SBP report and the untold fiscal affairs

The SBP's recently released quarterly report suggests that the economy is moving on its growth trajectory, amid some challenges. This column agrees partially to the growth story but opines that the challenges are underplayed by the central bank.

GDP growth of 5.7 percent is likely to be missed but the economy revival is broad based this year. Unlike last year, when the government support was prime reason for auto growth, and availability of gas jacked up fertilizer sector; this year growth seems truly demand driven.

The construction sector continues to dominate the momentum with cement and steel sectors booming. In November, the cement sector almost reached 100 percent capacity utilization. While in steel, despite no activity at the Pakistan Steel Mills, the sector is growing at unprecedented levels.

That said, the imposition of imports duty is not letting consumers extract real benefits as 20 percent import duty on cement should now be done away with. The sector is competitive enough to beat imports at parity and abolishing duty may lower prices for consumers to gain surplus. In case of steel, duties shall continue; but with a clear schedule to be eliminated in phases,

In the auto sector, the new policy is well embraced by private sector and the number of cars assemblers are likely to be doubled by 2018; and barring government schemes, the sector has exhibited some growth in the first quarter of FY17.

The problem in textile remains; and that has not let the LSM grow. It increased by 2.2 percent in 1QFY17 as compared to 3.9 percent in the same period last year. The textile package, and possible shift of China from textile and other labour incentive sectors open avenues for expansion. Pharma is another sector with a promising growth story; and government health insurance programmes may help the sector grow. The need is to have clarity on price structure for the sector to grow to its potential.

Agriculture is slowly reviving, yet cotton farmers fear has not subsided from last year's catastrophe. Lower global production would jack up prices and cotton would be in abundance in the years to come. Same is the story for rice; and in case of sugar, prices have already risen exporting the surplus without any subsidy makes sense. The growth of agriculture in FY17 is contingent upon the upcoming wheat crop.

The performance of heavy weight services sector is based on commodity producing and manufacturing sectors, especially for wholesale and retail trade. The CPEC related road network expansion would boost the transportation sector. Lower interest rates have marginalized growth in finance and insurance; uptick in interest rates can boost it. The SBP projects overall economic growth to remain in range of 5-6 percent; it's more likely to be on the lower side.

Inflation is picking up as global commodity prices are moving up but it has a lagged impact in Pakistan. The artificial appreciation of currency (not at all mentioned by the SBP) is curtailing the inflation for the time being. The monetary aggregates are well in control; and the monetary policy stance is cautious as easing cycle is over with no change in rates in the last four policy reviews.

Right after the IMF programme, the government is swaying away from the long term stability measures in monetary aggregates such as domestic debt is shifting back to short term maturity papers, and fiscal borrowing from the SBP is back in action. The impact of latter is not visible now, as the quantum of shift in government borrowing from commercial banks to central bank is almost matched by reduction in OMO injections. In case of former, the rollover risk would be back, once interest rates start moving up. The credit in private sector has failed to pick up yet; however, higher long term lending is encouraging.

Challenges are primarily emanating from the fiscal and external fronts. And twin deficit - fiscal and current account, can seriously dampen the macroeconomic stability. The fiscal side is mired by lower revenues and higher development expenditures. The latter is good as it may help attain higher growth but comes with the challenge of higher fiscal deficit.

The core of the issue lies in the former. Non tax revenues have taken a major hit; CSF will remain elusive, and SBP profits may remain low. Increase in petroleum price is adversely affecting the sales tax, but it is partially compensated by higher consumption. Direct taxes are falling too and within it, the reliance is on WHT, which is regressive in nature.

The only silver lining in the fiscal house is curtailment of current expenditure and uptick in provincial tax revenues. But they are not enough to keep the fiscal deficit within target. Government is targeting FY17 deficit at 3.8 percent of GDP but given 1.3 percent of GDP deficit in the first quarter, SBP expects deficit to be in range of 4-5 percent of GDP. This column opines that even the SBP projections are optimistic.

The other challenge is current account deficit - in 1QFY17 it more than doubled over last year. There is no CSF money to support, remittances have started receding, there is no respite to exports, and non-oil imports are on rise due to higher machinery imports.

Oil imports ought to worry policymakers, as oil prices have picked up. The SBP has revised up its CAD projections from 0.5-1.5 percent to 1-2 percent of GDP. The higher deficit ought to be financed by financial and capital flows to keep reserves high. With no respite to the FDI, the reliance is primarily on external borrowing.

That is a dangerous trend. Policymakers need to address it. Unfortunately, the SBP has nothing to say on the adjustment in exchange rate to address the external woes. There is no concrete plan to jack up exports or control imports, and there is nothing to find new avenues of remittances as flows from gulf ought to decline more.