Reconfiguring the economy

Stuck in a low-growth loop

Pakistan is stuck with an economic model that is disproportionately dependent on consumption.  On a macroeconomic level, the Gross Domestic Product of a country largely comprises of household consumption, government consumption, investments, exports, and imports.  With the exception of imports, all other factors add to the GDP, while imports have a negative impact, and are often adjusted against exports, and referred to as net exports.  Pakistan over the last ten years has been maintaining consumption in excess of 80 percent of GDP, and more recently its contribution to GDP has been as high as 90 percent in FY-22, and 88 percent in FY-23.

Excessive reliance on consumption has led to a scenario where consumption is effectively driven by imports.  GDP growth is fueled by consumption, which is inadvertently fueled by imports.  The foreign currency required for funding these imports are provided by a mix of exports, remittances, and external debt.  As consumption continues to take up a significant component of imports, sufficient resources are not available to utilize imports for investments, resulting in slowdown in formation of capital, or any industrial base that can catalyze any growth in exports.  Consumption oriented growth results in an increase in imports, necessitating availability of foreign currency to pay for such imports.  As imports continue to outpace exports and remittance, and in the absence of any foreign investment, foreign currency reserves continue to erode, eventually resulting in a position where the country does not have sufficient foreign currency to finance its imports.

In absence of adequate foreign currency, the country keeps on borrowing more external debt to fund the same consumption.  The same has been happening for the last ten years where foreign currency liquidity was easily available due to close to zero interest rates.  This led to a substantial increase in external debt over the last ten years, which primarily fueled consumption, while industrial growth remained muted.  As interest rates have increased globally, foreign currency liquidity has dried up, resulting in a scenario where it is getting difficult for Pakistan to raise external debt to fund its consumption oriented growth.  As the world moves away from an environment where interest rates are not close to zero anymore, and as households and sovereigns across the world try to recover from an addiction to debt, ability to attain sustainable growth will remain compromised.

In the current environment, the ability of Pakistan to grow at a GDP growth rate of more than 3 percent without making any change to its composition of GDP, and its tax regime will remain compromised.  Any consumption oriented growth will require foreign currency to fund the imports, which will eventually fuel consumption – in absence of industrial investments, increasing export earnings may also not be possible.  It is estimated that the country would require additional external debt of more than US$ 7 billion every year, if it continues to grow at 4 percent or more, without changing its consumption oriented model.  Ability of the sovereign to raise debt in an environment where it already has a debt overhang is not just impossible, but also does not bode well for the sustenance of the economy at large.

If there is any serious thought about enabling sustainable economic growth for the country, it can only be done through reconfiguration of the economy from a consumption oriented economy, to an economy that is concentrated on investment.  The investment to GDP ratio in Pakistan averages in the range of 13 percent over the last ten years, whereas that for lower middle income countries is at 30 percent.  

There is a dire need to invest heavily in the economy by sourcing informal capital that is sloshing around as currency in circulation and driving up prices, and accelerating an industrialization process through the same.  More consumption oriented growth will not allow growth at more than 3 percent annually on a sustainable basis, which is only a few basis points higher than the population growth rate.  The failure of policy makers to reconfigure the economy is pushing the population towards poverty as consumption oriented growth remains unsustainable, while ever increasing demand for foreign currency continues to depreciate the local currency.  If policies are not amended, and the structure of the economy is not amended we may get stuck in this low-growth loop for years, and even decades to come.

Ammar H. Khan
Ammar H. Khan
The writer is the chief risk officer for Karandaaz Pakistan, an organisation that seeks to promote financial inclusion in Pakistan. He has previously worked at several financial institutions in Pakistan, both in commercial banking and capital markets



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