to an end without the disbursement of the second transche.

Unlike what some soothsayers have been claiming, the range of options that existed earlier has narrowed substantially. There is little room for manoeuvrability since the major structural weaknesses that have historically existed in the economy have not been attended to. If anything, the situation has worsened through accumulations as a consequence of the pursuit of transitory political gains. As a consequence of poor management the public sector which was supposed to generate resources for the growth of the rest of the economy became a drain on society as a whole, exposing the government's inability to manage even the most simplest things. With our situation having dropped to such depths globalisation is changing the paradigm, requiring a different institutional and structural framework, but for which we are the least equipped.

Even a blind man can see the writing on the wall. There is little chance of borrowing our way out of these chronic imbalances, so as to live to fight another day. The challenge is formidable for a government whose capacity to manage and implement reforms is doubtful. The few choices left are extremely tough for a regime that has, to date, relied essentially on concessions and incentives. The implementation of such changes will inflict a lot of pain.

The moment of truth for the socio-political structure of Pakistan has arrived and the real test of the mandate and the political acumen of the leadership has come. We can no longer postpone the reconstruction of the State structure. Some of the necessary reforms would have been relatively easier (??) to institute in the euphoria that greeted the installation into office of this government. Almost a year down the road putting into action many of the tough choices will be that much more difficult politically. And 6 months from now it will be next to impossible as the irritants of today become gigantic problems of tomorrow.