Q2FY17: SBP report

There is an obvious disconnect between the recently released quarterly State Bank of Pakistan's prognosis on the state of the economy and the statistical data and accompanying analysis. The report begins with the following statement: "the overall economic environment continues to remain conducive to growth. An accommodative monetary policy stance; increase in development spending; substantial growth in private sector credit, especially for fixed investment, and ongoing CPEC inspired activity in the power sector and infrastructure are providing the needed support."
The SBP's contention that the economic environment remains conducive to growth can be challenged on three counts. First, the growth in Large-Scale Manufacturing LSM was sugar-specific (sugar accounts for only 3.5 percent of LSM) and while it witnessed a negative growth of 14.2 percent in the first six months of 2016 its growth was positive 52.4 percent in the comparable period of 2017. LSM growth, excluding sugar, rose by 4.4 percent in the first six months of 2016 and by only 2.6 percent in 2017 or there was a decline in LSM growth. In addition, the report claims that growth in steel industry, accounting for 5.4 percent in the calculation of LSM growth, was negative 8.6 percent in the first six months of 2016 but showed a 15.6 percent growth in the comparable period of the current fiscal year. Textiles, the largest contributor to growth of LSM (21 percent) and to exports, grew by 1 percent in July-December 2016 and only 0.1 percent in the comparable period of 2017. The report maintains that further growth of industries that form a component of LSM would require capacity expansions as they have achieved capacity utilisation.
Agriculture growth is projected for wheat alone - from 25,516,000 tons three-year average to 26,000,000 tons in 2017 but this would require an increase in the yield per hectare in all provinces excepting Balochistan where a decline is estimated from 2,344-kg per hectare as a three-year average to 2250-kg per hectare; and in spite of a decline in area under cultivation in Punjab and Khyber Pakhtunkhwa.
Secondly, repeated claims by federal ministers that China has emerged as the major source of investment were challenged in the SBP report. The energy sector, considered to be the major recipient of Chinese investment under the China Pakistan Economic Corridor (CPEC) witnessed a shift from long-term loans (which are at a lower rate of interest) - the report classified them as fixed investments - towards "short-term (working capital) borrowing." In addition, "inflows from China dropped 54 percent to $204 million; a corresponding decline of 53.8 percent was noted in foreign investment flowing into the power sector (which amounted to $211 million). The decline in Chinese investment so far this fiscal year is somewhat intriguing as it does not seem to resonate with the extent of visible on the ground CPEC-related activities in the country."
Thirdly, the report notes that "unfunded debt, comprising of national saving schemes continued to slide in the first half of 2017 as returns offered on most of the instruments remained relatively lower than in previous years". The decline was nearly 18 percent between the first half of the current year compared to the first half of the year before - 338 billion rupees from 412 billion rupees. With investment from China, the game changer, declining as well as domestic savings reliance on short-term borrowing - both from domestic and external sources - has risen dramatically.
The report points out that despite a higher fiscal deficit, the pace of public debt accumulation slowed down in the first half of the current year. The decline in external debt was mainly due to revaluation gains. The SBP report claims that "after depreciating 0.9 percent during the first six months of FY16 the rupee appreciated by 4.4 percent during July-November 2016 in real terms." Be that as it may, there is sufficient evidence to show that with the rise in dollar in December 2016 and January 2017 and the subsequent rupee appreciation nonetheless, the rupee remained significantly overvalued precisely to show a lower external debt. In November last year, the difference between the real effective exchange rate and the prevailing average monthly market rate was a whopping 21.29 rupees per dollar. Domestic debt increased by 566.7 billion rupees in the first half of 2017, lower than the accumulation of 687.1 billion rupees in the same period of last year due to net retirement of long-term debt during the period.
Higher private sector credit taken to indicate higher private sector activity is challenged within the report by the statement "the increase in credit was evident in both working capital and fixed investment categories, and originated primarily from conventional banks. The increase was particularly strong in the last week of December, when banks reported to have lent out 229.9 billion rupees to the private sector. However, the caveat came in the first week of January when 111.5 billion rupees was subsequently retired." This belies Finance Ministry's repeated claim backed by Pakistan Bureau of Statistics (PBS) that machinery imports are on the rise which, in turn, would fuel growth. Not cited in the report but a factor that may well account for a rise in private sector credit nonetheless, a factor that has been consistently been cited as a reason for the decline in exports, was the rise in refunds considered the outcome of a deliberate decision on the part of the administrative ministry, notably the Ministry of Finance, to show a revenue higher than is in fact the case to understate the budget deficit.
The report also notes that "usually for any period import data recorded by PBS tends to be higher than that available with SBP: the 10-year average difference between the two (for July-December is $1.6 billion). However, the difference has widened considerably from FY15 onwards and touched an unprecedented $3 billion in July-December FY17."
And finally, most disturbing are the trends that continue into the final quarter of the current year, notably (i) declining exports (attributed to high refunds and an overvalued rupee - factors unlikely to be overcome by the recently announced export promotion package envisaging zero rating or lower taxes and ease of credit procurement), (ii) rising imports that are not machinery-based, (iii) lower remittances due to external factors, (iv) rising current expenditure relative to development expenditure, and (v) failure to reform the tax system to render it more equitable. The government has so far accused of relying on data manipulation to show a state of the economy that is repeatedly being challenged by independent economists premised on the blatant lack of government and industry-sourced data rationalisation by PBS. One can only hope that the government takes appropriate mitigating measures in the budget 2017-18 to arrest the negative trends but that would require realistic macroeconomic data compilation.