Economy blues

The Asian Development Bank (ADB) reports on Pakistan, as well as the SBP's quarterly reports, paint progressively more dismal pictures of the economy. As per the latest version of these reports, things may not improve even in FY12 - the fourth year in office of the incumbent regime; its promise to do things to justify its return to power for another term is a ploy; given its performance, the regime knows that this is its last term.
The key indicator of the regime's governance is the fall in GDP growth during FY08-11; growth could average 2.9 percent or less if it drops below 2.5 percent in FY11. The Governor SBP, however, expects it to be close to 2.8 percent although the FY11 would be the fourth consecutive year of decline in investment in large-scale manufacturing (15.4 percent until FY10) and electricity and gas (11 percent until FY10).
According to the ADB, energy shortfalls retarded real growth by "at least 2 percentage points annually". Indeed, the energy deficit is not reversible quickly, but the regrettable part is the corruption-prone strategy adopted to plug the gap, which was stalled by court action due to its visible long-term adverse economic impact. Consequently, the unplugged supply gap is retarding every sector, which the regime tactlessly seems reconciled to.
The SBP quarterly report too accepts that acute energy shortage and the prevailing political uncertainty have "hampered" productivity, but as summer approaches, power shortages are likely to worsen even though gas supply could improve as its usage for heating eases. However, continuing supply cuts belie that hope, which is forcing industry closure, especially in the Punjab.
In addition thereto, inflation - likely to stay at 16 percent during FY11 - is reducing the propensity to save. The quarterly SBP report admits that "the link between SBP financing and unadministered prices [courtesy unregulated markets] is becoming more visible. Unless, monetary policy can credibly limit government borrowing from the SBP, it would be difficult to change inflationary expectations".
Not surprisingly therefore, the ADB's Country Director for Pakistan believes that poverty levels will rise, while subsidies on energy, and support for the mismanaged SOEs may far exceed the fiscal space needed for investing in physical and social infrastructures. Even for repairs to the damaged river embankments the Supreme Court (not the state) had to set a deadline.
The key observation of ADB's Country Director was the "inter-link" between the political and economic realities - a covert reference to sustained bad governance. Although enhancing productive capacity is imperative for diversifying the higher value-adding industrial base (for import substitution and increasing exports) the collapsing physical infrastructure continues to impede its growth.
During 2010, the ADB disbursements ($799 million against projected $683.28 million) didn't help much because of low growth in tax revenue compared to the rise in expenses. For example, the ADB has revised its earlier (suspect) estimate of the damage caused by the floods from $7.8 billion to $10 billion, expenses on security are rising, and repayments to the IMF too will commence in 2012.
Agencies like the ADB were deceived by a tax revenue target that implied 26 percent rise in tax receipts - well over the 5-year average of 14 percent. Meeting that target is nowhere in sight because precious time was lost in flawed attempts at imposing the RGST, half-hearted attempts at expanding the tax net, and lame excuses for not taxing the agriculture and other sectors with visible ability to pay.
The SBP report admits that increasing the tax base is "the toughest structural reform to implement, and one that needs the greatest political will" but the Governor SBP is worried by a "structural shift" towards untaxed sectors. Given this shift, the tax-to-GDP ratio is destined to fall further. This trend makes you wonder about the real intentions of the regime.
The current account deficit - currently 0.5 percent of GDP - will rise to 1.7 percent by end of FY11, and to 2.3 percent of the GDP in FY12; its current low level owes itself to higher world prices for cotton and rice exports. While higher crops in 2011 may permit higher cotton and rice exports, Pakistan will again miss the chance to export value-added textiles and garments due to power shortages.
The oil price for July-February FY11 averaged $84 a barrel raising the oil import bill to $7.2 billion - 15 percent up over July-February FY10. If oil price shoots to $150 a barrel, the import price could average $120 a barrel for the whole of FY11 and the import bill could be $14 billion - a $4 billion jump over FY10. Therefore, the SBP as well as independent analysts predict a tough scenario for the rest of FY11.
At the end of FY10, the energy-related circular debt amounted to Rs 446 billion; given the on-going rise in oil prices, by end of FY11 it could only expand. Based thereon, while ADB estimates the FY11 fiscal deficit to reach 5.5 percent of the GDP, the SBP places it close to 6 percent or in the Rs 960 billion to 1 trillion range, which could lead to even higher bank borrowing.
The SBP admits that the recent rise in NPLs on lending to the private sector will encourage banks to finance public debt to lower their risk and capital adequacy requirements, but regrets that it would amount to banks giving up their financial intermediary role, which isn't a good omen for economic growth and increasing employment - the key factors retarding GDP growth since FY08.
The banking sector was deregulated too much too soon. So, to contain this trend the SBP must impose regulatory obligations for adequate credit supply to key sectors like import-substitute manufacturing, textiles, sports goods, food processing, power and energy (especially the emerging solar and wind sectors) to achieve real growth in employment and exports, and cut imports and external deficit.
The ADB has rightly pointed out that (to attract domestic and foreign investment) bolstering confidence in Pakistan's economic prospects depends on quick implementation of transparent [and equitable] fiscal reforms and a development strategy focused on increasing efficiencies to create an environment conducive for business and industry, and job creation.
Hopefully, the FBR and the Ministry of Finance see the urgency of achieving this aim, and can goad the provinces into taxing agriculture and untaxed entities in the services sector besides improving tax collection. All they need is to impose fair taxes in consultation with stakeholders, devise fool-proof systems for determining and collecting taxes, and hold the collectors responsible for producing results - all of it achievable with honesty of purpose.