Catch 22 – Part 2

To recapitulate last weeks column, Catch 22 has five components, viz. defence, economy, governance, terrorism and morality cum morale. Part 2 is about the economic despair of the country that has two concentric circles with synchronised expansion or contraction. The outer circle is external sector and the inner circle is domestic budgetary accounts.

 In today’s global economy, chronic trade deficit is a signpost to bankruptcy. That no sovereign State has reached there yet should be no solace. It’s true that no State has filed for bankruptcy till today or been taken to the retainers for being insolvent by its creditors but this is a dangerous false sense of security that has consequences far more serious than if simple insolvency procedures in the corporate form were to be adopted.

Hard facts are hidden from no one who cares to peek. Pakistan has suffered an average trade deficit of around two billion US dollars per annum along with around 5 percent of GDP as budget deficit. Borrowings balance the current account deficits. Pakistan has accumulated about 33 billion US dollars of foreign debt and about an equal amount of domestic debt. Just to meet the foreign debt liabilities an annual outflow of around six billion US dollars is required. Hence, debt is rolled over and even bloated further to balance the current account. Debt retirement is the largest component of national budget, followed by defence expenditure. National debt is not an evil in itself. U.S. Government has over three trillion-dollar debt but its ability to service it through foreign trade and domestic revenues makes it viable, even necessary to keep the economy vibrant. In Pakistan’s case, it is simply a case of borrowing from Peter to pay Paul.

Under the current situation, it is hard to service, leave alone retire foreign debt. (Recent re-scheduling has just bought more time, no more.) The equation is quite simple. In order to reach a level of comfortable debt servicing Pakistan needs to have a positive trade balance of around 8 billion US dollars. Increasing exports from the current 11 billion dollars to around 20 billion dollars to make that possible (since current level of imports will rise too from 10 billion dollars to at least 12 billion dollars in import of raw materials, capital goods and services to boost exports) within a medium term of lets say five years means an annual compounded growth rate of 17.3 percent per annum. At best, Pakistan may eliminate trade deficit, or worst, remain hovering around current levels. In either case an annual outflow of six billion dollars will start inflating foreign debt to unserviceable levels sooner or later, causing a terminal default that will push the economy into a death rattle. We are no more than ten years behind HIPC (Highly Indebted Poor Country) African States. Managing foreign debt requires a paradigm shift in our economic dynamics!

The solution, if there is one, lies in swapping our debt for something tangible for our creditors in a proactive way. At present we foolishly enjoy a false smugness in a passive obstinacy of defiance based on three negative bargaining chips — that we have nuclear capability that can be encashed if we are abandoned, that fanatical creeds will devour Pakistan if anarchy is allowed to breed here, that in a rogue state we can proliferate drugs to unprecedented levels.

Here is our chance! We can begin with seeking assistance of debt swap for neutralizing the potency of our negative potentials. The catch 22 is that the perpetrators of the negative mindset are the negotiators today! I call it a chance because the opportunity today (post Nine-Eleven) is not indefinite. If we don’t avail it, the opportunity that exists today will evaporate in few years. The sum of 33 billion dollars is paltry for the donors ¾ a third of Bill Gates net worth? A years turnover of a respectable multinational? Election budget of the top twelve States in the US Governor elections. But for Pakistan it is a lifeline. As explained earlier, unless a South Korean or Malaysian spirit miraculously infuses Pakistani economic dynamics with a growth rate of 17 percent, the future is pregnant with ominous prospects. The creditors will not loose a night’s sleep over this amount (perhaps they have written it off already); we have the noose round our neck. Lengthening the rope will make the final jerk that much more lethal! In a generic sense, Darwin’s theory of ‘survival of the species’ explains the outcome of such conundrums explicitly – adapt or perish!

Now to the inner circle of downward spiral! Resource mobilization by Central Board of Revenue (CBR) is a self-defeating mechanism. Out of the total Federal revenue receipts of Rs. 594.6 billion (1999-2000) direct taxes are Rs. 137 billion (23 %) only, but out of this, bulk is from withholding tax, deducted automatically without human intervention and mandatory deduction from salaries of Government staff and formal sector employees. Hardly 8 percent is collected through tax returns and scrutiny of the tax collection machinery. Income tax department is maintained to collect 11 billion Rupees out of 594 billion Rupees? Besides this, the leakages in custom duty collections are proverbial!

The economic distortions can be traced back to the early days of Pakistan when the ‘Harvard School of Economists’ took charge of planning and prescribed convoluted policies based on import substitution and support for the large scale industry. Dr. Mahboob-ul-Haq went as far as stating that at the developmental stage of an economy the large-scale enterprise must be supported at a cost to small industry and agriculture since the former has greater propensity for savings and re-investment, and this must be countenanced as a necessary evil. In pursuit of self-sufficiency and import substitution, local business conglomerates were cushioned through tariff barriers. Despite the quixotic assault of Mr. Bhutto in the seventies, the fundamental policy mindset did not alter. Growth was fostered on captive domestic markets ignoring exports as an auxiliary to domestic surpluses.

There were two imports from this policy: Trade deficit began mounting and economic growth was inequitable. As long as bi-polar world existed and Pakistan could play one super power against the other, trade deficits seemed benign irritants. After that, the malignancy surfaced and threatens to gobble the State today. Inequity of economic growth translated into poverty numbers: from 17 percent in the seventies to 33 percent in late nineties (the decade of poverty as it is named). Political instability exacerbated the intrinsic non-competitiveness of the large scale enterprise in Pakistan and the growth rates dipped too. So there we are today - Stagnant economy with rising poverty levels. The large-scale enterprise has too much fat while the small-scale enterprise (that is the backbone of developed economies) is impoverished and resides outside the main stream of formal economy. Small and Medium Enterprises (SMEs) employ 80 percent of labour, contribute 48% to GDP and 42% to exports but have a paltry 11% share of the total private sector credit in Pakistan. Most of all, they are the ones most vulnerable to effects of the impending WTO agreements.

The present government has re-discovered SMEs and poverty, and is inclined to address their basic issues. I was the CEO of the Small and Medium Enterprise Development Authority SMEDA, and I can tell you what six blind men say when they feel an elephant.

Given that road to economic redemption passes through poverty alleviation and development of SMEs, the Catch 22 is that despite growth these areas are still languishing.

Post Script: The contents of this column do not discount the efforts of the incumbents in forestalling nose-dive of the economy. I have apprehensions that current growth of foreign exchange reserves, stock and real-estate markets, and exports is overtly reliant upon expatriate contributions; domestic economy is still not firing on all cylinders. This may be a transient phase. Hence my column is based on probabilities of a broader time frame. Concerns listed here are still valid.

Iqbal Mustafa
12 September 2003

1325 words