Our economic development paradigm - IV by MIAN ASIF SAID

ARTICLE (March 02 2010): Part I of the captioned series of articles that appeared in these columns on February 1, 2010, had enlarged upon historical failure of our financial managers to enunciate a coherent set of policies for long term economic development. By accepting a WB/IMF programme for the umpteenth time, the present government has demonstrated that it is equally at sea.For Third World countries, caught in a fiscal bind, the Washington institutions famous "one-size fits all" tool-kit of Demand-Suppression remedies often aggravate miseries of common folk. Part II published on February 9, 2010 outlined key pillars of an alternate model of economic development implemented by the Asian Tigers and China. Of course, one can argue that a large measure of their success was attributable to their visionary leaders like Deng Xiao Ping, Lee Kuan Yew, and Mahatir Mohamed.However, the common thread that ran through their development models was a single minded focus on the following four fundamental initiatives: 1) Rapid reduction in the rate of population growth that enabled transfer of national resources away from subsistence and survival;2) High level of spending on health and nutrition to improve labour productivity;3) Persistent commitment to and allocation of large resources for primary and vocational education; and,4) Promoting a culture of savings among the masses; savings that formed the bedrock of a high rate of investment in infrastructure year in and year out without significant recourse to foreign capital.Our national failure on all of these variables is today evident from the consequences thereof, ie a teeming humanity, which we can barely feed, high incidence of infant mortality and disease, an illiterate labour force with perhaps the lowest productivity in the world, and a pathetic rate of private savings and hence negligible investment in basic infrastructure (schools, hospitals, dams, roads, railways etc).Consequently, we seem condemned to perpetual current account and budgetary deficits with a high and rising foreign debt (for budgetary support rather than development), rapid currency depreciation, and persistent inflation, which in turn has already pushed 40% of the population below subsistence!It is this scribe's contention that unless our economic managers temper the WB/IMF bromides in favour of output enabling (Supply Side) policies that leverage off primary drivers of GDP growth (our abundant natural resources), while devoting all development resources to the abovementioned four pillars, we shall be forever condemned to a "Hindu Rate of Growth" of 3% per annum.Yes, we have occasionally witnessed episodes of rapid growth fuelled by massive injections of motivated foreign assistance (Ayub, Zia, and Musharraf eras for instance). But, in each instance, the moment Consumption-Spending steroids were withdrawn, our GDP growth rate plummeted.The first three of the named policy initiatives were addressed in Part III of this series on February 21, 2010. In the current segment, we shall address the fourth critical policy initiative, ie a high rate of savings and investment without which a sustained high rate of GDP growth will remain a pipe-dream. Here's a 2005 comparative snapshot of Gross Savings rate as percentage of GDP for some relevant countries:======================================
China 50% Singapore 40%
Malaysia 38% India 32%
Hong Kong 32% South Korea 32%
Nepal 31% Bangladesh 29%
Pakistan 18%
======================================We have by far the lowest rate of gross savings. Our Net Savings Rate (after depreciation) is even lower, a pathetic 9.5%. No wonder that all international institutions and independent economists (employing the usual 3:1 Incremental Capital Output Ratio) project our likely GDP growth for the foreseeable future at 3% per annum.To double this projected growth rate, we'd have to save like India, Hong Kong, and South Korea, and if we wish to grow at 10% per annum, we need to save like the Chinese. This is not a theory; it is a mathematical certainty!For proof that all successive governments have been oblivious of this reality one need only refer to our national economic policy document, the Pakistan Economic Survey, which comes out each May. Each issue pontificates ad nausea on government policies and initiatives on every thing under the sun; that is everything except National Savings.In fact, our monetary policy actively discourages savings by ensuring that the country's banking system sets a rate on customer deposits, which is on average no higher than 50% of SBP discount rate and a third the average CPI (the former is currently 12.5% and the latter 18%).Consequently, total deposits of the banking system (worth PKR 4.5 trillion today) have struggled to keep pace with annual monetary growth that has averaged 16% over the past 5 years. Similarly, the National Savings System (DSCs, SSCs, etc) has barely generated PKR 1.3 trillion over 20 years.The result of such a policy of neglect is before us. Being assured of losing a large chunk of their savings to inflation each year, citizens have opted to put their savings into real estate, agricultural land, and for the past ten years (when inflation was subdued) into listed shares. We thus have one of the most expensive urban lands in the world.A plot measuring 500 square yards in key cities like Karachi, Lahore, and Islamabad today go for as much as PKR 15-25 million. For an equivalent sum, one can buy a decent 2-bedroom apartment in downtown Manhattan, New York. To give us an idea of the kind of capital locked up in rural agricultural land alone, we can multiply the country's arable acreage of 55 million with its average cost of PKR 300,000 per acre.The sum involved comes to a staggering PKR 16.5 trillion. Again, perhaps twice as much is locked up in equity financed urban land. These are all savings of past generations which when unlocked by secured modes of financing can