Economic Challenges for the New Government: Change or Continuity?

By Yousuf Nazar

 

The new government’s economic managers may hold the key to its success or failure. Inflation, energy crisis, and stagnant exports would need immediate attention. There is a tendency to look at the economic issues in isolation from the politics but the economic policy would need heavy engagement from the new leadership. It will need to demonstrate that it has the capacity to take bold and imaginative decisions. The new leadership may not have the luxury of any honey moon period and  is likely to face not only a rough ride but also the risk the bureaucracy or former World Bank types would drive its policy and ensure its failure.   

Pakistan’s major economic issues are usually cited as inflation, energy crisis and the growing current account deficit. This is deceptively simple. While energy crisis is a huge issue and no quick fixes are possible (except import of electricity and oil from the Gulf countries and Iran at favourable terms), inflation and current account deficit represent symptoms not causes. Low agricultural productivity, narrow tax and export bases, trade policy distortions, and big government non-development expenditure are among the major reasons why the government has not been able to address these issues for a number of years.  While the media, government and the opposition talk a lot about inflation, there is little discussion on its causes and remedies. One reason is the absence of quality research in our business and academic institutions and lack of meaningful and substantive debate in public forums. 

 

Take, for instance, the issue of food inflation.  The last year’s GDP growth of 7 per cent was helped by a 5 per cent growth in the agriculture sector, which accounted for 20.9 per cent of the GDP. However, the growth in the crops sub-sector (which accounts for only 47.9 per cent of the agriculture sector, the livestock’s share being 49.6 per cent) masks the fact that the (i) 7.5 per cent growth in major crops was from a low base as prior year’s growth was negative and (ii) the minor crops grew by only 1.1 per cent during 2006-07.  However, going beyond a single year’s production data, the last seven years’ record indicates more fundamental and structural problems with the growth trend of the agricultural crops.  The production of cotton, wheat, rice and sugarcane grew by a yearly average of 1.63, 1.23, 0.59 and 1.87 per cent respectively during the seven years from 1999-2000 to 2006-2007 and was below the estimated average population growth of 2.2 per cent or so during this period. An examination of a sample of the production of other agricultural produce reveals similarly low and volatile rates of growth.

 

The government needs to pay immediate attention to food crops’ production.  The international  price of rice and wheat has doubled in the past year while freight costs have also increased sharply on the back of rising fuel prices. International food prices are rising on a mix of strong demand from developing countries; a rising global population; more frequent floods and droughts caused by climate change; and the biofuel industry’s appetite for grains, analysts say. Soyabean prices on February 22nd hit an all-time high of $14.22 a bushel while corn prices jumped to a fresh 12-year high of $5.25 a bushel. Given the soaring food prices worldwide, the most immediate decision it may have to make is about the issue of procurement price of the next wheat crop. The caretakers have fixed a price of Rs. 510 per/40 kg but this is too low and should be at least Rs. 700/kg otherwise this may not be enough to encourage the farmers to grow more wheat due to escalating prices of food crops and inputs.  

 

Another issue is rural poverty - an area where the PPP would need to deliver to keep its vote bank. It is a common misconception that the improvement in agriculture alone holds the key to lift rural population out of poverty. Not entirely! Let see why?  Rural population accounts for 70 per cent of the total but 80 per cent of  Pakistan’s poor live in the rural years. Agriculture (including both crop and livestock production) accounts for only about 40 percent of rural household incomes and the poorest 40 percent of rural households derive only about 30 percent of their total income from agriculture.  The new government must undertake massive infrastructure, particularly in water and transportation, investments to benefit the rural areas besides taking steps to solve high quality seeds, fertilizer and related issues to attack poverty and increase incomes in rural areas.  A key to improving crop yields would be modern technology with a special emphasis on growing high-yielding varieties of grains by encouraging free flow of technology transfers and investments from countries such as the United States, China, India and Mexico. 

 

Massive infrastructure investments in the rural areas may sound counter-intuitive to some but the fact is fiscal deficits are not necessarily harmful. However, they can be deadly if they are used to finance wasteful spending rather than productive investments. We have been guilty of big government and wasteful spending. This brings us to the most immediate and pressing issues of inflation and fiscal deficit. The situation calls for a holistic approach involving a comprehensive reorientation of fiscal and trade policies from protectionism and big government to fair competition and less government in areas where it is least effective or non-productive. 

 

In simple words,  the government (i) must allow duty free import of all food items to lower inflation as a short-term measure and make increase in crop yields a top priority, (ii) must increase taxes on non-productive areas (such as imports of cars) or those not under the tax net to reduce deficit, (iii) cut taxes on productive areas (e.g. manufacturing) to boost production and exports, and (iv) eliminate guaranteed profits to oil companies to lower or minimise increase in oil prices, and lastly but no less importantly (v) undertake rightsizing of the government bureaucracy. 

 

Fiscal incentives and lower energy costs would give a shot in the arm to the industry to increase exports and removal of restrictions/lowering of tariffs on food imports would help lower overall inflation through more supplies and lower costs. Cutting the overall deficit through new (or higher) taxes would also lower government borrowings and interest rates but that effect will not be felt until after 18 months or so.

 

The areas where tax policy needs a review include: (a) a cut in income tax rates for the publicly listed companies (excluding financial sector) to 15%, (b) increase in income tax rates for the banking industry, (c) imposition of income tax on trading income from stocks (d) imposition of tax on capital gains from land and property, (e) withdrawal of blanket exemption to all income from agriculture regardless of income level, etc. 

 

The government should also rationalize payroll and sales taxes for publicly listed companies because levies such as Employees Old Age Benefits do not profit the workers. Instead, the government should encourage stock options and direct cash compensation to allow the benefits to flow through to the employees. In this respect, the government while doing away with schemes that are de-facto indirect taxes, should increase the minimum wage to Rs. 8000 per month.  In the arena of monetary and foreign exchange rate policies, the government needs to replace borrowings from the State Bank with market instruments, allow the exchange to be determined by market forces and phase-out subsidized lending schemes prone to abuse.

 

The above suggested measures are just some examples but illustrate and underscore the need for a qualitative change in policies rather than the so-called continuity that has failed to deliver. We need policy changes that would send a clear message to local and foreign investors that the new government means business.