Fiscal, monetary imperatives

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No press release was officially released on the Thursday's meeting of the Fiscal and Monetary Board in Islamabad. Since the board met on the subsequent day of issuance of SBP Annual Report or the annual review of country's economy by the central bank, its fiscal managers should have demonstrated the ability to understand its profundity immediately, without the need for conscious reasoning.

There is, however, little doubt about the fact that the fiscal side knows well that there is very little it can do in the six weeks before the dissolution of Assemblies. Governments can change but the problem, ie, a negative primary balance implying current expenditure exceeds the total revenue (tax + non tax), remains.

The fiscal Responsibility Act 2005 ordains that the debt limit must not exceed 60 percent of the GDP while the SBP Act requires the government to retire its stock of debt with SBP within seven years. This has not happened and is not likely to happen either. What are the options? (a) To go to the parliament and have the debt limit raised? or (b) remove the limit and instead link future yearly borrowing with the total revenue collected. However, enforcement of 'option b' would need an amendment in both the laws. At present, the FRDL and the SBP Act are being violated with impunity because the government needs to maintain a minimum level of delivery to the people. Power and gas supply has to be maintained to the most noisy and violent constituents; air, rail and road transportation system has to be kept running for the economy to function and allow the constituents to move around. The law requires SBP to have control of its balance sheet. At present, SBP perforce has to inject liquidity into the system as the foreign exchange reserves are depleting and sucking the rupee liquidity out of the financial system. Failure by SBP to do so would stop the economic wheel from moving and send the money market in a spin. However, SBP should not allow banks to build-up their investment in government securities from money injected through open market operations (OMOs) and instead finance the budgetary deficit directly instead of leaning on commercial banks, because the end-result is the same - pressure on the price line.

Private sector has neither the inclination nor the resources to fully take over and compete with public sector operating in these vital sectors as they cannot afford endless losses unlike the government that injects over Rs 300 billion in subsidies to the PSEs. Similarly, the government cannot completely withdraw from commodity operations such as procurement of wheat. However, all this can change under a phased plan with a clear vision and staunch commitment that government shall withdraw from business ventures and instead just regulate the market with a soft touch and allow private sector to be the true economic agent. SBP is all praise for a privatised KESC - a sharp contrast as far as government-managed PSEs in the power sectors are concerned.

Servicing or repayment of external debt has to be aligned with export earnings and domestic debt with tax and non-tax revenue and both kept within a sustainable limit. The stock of external or rupee debt can never and will never be zero. It is the flow that is important. External debt servicing as a percentage of export of goods and services needs to show a reducing trend. Similarly, domestic debt servicing as percentage of rupee resources earned in a year needs to go down. Moving the benchmark performance criterion from measurement of nominal GDP to percentage of earning/collection makes more sense. It will show whether public financial management is being strengthened or weakened.

Explicit limit on borrowing from the central bank does help in controlling inflation. The Terms of Reference (TOR) for Fiscal and Monetary Board indicated that the Ministry of Finance will advise the monetary side on the growth and inflation target, for each year, and the Commerce Ministry will present the trade requirements to the Board. SBP will then independently apply its monetary tools to meet these objectives laid down by the government. Therefore, Fiscal and Monetary Board is a talking shop and not a decision making body. The SBP Central Board is the ultimate decision maker. From the very first meeting of Monetary Board in 1990, SBP is asked to provide its rationale for the conduct of monetary policy because the fiscal side conducts its operations based on decisions taken by the political leadership. Ministries regularly send proposals, throughout the year, outside the budget, for approval of the Economic Committee of the Cabinet (ECC); because the Prime Minister or the President so desires (case in point being the Rs8 billion subsidy recently given to the sugar mills). Approval is given by ECC on an ad hoc basis. Later, supplementary grants are approved by the National Assembly through cut motions prior to approval of the budget for the next year. In theory, government in our country is accountable to Parliament but practically it circumvents all rules and regulations. A pro-active judiciary is desperately trying to rein the executive and it attracts catchy headlines in the Media but until there is a fundamental change in governance there just will be no change. The judiciary may appear to be on a war path with the Executive that is not willing to work under the law. People are confused amid chaos and growing uncertainty, investors are holding back, unemployment is rising and genuine fears are being expressed of a return to unconstitutional rule. Food availability and security of life are more important than freedom alone. One needs to earn to put food on the table and have a shelter for his family. Creating jobs must have priority over deficit and debt. However, this does not mean we avoid cutting waste or continue to print notes without the backing of production of goods and services. Targeted economic reforms are needed for revival and increase in productive capacity. Strong macro-economic fundamentals sustain growth. At present, the economy is heading towards a Rs 2 trillion deficit and external debt repayments in excess of six billion dollars that will put pressure on forex reserves. To meet these challenges it is imperative that expenditure is reduced by curtailing losses in public sector starting with containment of power subsidies; improving government's debt management capacity and undertaking tax policy reforms with a strong emphasis on greater responsibility to provincial governments to exploit their own tax revenue potential. Last but not least. The governments at Centre and as well as in provinces are required to make a solemn pledge that they will not embark on a pre-election spending splurge. One must not lose sight of the fact that in political economy model of competition, the traditional intuition has been that opportunistic politicians will manipulate economic policy around election time for political gain. And, in a country like Pakistan, the poor and largely uneducated electorate is more likely to be susceptible to political manipulation. The SBP Annual Report seems to have hinted, albeit obliquely, at this grim prospect.


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