unleash massive amounts of capital for development.Remedial policy: To generate resources for the massive investments required by population planning, health, and education, and for the large infrastructure needs of schools, hospitals, roads, dams, and railways, etc we must urgently double our rate of savings, and then perhaps increase it some more! Two immediate and key legislations come to mind:1) The National Assembly needs to pass a bill that puts a floor under the profit rate offered on citizen's savings by either the banking sector or the National Savings System. This floor rate, to be revised periodically, should be set equal to the Consumer Price Index. Once implemented, our national savings rate is sure to rise rapidly and perhaps double in a couple of years. And,2) Title to land needs to be computerised across the country in double quick time (say within 12 months) and hassle free one-window transfer of title mechanism should be implemented. This would free trillions of rupees worth of capital so far unproductively locked up in land.In its current budget, the present government is struggling to close the gap between revenues projected at PKR 1.6 trillion and expenditures that threaten to exceed Rs 2.4 trillion. Based on our running rate GDP of Rs 15 trillion, the financing deficit will easily exceed 5%, even if, as recently announced, the government slashes its Development Budget by 60% down to a miserly PKR 250 billion.Implementing the two suggested policies will, in one fell swoop, eliminate the resource gap as national savings, both in the banking sector and the National Savings System; explode from their meagre level of 35% of GDP to well over 50% within 12-24 months. This is the key to magnetisation of our economy and to bring the 60-70% "Black Economy" into the mainstream of economic life of the country.Government misgivings: Before our government mandarins pooh-pooh your scribe's policy initiatives noted above, let me address their likely objections to it:-- How will these policies improve the abysmal tax to GDP ratio that has been declining persistently over years and currently stands at 8.8%? And,-- If the government borrows heavily from the banking sector and via the National Savings System (which by itself is preferable to inflationary borrowings from SBP), won't it cause the national debt to balloon? And won't the higher rate of profit paid on these borrowings swamp the already strained budgetary process?The answer to the first question is that when we talk of Rs 1.3 trillion in budgeted taxes on a Rs 15 trillion economy, for an 8.8% yield, we ignore the black economy. The aforementioned policies are guaranteed to "whiten" several trillions of rupees of our large invisible economy.We are, therefore, likely to see a quantum leap in our white economy as money pours out of real estate into high yielding deposits and savings schemes. Even if only a third of the current estimate of our black economy is monazite, within the next 12 months we would be looking at a Rs 20 trillion economy. An 8.8% tax yield on this larger cake amounts to Rs 1.76 trillion, ie a net growth of Rs 360 billion in tax revenues!The second fear, one of sharply escalating national debt, is also easily addressed. As I have mentioned in earlier instalments of this article, our current national debt stands at approximately PKR 9 trillion divided roughly 50-50 between domestic and foreign currency.That is 60% of our "white" GDP...the maximum allowed by legislation. But, that is only a static picture. As compared to several developed nations like Japan (190%), Italy (120%), and USA (90%), we are not too badly off. A more logical approach to viewing national debt is to judge the burden imposed by its annual servicing (interest plus amortisation of principal).Since domestic debt can always be rolled over (fresh debt issued to retire old, and then some more), only its interest is a burden on the budget. Foreign currency debt is, therefore, more dangerous in not only that principal instalments have to be paid on time, but also because its rupee burden escalates rapidly as the rupee depreciates against foreign currencies. Thus, for a developing country like ours, it is better to borrow in local rather than foreign currency.Our current annual budgetary burden of debt service stands at PKR 675 billion. Of this, only Rs 110 billion (USD 1.3 billion) is serviceable in foreign currency. That is hardly alarming. The balance of PKR 560 billion represents interest on domestic debt. According to official records, the average rate paid on domestic debt (which includes government bonds, T-bills, and National Savings Schemes) is approximately 14-15% per annum. The important thing to note is that with current inflation of equal magnitude, if not higher, the real burden of domestic debt is not rising! In other words, the government's real rupee borrowing cost is practically zero.Yes, domestic debt will and should rise in absolute terms as the government attempts to bridge its tax revenue shortfalls, and works on improving its tax to GDP ratio. But as long as it's primary deficit (excess of expenditures over revenues net of debt service) as a percentage of GDP is lower than the annual growth in GDP, overall debt burden will not rise as a ratio of GDP.In other words, the WB/IMF's scowls at our current budget deficit of 5% are a red herring. The US and most 3 OECD countries are currently running budget deficits of over 10% of GDP. Have we heard these Washington institutions admonishing them? Of course not. That would be L'ese Majeste!Having outlined the four fundamental principles of growth for a factor-driven economy like ours, and hopefully convinced readers that our current economic managers are clueless about them, sequels in this series will address the structure of budgets going forward, ie how our proposed model of growth can be funded with judicious reordering of our spending priorities.

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