Each time we think of economic growth, the general perception that pops up is that government needs to do something to mend the weakening economy. The idea though is not so wrong. The government does play a significant role, however, in an ideal case; its jurisdiction should be limited to playing an indirect role.
The government can chip in the economic amelioration by enhancing the quality of human capital, encouraging public participation in the development process, financing public services, increasing equality of opportunities, improving law and order backdrop etc.
Keeping aside the states role, the other crucial factor without whose participation, wondering growth seems like chewing the cud, is the private sector. Not only does it support the economic activity by buttressing GDP growth, creating employment opportunities and enhancing foreign trade, the private sector generates the revenues that governments need to expand access to health, education and infrastructure services and thus contributes a great deal to economic productivity.
Keeping in view the magnitude of private sectors importance, whereas, most of the developing nations are taking significant moves to strengthen their private sector; Pakistan is portraying an upsetting picture.
Pakistan economy is fluttering on the plateaus of high inflation and low growth. Although the average CPI stayed within the targeted perimeter of 12 percent during FY12, however, the key reason for the decline in CPI was collapse in real private investment, signifying a structurally frail economy.
For the fourth successive year in the string, the private investment in Pakistan contracted miserably, while total investment, as a percentage of GDP, fell to 12.5 percent in FY12, which does not bode well for future.
The major factor that drives private investment is the flow of credit to the private sector which stood at Rs 235.2 billion in FY12.
Although this is the highest net flow of credit to the private sector since FY08, and depicts a YoY growth of 7.5 percent, however, an in-depth analysis reveals that a huge portion (Rs 121 billion) of private sector credit was availed by NBFCs while the credit to businesses stood at a skimpy Rs18.3 billion, which touts a drastic YoY decline of 89 percent.
The difference between total private sector credit and credit to the private sector businesses has been about Rs30 billion since FY08. However, in FY12, it surged to a record high stratum of Rs217 billion.
The key factor contributing to a muted growth in the private sector credit is the excessive government borrowing from the banks. With fragile fiscal fundaments being the key reason to moan, the risk free government securities have given banks an alternative source of investment with embedded advantage on their Capital Adequacy Requirements (CAR), leaving them with a little incentive to extend finances to the private sector.
If we look at the flip side of the picture, not only does the banking sector hesitates in financing the private sector activities, amid crippling power shortages, poor security situations and uncertain law & order position, private sector businesses are avoiding huge commitments in terms of capacity enhancements and fixed investments and thus crave for little credit.
The repercussion of weak private sector growth is evident by the fact that exports dropped by 2.8 percent while import payments grew by 11.6 percent during FY12. Moreover, the aversion of foreign private investors illustrated by 50 percent YoY decline in FDI in FY12 also roars for some grave reforms.
Towards, the solution side, the private sector will not revive until structural issues particularly energy crisis is resolved. Thus, to perk up economic growth, an endogenous reform should be undertaken that focuses on improving infrastructure, productivity, and governance.
On the financial side, the governments fiscal indolence comes as an enormous cost to the economy in terms of financial stability and private sector credit flows. The probable way out here could be amending tax collection policies and development of a well-organized corporate debt market.