Vibes are good and storytelling is positive. SBP's second quarterly report tends to highlight silver linings in the economy while challenges somehow did not get ample space. Accommodating monetary policy has started yielding some results while the euphoria of CPEC is scrubbing the tainted picture of Pakistan across the globe.
Consumer demand is driving broad-based economic growth and sectors catering to domestic demand are in expansionary phase. White goods are selling more, passenger cars – excluding Apna Rozgar scheme – are moving up; beverages consumption is on the rise and petroleum products sales are soaring. The highest jump in private credit is seen in consumer finance as low interest rates gave further imputes to consumerism.
The construction boom continues as both cement and steel sectors performed well. The demand is primarily driven by high government infrastructure demand and that ought to remain high till elections. Although the LSM in Jul-Jan grew at a slower pace than the same period last year, the growth is more broad-based and less on the government clutches, as last year the growth drivers were fertilizer and Apna Rozgar scheme while this time it’s consumerism.
Seeing this, many industries are expanding and that is triggering private sector credit, as in Jul-Feb ‘17 fixed investment credit was Rs161 billion – up by 65 percent. Energy and construction sectors continue to dominate the credit growth while cement, textile, and food & beverages follow suit this year.
But all this comes with a cost. The imports are up both on accounts of consumption and expansion. The machinery imports contributed 73 percent of increase in imports during 1HFY17 while the public transport demand is piling up imports including buses, trucks and other heavy vehicles, which contributed one fifth in rise of import bill in 1HFY17. The POL-related import bill growth was in the green for the first time during 2QFY17 since 1QFY15. And it's not prices that are making imports high; the consumption is going up – during 1HFY17, in quantum, HSD is up by 41 percent, motor spirit increased by 22 percent, and furnace oil grew by 24 percent.
It is pertinent to note that not all the machinery imports are being depicted in the import bill computed by SBP, which is based on the L/Cs data provided by commercial banks. On the other hand, PBS data records imports once the physical goods cross the border. There is always a gap – the last ten years' first-half average import gap between PBS and SBP is $1.5 billion while it was $3 billion in 1HFY17. The widened gap is probably attributed to CPEC-related imports as bulk of machinery imports are being financed by outside the banking channel of Pakistan. SBP has asked banks to revise their reporting of imports to SBP, and once that happens, the figures of both imports and loans/FDI in SBP's balance of payments may be revised up. However, overall balance of payment situation will remain unchanged.
Anyways, the domestic production is simply not enough to cater to the rising demand and hence there’s no stopping imports growth. On the flip side, exports receipts are not picking up. But it's encouraging to note that within the better performance of high value-added textile exports, the quantity is growing while the pricing remains depressed. This implies that recovery in international cotton prices has yet to translate to high unit values of Pakistan's exports.
The bottom line is that current account is slipping lately and it is concerning. The simple equation is the more the economy grows or expands, the higher is the current account deficit, given the remittances are not matching the pace. This is the cost the economy is paying for heating up.
The reliance of balance of payment funding is on the borrowing, as the both FDI and portfolio investment remains low. SBP argues that it’s due to the global environment, which is not conducive for portfolio investment and it declined not just in Pakistan, but the phenomenon is true for many other emerging economies. This was in anticipation of US fed rate hikes and it may continue. In case of FDI, global merger and acquisition activities picked up as global M&A grew up by 67 percent to $721 billion since 2015. Pakistan seems to have missed the bus; but SBP is confident that we are coming on track as in the last quarter two deals in food processing and electronics broke and there are some negotiations going on in pharma, automobile, and power. Let's see how much truth is in SBP's optimism.
In the absence, the commercial and capital markets borrowings are left for balancing foreign outflows. Pakistan bond yields have improved in the international market – credit default swap stood at 368 bps in January 2017 from its peak of 1,219 in 2011. All the government bonds are trading at much discount to their respective yields at the issue. The country's ratings have notched up; but still in junk.
Does this mean Ishaq Dar’s philosophy of external borrowing to keep reserves growth intact is the right strategy? The argument is that nominal GDP is growing fast and increase in foreign debt can still keep debt-to-GDP ratio sane. This may not be sustainable, and with the US becoming a safe haven for investors, the yields of emerging economies’ bonds may start moving up, and debt may become costlier.
The fiscal deficit is getting higher lately as in 1HFY17 the primary balance was in deficit while it was positive in 1HFY16. This implies debt servicing ought to be financed by debt and that is no good. However, the inflow of CSF ($550mn) in the third quarter is encouraging both for fiscal and current account balance. But it's not enough and given the uncertainty in Pak-US relations, the need is to not bank on CSF flows.
What the SBP report did not highlight is the danger of the twin deficit, both fiscal and current account. And with economic activities picking up, based on consumer and government demand, the twin deficits ought to grow more, and the elephant in the room is CAD which has to be addressed either by currency adjustment or by tight monetary policy. Cash incentive to exporters or cash margins requirements for non-essential imports are simply not enough.
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