Unsustainable stability?

It was a treat to read comprehensive analysis of recently-published SBP annual report which includes highlights of anomalies and shortcomings in documenting the economy. The essence of central bank’s analysis is to ponder on the sustainability of the nascent economic recovery. Whether it is fiscal balance or external debt, inflation or industrial growth, domestic debt or pick up in private credit, every variable change is either through one-off flows, exogenous factors (low commodity prices) or statistical discrepancies (creative accounting).
The foremost achievement of government is to reduce the fiscal deficit at 5.5 percent of GDP in FY14 as against the target of 6.5 percent and previous year’s deficit of 8.2 percent. Does it really warrant a star on Dar’s shoulder?
The unconditional money (Rs157 bn) coming from friendly countries in Pakistan development fund has been treated as statistical discrepancies to show it above the line and slash the deficit accordingly. The other careful arrangement was made in settling circular debt to beautify the numbers in FY14.
Recall that the government did not pay the circular debt of about Rs235 billion in FY14, which was piled just in this year. The authorities could only get away from this even after clearing Rs322 billion just two days before the start of the FY14 and non-cash adjustment of Rs138 billion in July 2013.
If the recovery of Rs56 billion from PSE (on account of mark-up on circular debt clearance) and Rs67.7 billion extraction from the Universal Support Fund are added, the fiscal gap would have soared to 7.5 percent of GDP and FY13 deficit would have been reduced to 7.5 percent had the circular debt settlement been equally divided in two years. .
Another claim of fame of Dar’s regime is strengthening external flows and rebalancing the debt composition. Well, the SBP thinks otherwise. “Certain debt sustainability indicators witnessed erosion in FY14. More specifically, external debt servicing as a fraction of export earnings and/or foreign exchange earnings (i.e. exports and remittances) both increased, as did the stock of external debt as a percentage of GDP. This should be viewed as a warning that Pakistan must increase its hard currency earnings in the future, and not take on expensive debt to finance its external deficit”
On the contrary, government issued bonds of $3 billion (15 and 10 years maturity) in the calendar year at exuberant rates for financing non-development expenditure. Similarly expensive long-term options were sought in domestic debt. The share of permanent debt reached 37.1 percent from only 21.2 percent in just six months (2HFY14) as share of floating debt decreased from 57.4 percent to 41.6 percent.
This unprecedented re-profiling is deemed to be too much in too short time, though it is part of medium term debt strategy 2014-18. The yield gap between the 3-month and 3-year papers hovered around 200-250 basis during most of the year. The trend has continued and incremental PIBs of Rs1.9 trillion (in mere six months) can increase debt servicing by Rs38-48 billion per annum.
Interestingly, the change in banking appetite after November coincided with artificial stability in the currency and softening inflation. Assuming no coincidence, one may ponder that this is a reward for keeping currency in the band of 98-100?
Banks had to forgo capital gains by punting in the currency markets in volatile days but that has been more than compensated by handsome gains from investing in long term papers at the time of lowering inflationary expectations. Inflation was in double digits in Nov 2013 and monetary policy was tightened as well. But soon after, owing to a drop in food prices and other commodity prices, inflation nosedived but banks kept feasting on the mouth-watering PIB yields.
Although the incremental government borrowing lowered significantly in FY14, with money locked away in PIBs, the crowding out of the private sector will persist much longer. This might be termed a poor strategy by keeping in mind that credit to private sector has kept on falling in Pakistan and is much less than regional countries.
Domestic credit to GDP ratio in Pakistan has declined from its peak of 27 percent in FY08 to 15 percent in FY14. The ratio is around 50 percent both in Bangladesh and India while in China it’s as high as 140 percent. This explains the erosion of economic potential in past few years when higher subsides and leakages in fiscal house attracted all the banking assets at the cost of private sector.
The inefficient use of capital is one of the prime reasons of high inflation and low growth as well. Nonetheless, inflation is coming down owing to softening commodity prices and the SBP expects it to be in 6.5-7.5 percent range for FY15.
The growth is still not really picking up. The poor GDP composition and lack of data undermine the depiction of true economic growth of the country. For example, this year growth in the livestock sector (56 percent of agri sector) is vaguely estimated on past census; and lower growth of agriculture in FY14 is attributed to poor performance of livestock.
Then in LSM, the fast-moving consumer goods (FMCGs) sector that includes the likes of Engro Foods; P&G; Unilever; Nestle; etc., are not even covered by PBS surveys. Similarly in services, most new IT-based start-ups, fast-food chains, shopping malls, and specialized retail outlets that have been sprouting up, are simply not covered.
In a nutshell, large part of the more vibrant economic activities in the country, are not reflected in official data. Pakistan’s informal economy is probably a more powerful engine of economic growth, compared to the established businesses captured by official data.
Although the PBS follows international standards for compiling national accounts, the construction of the LSM index is based on the Census of Manufacturing Industries (CMI), which was last conducted in 2005-06. SBP expects a new CMI census for 2010-11, which is currently being compiled, will allow PBS to publish a more inclusive picture of LSM.
The tale of energy sector is also missing long term sustainable solutions. The resurgence of circular debt to alarming levels after tall claims of partial resolution is an indication. The other departure from reality is having all focus on enhancing power generation, giving little to no attention to the more chronic distribution capacity issues.
The existing distribution and transmission network can reliably handle loads of 11500-12500 MW and that is the band in which power generation remained in the past few years. Any increase in generation capacity would only enhance idle capacity in absence of up gradation in the T&D system. And the country could face episodes of system tripping on large scale the way it happened last week when more than half the country faced blackout for hours.
Additionally, the subsidy is skewed towards non-productive households and commercial segments while the industry bears the burnt. The other issue the industry faces is acute shortage of power as the cheap indigenous energy resource (natural gas) is high on priority for fertilizer than the power sector. The SBP computed the net benefit of relocating all the gas from fertilizer to power of $1.4 billion in imports and Rs164 billion savings in subsidies.
To add to the ado, unaccounted for gas (UFG) losses in natural gas have abnormally increased in the past few years owing to the overuse of subsidized gas by households and CNG stations. There is an immediate need to address these energy woes through right mix of policies.
Ironically, by having the right energy mix, the cost of ending power shortage is much less than building tens of thousands of new power plants. But all this would go against rent seekers without prioritizing economic gains, all the reforms are meaningless and no spell of high growth is sustainable.