The present government is rightly focused on the need to increase the rate of investment in the country to around 20 percent of the GDP, which is required to generate an annual growth rate of 6 to 8 percent on a sustained basis. In this regard, it has been holding conferences to attract foreign investment, cultivating domestic entrepreneurs and in general projecting itself as a business-friendly government.
Useful as these initiatives may seem, conferences, meetings and governance-related statements will not really make a difference without concrete action on several fronts and actual economic policy reforms that are helpful for saving and investment.
At present the gross fixed investment is less than 13 percent of the GDP which even in the best of circumstances cannot generate a growth rate of more than 4 percent per year. The private sector gross fixed investment is about 9 percent of the GDP with the residual investment made by the public sector. The bulk of the investment went to agriculture, transportation and communication, housing and real estate rather than the high-value-adding commodity producing sectors that could promote export-led growth.
The level of domestic saving at about 9 percent of the GDP is even lower. The gap between investment and domestic saving, and a part of consumption expenditure of the government, have been met by foreign sources or forced domestic saving through inflationary financing methods.
There is no doubt that the country indeed needs to increase the rate of investment to at least 20 percent of the GDP and tilt its distribution towards more high-value and productive activities. It is equally important that investment is financed by a sharp increase in domestic real savings in order to control inflation and reduce dependence on foreign borrowing. It requires a well thought out strategy and an action plan. Measures to promote domestic savings require equal, if not more, attention than those to increase investment.
It may be recalled that the Musharraf government indulged in consumption liberalisation assisted by large foreign inflows that were received after Pakistan joined hands with the western countries in the fight against terrorism. Consumption was also encouraged by the cheap money policy adopted by the State Bank of Pakistan. But the strategy to promote consumption-led growth was bound to backfire.
The economic managers of the Musharraf government were unable to grasp that in a saving-deficient country like Pakistan, consumption-led growth would prove very damaging for the economic prospects of the country in the long run. Sure enough, high inflation and declining foreign exchange reserves had taken threatening proportions by FY 2008.
The PPP-led government, instead of adopting structural reform measures to increase saving and investment, moved in the opposite direction in its own ways. It managed to obtain a huge front-loaded loan from the IMF with the help of the US government and then avoided undertaking economic reforms that were back-loaded.
Abandoning the path of structural reforms, the government indulged in wasteful public sector expenditure and corruption through large scale printing of notes and borrowing from commercial banks. As a consequence, the country has now been driven to a state of stagflation and a debt trap in addition to being in a serious balance of payments crisis.
The present government ought to learn from the mistakes made by the previous governments if it is serious in tackling the difficult economic situation. It has to shift its focus towards measures to promote domestic savings rather than seeking financial help from abroad without economic reforms, taking short-term measures to boost foreign exchange resources or continuing to rely on borrowing from the SBP and commercial banks.
The public sector is a net dissaver and it can help improve the rate of domestic saving by sharply increasing the tax-to-GDP ratio, curtailing non-investment expenditure, including price subsidies and losses of public sector enterprises, and sharply lowering the current high level of budget deficit. Since it will be a slow process, the real hope is that the government formulates a strategy to promote private savings to finance the increasing level of investment. In this regard, there are several points that need to be kept in mind.
First, financial savings flourish best in an environment of low inflation. The government will have to reduce the rate of current inflation as a prerequisite for increasing the rate of financial savings. Rationalisation of the macro-policy framework is a must to move to a higher trajectory of saving and investment.
Second, the thrust of taxation policy should shift from taxing savings or imposing it from the point of view of convenience of collection to taxing consumption and to curbing the tendency to indulge in conspicuous consumption. Private consumption must be discouraged through a broad-based value added tax at a low rate in addition to taxation of income from all sources.
Third, the nominal rate of return on financial savings should always be kept above the inflation rate so as to encourage saving. It requires an active interest rate policy that focuses on savers rather than borrowers.
As the borrowers are a more influential group of relatively rich people having strong lobbying power, and as the government itself is beneficiary from financial suppression and negative real interest rates, both the government and the SBP have been driven in their interest policy by non-professional considerations. It is important that the focus shifts from borrowers to savers and from government debt servicing through interest rate suppression to correct pricing of the factors of production. In this context, the monetary policy needs to be freed from the slavery of the budgetary compulsions.
Fourth, a large component of the population enjoys ‘rental income’ through patronage and privileges and also from a flourishing underground economy. The propensity of the ‘rentier class’ to consume is very high.
Transparency and accountability in governance, coupled with measures to dismantle the underground economy and taxation of non-essential consumption, will go a long way in promoting domestic savings. Equally importantly, the rising income disparity between the rentier class and the poor promotes conspicuous consumption through its demonstration effects and needs to be tackled.
Fifth, proper taxation of the agricultural, real-estate and service sectors and of capital gains of all types would expose the hidden wealth that encourages conspicuous consumption and discourages savings. Simultaneously, reducing the burden of taxation on the corporate sector, salaried class and saving instruments will help promote savings.
Sixth, it is not subsidies and tax concessions that should be used to attract foreign saving and investment. What is required is a competitive, secure, safe and corruption-free environment that attracts foreign direct investment in the commodity producing sectors and provides safeguards and protection to property rights. Tax holidays and exemptions lead to misallocation of resources, promote corrupt practices and are injurious for saving and investment.
Seventh, a strong and transparent regulatory framework for the corporate sector and adherence to rule of law to ensure enforcement of economic contracts are needed to attract foreign savings and investment.
Eighth, there is a group of economists that has argued persuasively that availability of foreign aid has in fact encouraged conspicuous consumption and wasteful spending in the public sector. The country would be better off if it were to break its begging bowl and begin the difficult journey towards self-reliance.
In summary, fiscal, monetary, exchange rate and other policies must be reviewed and revised to promote domestic saving simultaneously with the creation of investment opportunities. This is the only way to move towards a self-sustaining process of steady economic growth without fuelling inflation and increasing dependence on foreign borrowing.
(Courtesy: The News)