The fiscalitis virus

The whole world is facing a single pandemic virus. We are facing two – the coronavirus and the fiscalitis virus developed in Washington by the IMF. It has infected every limb and organ of the Ministry of Finance and the SBP, thereby seriously damaging its brain’s ability to think independently and distinguish between Pakistan’s interest versus the IMF’s key interest that “Pakistan’s capacity to repay the Fund remains adequate”. No other multilateral has such an explicit lending objective.

Prime Minister Khan is a real pro-poor PM, but his clarity of thinking on the Lives vs Livelihood debate has been clouded by the fiscalitis virus spreading to the PM House. He has to immediately put himself in self-isolation from those infected by this virus. Pakistan is not poor in resources, but in ideas on how to tackle the economic consequences of the pandemic.

The coronavirus has created a huge sinkhole in the global economy. The world simply does not fully understand the dynamics of paralysis. Once governments have put the economy into an artificial coma, all leaders with foresight and courage have recognized that they must keep the patient alive. They have also realized that pandemics are so disruptive that anything they can do to mitigate the destructive impact of the pandemic itself is going to be useful.

Courageous leaders, not infected by the fiscalitis virus, have recognized that they need to bring all the firepower at their disposal to match the scale of the problem. They have fully embraced the view that the paramount need of the hour is for the government to provide adequate financial support to all the poor and working class people, and SMEs, by enlarging the fiscal deficit.

Over the past month, governments around the world have embarked on one of the greatest peacetime borrowing binges in history, to fund the huge deficit arising from the unprecedented scale of the rescue and stimulus. The magnitude of fiscal measures in the majority of the countries is in the range of 2-3 percent of GDP and as high as 5.5 percent in the US.

The stimulus/relief package announced by the PM, amounts to about Rs800 billion or one percent of GDP – excluding the misplaced counting of wheat procurement and refunds as part of this package. While it is a very good first step, the package of measures is paltry beyond belief. As a minimum it needs to be doubled, if not more.

According to its most recent report, the IMF had estimated (before the onset of the pandemic) that at the end of FY19/20 the public debt-to-GDP would be 80 percent of GDP and fiscal deficit would be 7.3 percent during the year. Taking into account the government’s stimulus programme and latest tax revenue estimates, the IMF now estimates that fiscal deficit will increase to 9.3 percent of GDP and debt would increase to 85 percent of GDP.

Further increasing the deficit (and debt) by one or two percent of GDP, resulting from expanding the stimulus/relief programme by Rs1-2 trillion, would not lead to any insurmountable calamity or any adverse long term consequences. Critically, this additional expenditure would ensure that the patient not only does not die in an induced coma, but also can quickly come to life.

The additional resources would be generated through a judicious combination of more debt and printing of money. Without question, the new debt will leave taxpayers with a significantly larger burden to carry in years to come. Also expansion of the monetary base could increase inflation. Hence, it is absolutely critical that while announcing the expansion of the programme, the PM also announces a credible medium-term ‘corrective’ strategy to lower the debt levels and reduce the monetary overhang if inflation heats up. So far the corrective strategy is woefully missing. In designing this medium-term strategy, the PM should avoid listening to the IMF or his virus-infected economic team.

Some ideas on the medium-term strategy can be taken from history. Public borrowing in the rich world is set to soar to levels last seen amid the rubble and smoke of 1945. At the end of World War II, the majority of the countries had very high levels of debt arising from the financing of war . These countries shrank their debts over the course of decades, but only by using a bossy combination of high taxes on wealth, financial repression (forcing domestic investors to hold public debt at artificially low interest rates) and inflation, which erodes the real value of debts over time.

According to a 2011 IMF working paper, real interest rates across advanced economies were negative roughly half the time between 1945 and 1980. The British government paid an average real interest rate over the period of just -1.7 percent; the French, -6.6 percent. The effect was powerful.

Between 1946 and 1961 America’s debt-to-GDP ratio dropped by 68 percentage points. In the 1970s, debt-to-GDP across all advanced economies sank to a low of 25 percent. Therefore, one tool Pakistan must seriously consider for the next one to two years is financial repression. The IMF will never ever suggest financial repression, even though it has been widely practised throughout history when fiscal needs are exceptionally high. Short-run financial repression, along with other complementary tools, has no serious long-term consequences.

In addition, today’s emergency measures are temporary. The need for most of the new stimulus programmes will melt away as soon as the threat from the virus eases. All this argues strongly that the current borrowing binge should turn out well – so long as things get back to normal in relatively short order.

Another set of tools that Pakistan must deploy, which the IMF would never support, is capital controls and delays in servicing foreign debt owed to banks and bondholders. Most Latin American countries have imposed capital controls and even defaulted on foreign debt, with no adverse consequences in respect of access to foreign capital. Argentina has defaulted on foreign debt nine times , in the last few decades, and yet once the dust settles down, foreign money flocks to Argentina. One is definitely not recommending debt default, but deferring payments on debt, dividends and capacity payments of IPPs would have no reputational risk for Pakistan.

Pakistan has sought debt relief, because of the myopic views of the economic managers. Sub-Saharan Africa most certainly needs debt relief. As a nuclear state with a large wealthy class, it is shameful for Pakistan to seek debt relief. The PM must withdraw the request for debt relief to restore the self respect of a nuclear Pakistan.

An important element of the ‘corrective strategy’ should be aggressive reduction in wasteful expenditures and a bold tax reform programme. While a forceful expansion of the tax net should wait until the growth picks up substantially, aggressively taxing the wealthy should start now. The wealthy must bear a significant burden of raising revenues to finance Covid-related expenditures now, and to reduce debt in future.

The IMF will cry hoarse that increasing deficit and printing money will lead to hyperinflation. Their mantra is totally misplaced when dealing with a collapsed economy and depressed demand. The inflationary impact of any expansion of money or increase in the deficit depends on how the money is spent. In this instance, with adequate stock of food items and basic goods, putting money in the hands of the poor and those with low income will have a modest impact on inflation. Moreover, even if inflation increases, it is likely to do so slowly; this would give the government enough time to respond.

The new rules of pandemic economics should guide our policy. Pakistan will make a big mistake if it succumbs to excessive worries about the soaring budget deficit. This is no time to fret about government debt. While cases of Covid-19 soar and economic activity grinds to a halt, the government must throw all the resources it can at efforts to limit the pandemic’s human and economic costs.

By listening to the carriers of the fiscalitis virus, the PM may get nominated for a prize by the IMF, but inadequate fiscal support today risks pushing the economy into a spiral of decline. In the absence of ‘full firepower’ deficit spending, not only would there be enormous suffering today, but our economy’s revival would also be imperiled and the resulting chaos could get Pakistan closer to being seen as a failed state.

The writer is a former adviser to the World Bank.