A view that is gaining currency amongst the government's economic managers is that having achieved "macro economic stabilization", the market mechanism has been rectified, and therefore there is no need to worry any more about either growth or poverty reduction. This is a dangerously flawed proposition. Flawed because it is based on invalid assumptions. Dangerous because it could prevent the urgent and wide ranging policy measures from being undertaken, that are necessary to address the serious structural problems, which underlie persistent slow growth and rising poverty in Pakistan. In this article we will briefly indicate the sense in which the official proposition is flawed to show that financial stability can be a prelude for policy action for growth and poverty reduction but not a substitute for such a policy.

As evidence that macro economic stabilization has been brought about, the government's economic managers point to four undoubted achievements: (i) The budget deficit has been significantly reduced. (ii) The inflation rate has been brought down. (iii) A historically unprecedented level of foreign exchange reserves has been reached. (iv) The exchange rate has remained stable at least since the last two years.

It may be pertinent to point out that these positive features actually belong to the financial sphere of the economy and if they were to persist for a few more years, it could at best be claimed that financial stability has been achieved. It is misleading to suggest as the government does, that this amounts to macro economic stability. For macro economic stability to be achieved it is necessary that: (i) The level of investment is high enough to ensure macro economic equilibrium at full employment in the short run and (ii) The growth rate of productive capacity is consistent with full employment equilibrium in the long run. Clearly neither of these necessary conditions for macro economic stability has been achieved so far in Pakistan. Worse still, it can be argued that unless rapid economic growth is achieved, the financial stability claimed by the government cannot be sustained.

As Keynes, the father of modern economics showed, the macro economy signifies levels of investment, output, exports and employment. It is this realm of the real economy that ultimately determines the financial variables such as budget deficits, inflation rates, and exchange rates. This is simply because if investment levels are inadequate, and growth of aggregate output and exports continues to remain low, then sooner or later budget deficits as well as balance of payment deficits will rise again. For after all governments finance their budgetary expenditures through the revenues they earn from a growing economy, just as the balance of payments are sustained by financing the country's import needs through export earnings. Thus, unless the persistent problems of low investment rates, inadequate exports and slow GDP growth are addressed, the twin crisis of debt and exchange rate instability will rear its ugly head again.

Two questions arise at this stage: (i) Can the financial (though not macro economic) stability that has been achieved, be sustained? (ii) Is the financial stability a sufficient condition for ensuring rapid economic growth, even within perfect markets, which demonstrably do not exist in Pakistan?

With reference to the first question we must remember that the exchange rate stability is not the result of a dynamic export capability but the result of a sudden surge in dollar deposits in the domestic economy by Pakistanis following 9/11. At the same time, some of the millions of dollars used to buy the loyalty of provincial power holders in Afghanistan as part of the attempt to stabilize President Karzai's regime, found their way into Pakistan. Consequently the exchange rate stability induced by temporarily propped up foreign exchange reserves is fragile. It can be maintained only if there is a sustainable sharp increase in exports based on a change in the composition of exports, towards high value added items, whose international demand is growing rapidly.

Regarding the second question, it would be dangerously misleading to suggest that with this fragile financial stability, the market mechanism will necessarily bring about both rapid economic growth and poverty reduction. A higher rate of economic growth clearly requires a higher level of investment (private plus public sector). For a higher private investment to occur, financial stability may be a necessary but is certainly not a sufficient condition. It is not enough to have just exchange rate stability and low inflation rates. Even more important for private sector investment is establishing peace on our borders and the conditions of law and order within the country, so that the life and property of citizens can be safe. Equally important are the availability of improved infrastructure, cheaper electricity, and trained manpower. Increased public sector investment for growth requires a sharp reduction in the government's non-productive expenditure to release resources for productive investment. Equally important, wide-ranging institutional reforms are necessary to increase the efficiency of public sector investment. Otherwise increased development expenditure may not lead to increased development. Have these conditions for increased private sector investment and a higher and more efficient public sector investment been achieved? Perhaps such questions are not asked in the corridors of power. It is more comforting to believe that the government has done its job with financial stability, and now the hidden hand of the market will catapult the economy into high growth.

We have argued that the current financial stability is neither sustainable nor can it be expected to necessarily lead to high growth. Let us now consider the issue of whether merely higher growth (even if it could be achieved) will end poverty. If there is no change in the composition of growth and the degree of inequality, then for growth to have a significant effect on poverty reduction, a GDP growth rate of at least 9 per cent will have to be achieved. Even the most optimistic projections of the government do not anticipate more than a 5 per cent growth rate in the foreseeable future. With such a growth rate, no significant poverty reduction is possible, unless of course there is a structural change in the growth process itself. This means that the productivity and incomes of the poor would have to rise faster than the overall GDP growth rate. (I have presented the analysis and detailed policy measures for such a change in the structure of growth, in the forthcoming National Human Development Report).

The current financial stability is fragile and therefore affords only a breathing space for urgent policy action to accelerate growth and reduce poverty. For the government to cultivate the illusion that this financial stability will in itself induce growth and poverty reduction, will only produce inaction. In replacing reality with illusion, the government may feel comforted, but will miss the opportunity of addressing the continuing national crisis through comprehensive reforms in public institutions, governance and the structure of the economy.