Beware of the twin deficits

In matters economic, one good year isn’t necessarily followed by a better year. The story of 5.3 percent GDP growth in FY17 has been repeated enough. There was a confluence of factors: growth in agriculture and services sector, a visible up tick in private sector credit, tamed inflation, high infrastructure spending, low interest rates, and better security. Central bank’s latest economic pulse validates these factors.

Now the target is to have a GDP growth of 6 percent in FY18. The target is predicated on a turnaround in exports, smaller growth in imports, controlled inflation, improving electricity supplies, continued availability of international financing, continued infrastructure spending, industrial expansion, etc.

Except that it may not turn out that way. The twin deficits are rearing their head at an inopportune time. Both the current account deficit (CAD) and the fiscal deficit may turn loose this fiscal, FY18, which is most likely an election year.

Due to double-digit import growth, sagging exports and subdued remittances, CAD came at roughly $9 billion – or 3.2 percent of GDP – in Jul-May FY17, a figure that is 2.8 times the CAD reported in the year-ago period. Trade deficit in goods and services reached a whopping $25.4 billion in this period. That deficit could not be financed entirely by hitherto-savior remittances and other secondary income sources. This external account imbalance wiped out roughly $2 billion from SBP’s net forex reserves in FY17.

Over on the government side, fiscal deficit stood at 3.9 percent of GDP in Jul-Mar FY17, up from 3.5 percent in the year-ago period. On the expenditure side, the government increased development expenditures while current expenditures’ growth remained in check due to lower interest payments in FY17. The federal government is running a record Rs1 trillion PSDP programme for the new fiscal.

But the revenue side is not responding. FBR’s tax collection grew just 8 percent in 9MFY17, a growth rate markedly lower than seen in 9MFY16, as per the SBP report. Already, the FBR has reportedly fallen short of meeting its FY17 revenue target, by Rs250 billion. Taxmen have been given a collection target of 14 percent in FY18. In that backdrop, the FY18 fiscal deficit target of 4.1 percent of GDP seems unrealistic.

The report doesn’t highlight political concerns, but it is evident that the country’s political stability is under increasing threat. The fate of Nawaz government is uncertain. Even in the case the ruling party scrapes through the Panama probe, an election will most likely befall FY18. That doesn’t bode well for the fiscal deficit target. But more worrying is the situation on the external front. Historically, political transitions have tested Pakistan’s macroeconomic stability. And already, external account is emitting a lot of smoke. The illustration shows a spike in the twin deficits in FY08, when CAD and fiscal deficit ran amok that year as a result of populist economic management, a messy political transition, and external shocks.

Pakistan is surely on a growth momentum. And higher imports of machinery, materials, equipments, etc are important to keep the growth engines running. But growth is at risk if CAD worsened in FY18 the way it did in FY17 and caused more depletion of forex reserves. Sure, non-debt creating inflows must pick up. But as such, there is a low likelihood of an export turnaround and healthy remittance growth in the short term. CSF inflows also seem at risk of completely drying up if Trump administration indeed got tough.

In this environment, more than just running to the Chinese for BoP support, it is important to have a deliberate and responsible political transition, which seems inevitable this fiscal. The SBP didn’t say as much. Yet it pointed out, “continuity and consistency in policies, especially those related to investment and industry would be necessary to ensure sustainability of the growth momentum.”