Walking a tight rope

LAHORE: Pakistan currently faces significant fiscal challenges. Its tax-to-GDP ratio is only 9.0 per cent and it spends a whopping 57 per cent of its tax revenue on debt servicing.

Following the budget approval, no segment of society has shown willingness to contribute additional taxes needed to run the country.But the government is not in a position to back away from most of the taxes imposed in the budget. It seems that rulers are simply dragging negotiations on many issues, hoping to calm down distractors as time passes.

Since a large portion of the government revenue goes to provinces, the federal government has to borrow to service its debt obligations. The impact of debt servicing is comparatively higher than in other countries because most of our debt is from domestic lenders and the central bank’s markup is over 20 per cent.

If the markup declines, the burden of debt servicing will be correspondingly reduced. In India, debt servicing consumes a 28 per cent share of revenue. Its domestic debt is also high, but the Reserve Bank of India’s policy rate is 6.5 per cent which is one-third of that of Pakistan. Had the interest been at the same level as Pakistan’s, India would have spent 84 per cent of its revenue on debt services.

This implies that our debt could also be manageable if we somehow manage to lower our interest rate. There are three problems that the central bank faces while loosening its monetary policy. The first one is high inflation, which was around 30 per cent until six months back but has now come down a little; in June, inflation was recorded at 12 per cent.

Many businesses think that the State Bank of Pakistan’s policy rate is too high compared with the prevailing inflation. But the central bank has had to adopt extremely harsh measures in the last three years to bring down inflation, which is still unstable.

The bank is also waiting to see the impact of huge taxation measures in this year’s budget. The impact is likely to be clear by the end of this month. After that, the bank may take a decision on reducing the markup.

High government borrowings from domestic commercial banks are another problem. High government expenditure and lower revenue also create inflationary pressures. The central bank would have to consider this aspect as well, when determining the policy rate. And finally, the central bank has to ensure the stability of the local currency.

It has maintained its stability by controlling imports and buying dollars from interbank. It has to reduce money flow by keeping interest rates a little higher. It is because monetary policy in Pakistan is subject to the precarious nature of our economy. We have to provide an interest rate cushion to lower inflation, keep the rupee stable, and maintain reasonable foreign exchange reserves.

Currently, Pakistan is not an ideal place for investment due to economic instability. The central bank is walking on a tightrope, trying to strike a balance between sustainable growth and economic stability. The IMF deal is a welcome sign.

The deal was made possible because of various compromises that the government and the central bank have had to make in the past four months. There are certain steps that we need to take before the IMF board’s meeting, which means adhering strictly to the agreed policies.