World Bank update

The Development Update of Pakistan has been released recently by the World Bank. The Bank has been the largest and trusted development partner of Pakistan. It has acted as the primary source of concessional funding for development projects and policy reforms. The relationship goes back to the extraordinary role of the Bank in the finalization of the Indus Waters Treaty and support for the construction/expansion of the Tarbela dam.
Therefore, there is need to take the Bank's advice very seriously and respond appropriately. The fundamental message of the Development Update is that today Pakistan faces major risks to sustained growth. These risks pose a big threat to the attainment of all the major targets set in the Annual Plan for 2017-18 by the National Economic Council (NEC), chaired by the Prime Minister.
The risks are manifested largely, according to the Bank, in the burgeoning current account and fiscal deficits. The former has gone up from 1.7 percent of the GDP in 2015-16 to 4.1 percent of the GDP in 2016-17. Consequently, after having risen for three years continuously, foreign exchange reserves have started falling from October 2016 onwards. They have plummeted by 28 percent or in absolute terms by $ 5.2 billion, now providing barely three months import cover.
Simultaneously, the fiscal deficit has jumped up from 4.6 percent of the GDP in 2015-16 to 5.8 percent of the GDP in 2016-17. This has been due to loss of momentum in the growth of tax revenues and spiraling up of public expenditure, in the immediate aftermath of the end of the IMF program.
The World Bank clearly is of the view that unless stabilization of the economy takes place the process of growth will be jeopardized. A number of appropriate recommendations are made. Managing the current account deficit will require major reforms to substantially improve export competitiveness. In the short-run, the Bank emphasizes on the need to reduce the extent of overvaluation of the rupee. Actions on the fiscal front must include efforts at broadening the tax base, improving tax administration and enhancing taxpayer compliance.
An important observation made by the Bank is the link between public finances and the balance of payments. Large fiscal deficits push up aggregate demand and put pressure on imports. As such, there is need to reduce the investment-savings gap in order to bring down the trade deficit in goods and services.
Based on the above analysis and recommendations, the Bank makes a number of projections for 2017-18 and 2018-19 of key macroeconomic variables. Assumptions underlying these projections on the change in key policy parameters, like the exchange rate, tax rates, level of development spending, etc., are, however, not made explicit.
There are some apparent contradictions in the projections. Despite the identification of major risks to growth, the Bank projects that the GDP growth rate will continue to rise. Accordingly, from 5.3 percent in 2016-17 it is expected to go up to 5.7 percent in 2017-18 and further to 5.8 percent by 2018-19. This the Bank feels will happen even in the presence of a very high and growing fiscal deficit and, more or less, constant current account deficit as percent of the GDP up to 2018-19. These projections can be seen as not being consistent with the basic message in the Development Update.
A technical analysis of the projections reveals a number of problems. First, the Bank sees consumption spending as one of the key drivers of growth. For example, it highlights the dominant contribution to the above 5 percent growth in 2016-17 by the almost 9 percent increase in consumption expenditure. But the level of private consumption is not measured directly and behaviorally determined. It is the residual which equates the supply-and demand-side of the GDP.
The marginal propensity to consume was as high as 1.38 in 2016-17. This is beyond the realm of possibility. Actually, the supply side of the GDP was consciously overstated by the Bureau to yield a higher estimate of the growth rate. Consequently, the residual of private consumer expenditure was artificially large. A more realistic estimate of the GDP growth rate in 2016-17 is 4.4 percent, as highlighted in an earlier article in this newspaper. The Bank has projected that the overstated private consumption expenditure will grow further in 2017-18 by 4.8 percent. This implies that the GDP this year will again be overstated.
Second, based on the SBP projection of the GDP at market prices at $ 340 billion in 2017-18, the Bank's estimate of the current account deficit is close to $13.6 billion in 2017-18. This is $1.2 billion above the deficit in 2016-17. But already in the first quarter of 2017-18, the deficit has increased by $1.9 billion. Does the Bank expect that there will be a spectacular recovery in the balance of payments position in the remaining eight months of 2017-18? The latest projection by the IMF of the current account deficit in 2017-18 is significantly higher at $16.7 billion.
A corollary of the above mentioned projection is that the Bank expects the foreign exchange reserves of Pakistan to fall by $2.4 billion in 2017-18. They have already declined by $2.6 billion by 10th of November 2017.
Third, the Bank projects that the fiscal deficit will rise by approximately Rs 240 billion in 2017-18. However, bank borrowing alone is up by Rs 181 billion as of 3rd November. Here again, the Bank's estimate of the fiscal deficit appears to be on the low side.
Fourth, there is one variable where the Bank may have engaged in a degree of overstatement. This is the rate of inflation in the CPI. It is projected at 6 percent in 2016-17. In the first four months the average rate is only 3.5 percent. This implies that it will be over 7 percent on average monthly during the next eight months of 2016-17. This again is unlikely unless there is quantum depreciation in the exchange rate soon and/or there is a spike in oil prices.
Fifth, the Bank expects the financial and capital accounts of the balance of payments to yield a net inflow of as much as $11.2 billion in 2017-18. This will be higher by 9 percent over the level last year. There was a massive resort by Pakistan to high cost commercial borrowing of over $ 4.4 billion in 2016-17. Does the Bank expect Pakistan to do the same or more this year?
Sixth, and finally, it is too early to make formal projections for 2018-19. There are many economic and political uncertainties in the intervening period. In particular, if reserves fall more than anticipated by the Bank in 2017-18, then Pakistan may have to seek a program with IMF. As such, growth will have to be sacrificed once again at the altar of stabilization. A GDP growth rate close to 6 percent may become very elusive. However, we hope and pray that the Bank's optimism is validated and crisis mongers are proven wrong.
Overall, the message and the policy advice by the World Bank ought to be listened to. Unfortunately, the projections for 2016-17 and 2018-19 are not consistent with the message. This may have been motivated by the concern to soften the impact of any potential bad news. Perhaps the Bank may consider updating the projections, such that they are more closely linked to the trends witnessed already in the first four months of 2017-18 and reflect better the emerging ground realities.
(The author is Professor Emeritus and former Federal Minister)