Capital market transactions: Remarkable achievement

Pakistan floated two capital market transactions, a Sukuk and a Euro Bond. Both met with remarkable successes. The two issues were over-subscribed by 2.5 times compared to the amount of $2.5 billion finally accepted, and at a weighted average price of 6.4%, perhaps the best pricing in the history of Pakistan's capital market issues.
Although many analysts may express surprise, we think that the international investors have correctly assessed the strengths of Pakistan economy and the high potential it offers going forward. Undoubtedly, Pakistan was helped by relatively easy liquidity conditions prevailing in the market but the final pricing is significantly better than the initial price thought (IPT) implying that the demand for Pakistan securities was strong even at tighter prices. The events happening in Pakistan in the run-up to the issue could have neutralized temporary favorable conditions like extra liquidity if the stronger underlying factors were absent.
In our writings, we have been arguing that Pakistan's economy is passing through an exceptionally buoyant phase in its economic history. Its economic fundamentals are very strong. Undoubtedly, there are vulnerabilities we are facing and those should be attended urgently. Let us first count the strong fundamentals:
First, and foremost, is the high growth trajectory the country is following. Last year, it registered a growth of 5.3%, which was highest in a decade. It is on the back of a 4.0%+growth that we had in the previous three years of the present government compared to an average of 3% during the 2008-2013. This fiscal year, the target growth is 6% and all indications are that the target would be achieved.
Second, the early estimates of output in both agriculture and manufacturing are indicative of rising production. The three main Kharif crops of sugarcane, rice and cotton are posting decent growth rates compared to last year, whereas LSM growth for the first quarter (Jul-Sep) was registered at 8.36%,led by iron and steel (47%), automobiles(30%), engineering products (26%), coke & petroleum products (13%) and food & beverages (10%), all showing double digit growth. Textiles also posted positive growth. The services sector, which depends on these two sectors would follow the trend.
Third, the growth is not accompanied with inflationary pressures, as inflation has remained remarkably low (less than 4%) during 2015-17 and remains subdued during the current fiscal year. It was recorded at 3.8% for October compared to October 2016 and the average inflation for July-October 2017 was 3.5% compared to last year. While price stability owes much to the stability in international commodity prices, including that of oil, adequate domestic supplies play no less a contribution. Growth with price stability, therefore, reflects better utilization of capacity on the face of rising demand.
Fourth, even though data on investment is not published on monthly or quarterly basis, there are some indicators that point to rising investment activity. One, the imports have increased by 26% during Jul-Oct, on the back of an already elevated level; Two, the import of plant and machinery increased by 25%; Three, imports of raw materials such as metals, textiles and chemicals have also shown double digit growth; Four, there has been a 30% increase in oil and gas imports; and, Finally, against a less than Rs 1 billion last year, this year until 17th November, flow of credit to private sector was nearly Rs 70 billion. All these developments point to accelerating investment and economic activities.
Fourth, the rising current account deficit is an equally important indicator of both increased economic activity as well as overall investment as it increases national savings. This deficit was barely 1% of GDP during the period 2011-2016 and has then shot up to 4% in FY2017. For the current fiscal year, it is slated to be around 5%. This is a phenomenal increase, which would have a salutary effect on increasing the growth rate. We may also note that the exports slow-down has been reversed as in July-October exports registered a healthy growth of 13%. Undoubtedly, more efforts are needed for stimulating exports. In this regard, removal of the energy constraint through adequate supplies of electricity and LNG would be quite helpful.
We now turn to point out what vulnerabilities threaten to unhinge the economy. The problem is that of twin deficits that seem to be unraveling the stability of macroeconomic framework.
The fiscal adjustment by reducing the deficit from 8.2% in FY2013 to 4.2% (excluding security related expenditures) in 2016 was a key achievement under the Fund programme during 2013-16. Against a target of 3.8% in FY17, actual deficit was 5.8, a major reversal in fiscal discipline. This year, the target is 4.3%, but the first quarter deficit is reported at 1.2%. The debt stock, on the other hand, has increased by Rs 656 billion or 1.8% of GDP. Technically, marginal change in debt stock is the deficit during the year, but then there are increases in government deposits with the banking system, which are subtracted before arriving at the deficit figure. This is known as a statistical error. Normally, it builds slowly during the year and peaks in the last quarter. Such a large error in the first quarter is something that budget managers would like to closely examine and reconcile, for carrying it till the end would not be possible as the deficit would be rising as these deposits are drawn down during the year. The bottom line is that the deficit looks following the same path as last year, which would not augur well for the economy. Furthermore, without controlling the deficit, we have no hope of ensuring the stability of the economy.
The other deficit, namely balance of payment or current account, is a mirror image, to a large extent, of the fiscal deficit. We noted above with satisfaction the rising current account deficit, on account of its contribution to national savings and therefore to the growth. The key to this deficit is its sustainability, which means do we have sufficient external resources to finance it.
During the Fund programme, the country accumulated reserves that touched a historic level of $24.5 billion in October 2016, of which SBP reserves were nearly $19.5 billion. However, just as the fiscal achievement was squandered so have the reserves. We have lost nearly $5.5 billion since then. This means that we have been financing the current account deficit by drawing down on reserves. This happens when we wed to a given exchange rate and begin to support it at given rate by pumping the precious reserves to meet the rising demand (for imports). Not allowing exchange rate to move in line with market conditions is like postponing treatment of a disease only to discover that it has acquired a menacing character.
The success Pakistan has achieved in the international capital market is a reflection of the fact that the investors have weighed the strong fundamentals more than the emerging vulnerabilities. We should, therefore, not be complacent. The amount of $2.5 billion is barely sufficient to make the loss of reserves during the period July-October and hence would not provide the cushion for the rising aggregate demand, which would require a significant adjustment in the exchange rate. The earlier we signal to the market that there is no sacred variable beyond the scope of market forces, the sooner we would be able to wither the gathering storm.