The SBP’s nine month report reflects virtually all the good things happening with the economy. The not-so-good ones, though, are not fully reflected in the document. Highest growth in ten years and controlled inflation are highlights of the brighter side. The worrisome part is the slippage in current account which has magnified in the last quarter and is not fully reflected in the SBP release.
The economic growth is driven by recovery in agriculture, LSM, construction, and services sectors. There is significant government support, as per the SBP, which has put the economy on the high growth trajectory. “Price subsidy on fertilizer, and affordable access to credit facilities (owing to decades low policy rate) resulted in the important crop segment posting a growth of 4.1 percent”, stated the central bank. The other factors of growth noted by the SBP are better supply of energy, increased development spending, supportive monetary policy, and improved law and order.
It is true that government’s direct fiscal and indirect policy support, apart from upbeat consumer demand, have played a vital role in spurring growth. The question is on sustainability and possible repercussions of running expansionary polices? The fiscal spending ought to get tight post 2018 elections, this coupled with burgeoning external imbalances would adversely impact inflation, currency parity and may halt high growth momentum.
The highest growth in major crop is in sugarcane, and sugar, and its products are the highlights in the industrial growth. However, the bumper crop has been mismanaged and an opportunity of generating exporting surplus has been lost. There is supply glut in sugar. And in case of wheat, prices are unfavourable for export.
The other areas of growth are pharmaceuticals, electronics and steel. The rising consumerism and low base (decline in FY16 by 5.3%) resulted in high growth (15.3%) in electronics (mainly white goods); the growth may normalize in a year or two. In case of pharmaceuticals, the increased spending by government on health (products like Rotavirus in Punjab) and drug pricing policy helped the industry grow. The sector grew by 8.7 percent after posting 6.8 percent growth in the previous year.
The performance of steel is due to growing development spending and protection - after contraction of 7.5 percent in FY16, the sector is up by 16.6 percent in FY17. Favourable policies (anti-dumping duty ranges from 6-40.5 percent on import since Feb17) and 27 percent rise in international prices during Oct-March explain high growth from a low base. The industry is in expansionary phase and growth momentum would continue in FY18.
Apart from these, most manufacturing sectors under-performed and those which were the pick of FY16 remained subdued in FY17. For example, fertilizer, automobile and electricity generation were too low in FY15 and were supported by government policies and subsidies (Apna rozgar scheme, availability of gas for urea etc).
Due to the low growth era of FY09-14, there were gaps in various sectors and most of them have now been filled by government support in one way or the other. Growth momentum is hinged on domestic demand and expansion in private sector. Macroeconomic risks are emerging at the same time to challenge the growth thesis.
Both the fiscal and external accounts are showing concerns. In terms of monetary assets, M2 growth is encouraging, with multiplier working as reserves money growth is less than broad money. But there are caveats still. All the growth is emanating from domestic assets while net foreign assets are in red. The deteriorating NFA to NDA ratio is inflationary in nature.
Within NDA, although, government budgetary borrowing increased marginally (Rs695bn in Jul-Mar17 versus Rs538bn Jul-Mar16), the pie is growing at higher pace (Rs1050bn in Jul-Mar17 versus Rs594bn Jul-Mar16) which has created space for non-government borrowing. The private sector credit increased by 35 percent to Rs438 billion, but the more significant jump is in credit to PSEs from mere Rs12 billion to Rs197 billion in Jul-Mar17.
It’s a subtle point, that although direct fiscal borrowing from banking system is on a decline, the quasi fiscal operation is taking the share. “...Sharp increase in credit to PSEs (especially energy-related).This can be traced to the re-emergence of circular debt, which apparently tightened liquidity conditions in the entire energy supply-chain”, lamented the central bank.
One problem not mentioned by the SBP is that once all the new power plants are online, there would a supply glut and capacity payments have to be extended to IPPs with or without electricity generation. The circular debt problem may escalate further and credit to PSEs would continue to be high. Thus, quasi fiscal operations could well crowd out the private credit.
And within direct fiscal borrowing, which is currently shifted towards central bank borrowing, the onus sooner or later will revert to commercial banks. The fiscal deficit would likely miss target in FY18 and the fiscal financing problem may resurface again. The interest rates may go up by that time as well. The pattern of commercial bank borrowing suggests that interest rates have bottomed out as they are primarily investing in short term papers, as PIBs are a hard sell at the moment.
It is all manageable; given external balances do not go out of hand. Unfortunately, external account is shaking. The equation is simple – the more the economy grows to meet domestic demand, higher would be the current account deficit. Right now, the expansion in power sector, cement, steel and other sectors is driving import demand and once the expansion cycle is completed, the import of fuel and raw materials would take the lead.
Virtually all the expansion, despite some incentives for textile machinery imports, seems to be for domestic market. It is simple economics - the returns in industries catering to domestic demand are high as most industries have protections. In case of exports, our exporters have failed to match regional efficiencies.
Bottom line is that economy would grow at even higher pace in FY18 and trade deficit would grow in tandem. What will fill the foreign exchange gap? It could be remittances to some extent, if the theory of whitening tax evaded money earned from domestic economy sent abroad through grey channels and getting back by official remittances route is true.
The FDI is hard to pick without the due currency depreciation as anyone interested in spending in Pakistan would wait for the currency to correct. Most of the gap is left for debt/donor based flows to fill. In Jul-March17, $1 billion was raised from Sukuk, $850 million from ADB, around $1 billion from Chinese project loans and $1.3 billion from short and long term commercial loans.
The practice continues in the fourth quarter as well; as to cover CAD of $2.8 billion in April-May, loans of $1.4 billion have been received in May17 out of which $1 billion is from China Development Bank. This is followed by $728 billion by ADB and WB in June. FY18 would be no different as CAD is expected to be north of $10 billion. Dar does not mind loans it seems.
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