Pakistan 2011: Policy Measures for the Economic Challenges Ahead

Article excerpt

Abstract

Pakistan faces economic challenges in the summer of 2011 with regard to its balance of payments and its public finances, resulting primarily from the suspension of an ongoing International Monetary Fund (IMF) program, the associated cessation of program lending by other multilateral financial institutions, and the termination of the US's cash logistics support. This paper argues that these challenges can be met without resorting to a new program with the IMF. The policy measures recommended with regard to the balance of payments are: (i) to allow the orderly depreciation of the exchange rate in the foreign exchange interbank market by about 5-15 percent or to PKR90-100/US dollar, (ii) to impose import surcharges of 10-20 percent on nonessential imports, and (iii) to re-impose measures originally imposed to increase the cost of import letters of credit. Public finance-related policy measures recommended on the expenditure side are: (i) to gradually reduce the State Bank of Pakistan's policy rate by 300 basis points in the fiscal year (FY) 2012 from its present level of 13.5 percent, thereby reducing the interest burden on public debt; and (ii) to utilize these savings to restart the stalled public sector infrastructure development program. These measures will also stimulate economic activity. On tax policy, the paper recommends that: (i) the sales tax rate be increased from its present 16 percent to 18 percent, (ii) custom duties be increased by 10-20 percent on nonessential imports (as also recommended for the balance of payments, and (iii) regulatory and excise duties be increased and their original (FY2011) coverage restored.

Keywords: Economic Policy, Balance of Payments, Public Finance, Pakistan.

JEL Classification: H29, G18.

1. Introduction

Pakistan entered into an International Monetary Fund (IMF) program in late 2008 as its foreign exchange reserves depleted as a result of economic adventurism during 2004-08 by its economic managers. The IMF program was generally implemented during 2009 and 2010 but finally suspended in the summer of 2011, which was also notable in that the US cut off its cash logistics support program (roughly USD1 billion per annum) to Pakistan. These twin events followed in the wake of exceptional floods in the summer of 2010, which displaced about 20 million people, and caused a loss in infrastructure estimated at about USD10 billion and an income loss estimated at about 2-3 percent of gross domestic product (GDP). As a result, Pakistanis are generally concerned about the future direction of the economy and particularly the policy options available to them. This paper aims to address some of these issues.

2. Economic Fundamentals

Pakistan, with an area of 877,365 square kilometers; a population of 175 million; more than a dozen urban centers of more than 1 million people (Karachi, 12 million; Lahore, 7 million); large agricultural areas (in excess of 50 million acres); and possessing a sophisticated industrial, scientific, and financial infrastructure is easily a significant political, economic, and social entity on the world scene.

As Table 1 below indicates, the country's current GDP is about USD235 billion at current market prices (probably about USD500 billion at purchasing power parity [PPP] prices) and its per capita income about USD1,400 (USD3,000 at PPP prices). It is also a large and flourishing democracy with a fiercely independent media and judiciary. An economy and society of this size and sophistication should be able to manage its current economic problems, which essentially stem from a low growth rate/high interest rate syndrome imposed by the IMF, and an apparent financial squeeze imposed by other multilateral financial institutions (the World Bank and Asian Development Bank) after the breakdown of the agreement with the IMF.

3. Balance of Payments

Consequent to the boom-and-bust policies followed by Pakistan in the 1980s and early 1990s, essentially involving in each case a balance of payments crisis and subsequent recourse to the IMF, Pakistan moved to institute an orderly market-determined exchange rate. …

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