Read, comprehend, and rectify

There is considerable food for thought for members in both the houses of parliament (National Assembly and Senate) as well as the federal government in the third quarterly report of State Bank of Pakistan (SBP). The opposition members need to hold the government of PML (N) accountable for a lacklustre growth in FY15. And, the government too should realise that it needs to undertake the necessary measures to promote growth - provided they care to read and respond to challenges by tackling the structural rigidities that are impeding economic growth and stifling job opportunities. Pakistan does not need the International Financing Agencies' (IFIs) help and advice. Our economists are good enough to carry out the required research and come up with solutions provided they have the time to study these problems and our decision-makers have the political will to tackle thorny problems afflicting the economy, namely the twin deficits. Our current account continues to be in deficit. And, we have failed to keep the fiscal deficit in check by raising the necessary revenues and curbing the current expenditure. SBP's report says that the fall in export earnings needs to be reversed and non-debt creating inflows enhanced with a view to financing the current account deficit instead of building up the liquid foreign exchange reserves with debt creating inflows. SBP describes the 12.7 percent rise in tax revenue as 'modest' and blames the rise in non-discretionary spending (interest on governmental debt) - squeezing the fiscal space for promotion of growth. And, SBP researchers feel that the inter-agency receivables - circular debt - is a formidable obstacle towards efficient functioning of the energy sector.
The central bank is not happy on reliance on livestock to show a boost in agriculture growth, as the crop sector grew by only one percent with important crops rising by only 0.3 percent as against eight percent in FY14. SBP rightly notes that the farm income recorded a sharp decline as prices of both rice and cotton plummeted in FY15. Further, the spillover effect of sugarcane is visible in the manufacturing sector with Large Scale Manufacturing (LSM) growing by only 2.5 percent during July to March 2015 against a target of seven percent for the year and a 4.6 percent growth in corresponding period of FY14. Within LSM, automobiles and construction-related industry performed better than they did the previous year. There was a rise in car sales due to introduction of new models and Punjab government's Apna Rozgar Scheme initiative. SBP also feels forward and backward linkages in construction activity lend promise of a healthy growth and it will help in future. The strong performance of the services sector, SBP states, was primary due to a rise in government salaries and pensions and high investment by banks in government bonds. Wholesale and retail sector's growth was relatively lower and transport while communication sector's growth was clouded by cellular companies' focus on SIM verification and the central bank hoped that mobile companies' growth will rebound in FY16 due to issuance of 3G/4G licences.
Bank credit to the private sector was nearly halved. It was only 5.5 percent against 10 percent last year; it was basically due to softening of commodity prices such as cotton, POL, rice, edible oil as well as healthy corporate profits requiring lower working capital borrowings. Because of a significant drop in inflation and lower growth of reserve money, SBP in FY15 eased its monetary stance further and narrowed its interest rate corridor to 200 from 250 basis points with a commitment that money market rate will be close to its rate of 6.5 percent. However, SBP is worried on account of slight higher borrowing for budgetary financing in FY15 over FY14. A massive rise in interest payments to 40 percent of current expenditure is a source of concern. The SBP is of the view that the rise of 7.2 percent in FY15 in borrowing, after a 17.7 percent rise in July-March FY14, was because of non-discretionary spending. The federal government continues to honour contingent liabilities (sovereign guarantees) issued to banks to support Public Sector Enterprises (PSEs), which continue to bleed the federal budget. Liquid foreign currency reserves of SBP itself were recorded at 13.6 billion dollars on account of better loan disbursements (dollar 3.8 billion in FY15 compared to dollar 2.3 billion in FY14) from IFIs and higher inflows of Coalition Support Fund (CSF) - dollar 1.1452 billion compared to dollar 675 million in FY14. The favourable impact of lower oil bill was largely offset by non-oil imports of metal products, machinery and auto parts and other raw materials. However the export fall remained a cause of concern due to concentration of Pak exports to the EU and the US. SBP says Pakistani textile exporters failed to capture the fall in Bangladesh garment exports to the US (which fell on account of labour-related difficulties) but China and India did. Lowering of FDI was seriously noted as it came down to dollar 709 million last year compared to dollar 1600 million in FY14 and was a partly dollar 100 million in June of 2015 which is reflective of the poor performance of Miftah Ismail-led Board of Investment (BoI), Islamabad.
The SBP analysis shows that depreciating the PKR will not provide for higher exports. And, the country needs instead a more effective trade policy coupled with a comprehensive industrial policy. We are required to add an efficient labour policy to this since without training and upgradation of skills higher productivity will never be achieved. The complex relations in the import substitution industries between raw material and machinery need to be studied critically. It needs to be understood that merely having a competitive exchange rate to overcome structural issues may not work. Moreover, it is absolutely essential to distinguish between devaluation and depreciation of PKR. We feel, however, the exchange rate depreciation in small spurts effected by market forces could be a better solution than a massive devaluation. One must not lose sight of the fact that a devaluation is when a country makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate. Technically, therefore, a devolution is only possible if a country is a member of some fixed exchange rate policy. And REER's basket of currencies is now less relevant, however, inflationary differential between Pakistan and the dollar denominated area would need still to be taken into account to adjust PKR and keep exports on an even keel. SBP has rightly pointed out that the government, thus far, has been unable to sell any bleeding PSE or achieve a shift in management control of a major PSE. SBP says divesting shares in profitable financial institutions (UBL, ABL and HBL) are capital market transactions and until sell-off of loss-making entities or of energy-related PSEs these units would continue to remain a burden on the exchequer. Further, a low tax-to-GDP ratio remains a recurring problem. SBP rightly advocates in its Third Quarterly Report on the state of the economy: improvement in property rights, effective contract improvement, as well as accountability and provision of justice are a "must to improve tax collection". Will anyone reading it take some remedial steps in this regard?