External Shocks in Pakistan

In twentieth century, global economy witnessed the period of integration strikingly comparable with the contemporary phenomenon of globalization. This wave of globalization has accompanied with increasing probability of external shocks. Dr Pervez Hasan, the author of Pakistan at the Cross Road, sermons the issue of external shocks in the history of Pakistan in weekly seminar of Nurturing Minds, held at PIDE on 7th September. He asserted that course of economic development is never smooth and shocks are the inevitable outcome of the normal functioning of capitalist economy. Real development is how well economies accommodate adverse shocks and how they exploit long-term benefits from favorable shocks.

Peeling off the folds of the history of external shocks in Pakistan, he corroborated that external shocks may not vitally be an upshot of international factor or natural calamity. It can be government own policies that may divert international economic temperament against country’s own pursuance. In this context, he referred the government policy toward foreign exchange in 1949 as first external shock.

In 1949, the members of Sterling Area agreed to devalue their currencies with respect to the US dollar. India went with other Sterling Area countries; Pakistan refused to follow. The result was that the rate of exchange between the currencies of the two countries changed from parity to 100:144 in favor of Pakistan. It severed repercussions for Pakistan’s economy. However, the outbreak of the Korean War (1950-53) and the consequent price rises in jute, leather, cotton, and wool as a result of wartime needs, saved the economy of Pakistan.

He further proceeded by highlighting oil price hike of 1973 as second adverse external shock to Pakistan’s economy. The decision by the oil producing and exporting countries (OPEC) to sharply increase the price of oil in 1973 produced a world economic recession. It also ultimately led to the debt crisis experienced by many middle income countries, including Pakistan, causing economic stagnation that lasted for more than a decade.

This antipathetic decade ended with approbatory increase in remittances on 1980s – remarked as third external shock by Dr Pervez. However, instead of channeling these remittances to self sustaining development programs, Pakistan increased its fiscal deficit by expanding the size of defense expenditures. With the increasing coherence of economic systems through out the world, flexibility of responses of macroeconomic activity toward international economic conditions, magnified. That’s why multiple adverse events that concentrated in 1990s and 2000s, i.e. Asian financial crises, economic sanctions due to nuclear explosion, global recession, and the post-9/11 military action in neighboring Afghanistan, with a massive influx of refugees from that country, proved fundamental external shocks hereafter.

Economic policy response to these shocks was almost skipped in seminar. Instead of badgering and pondering over and again on previous policies agenda in the face of shocks, I will emphasize on some precautions that are equally considerable for the shocks of all nature. After shock remedies are exempted, as these are shock specific.

Pre-shock remedies intended to alleviate the vulnerability of LDCs, including Pakistan, to external shocks. This vulnerability closely relates to the difficulties that LDCs face in competitive terms, either in existing activities, or vis-a-vis new trading opportunities. These remedies necessarily encompass a list of infinite steps, some of which are as follows:

1. To ambush their inbred competitive handicaps, which are fundamental causes of the lack of diversification and inadequate specialization of many LDCs economies. This will reduce the competitive disadvantages and expedite natural adaptation in global economic structures.
2. To dampen the proneness of international price shocks. Price shocks are mainstream expediter of fluctuations in Pakistan. On microeconomic level its effects are more deleterious to agricultural supply when producers are poor and unable to obtain insurance. This in turn results in technological and human capital digression. On the macroeconomic level, unstable international prices, because they lead to instability in export earnings, are also a factor in real exchange rate instability. By disrupting signals about long-term market trends, this instability leads to poor resource allocation and hence to lower factor productivity. Two mechanisms are suggested to increase the resilience of LDC to these external price shocks. a) Flexibility in fiscal expenditure or stabilization fund; and b) Insurance of timely contra-cyclical grants to LDCs.
3. To develop a sustainable monetary anchor and strengthening the banking sector.
4. To reduce external current account deficit through consolidated fiscal policy. This also entails the increase in private and public saving to enhance the investment opportunities and productivity.
5. To improve human and social capital.
6. To weakened political interference in lending decisions and the moral hazard associated with wide-ranging, albeit often implicit, government credit guarantees.
7. To prudent debt and liquidity management problem by lowering the ratios of short-term external debt to foreign reserves.

 

In conclusion, it is worth reiterating that the most important consideration in preventing any shock is establishing sound domestic policies and robust financial institutions in economies. No reforms of the international financial architecture can, by themselves, overcome deficiencies in LDCs. However, an incremental contribution can nonetheless be made through improvements in the international financial system and in international institutions. Such initiatives can provide information, incentives, and assistance to LDCs to encourage them to adopt sound policies and can mitigate the damage to international financial markets when problems do arise.