Distressing trends

The opportunity of mid-course economic correction provided by the second mini-budget was missed. Accordingly, it seems no significant corrective measures will be witnessed until the next budget in June. What then would be the likely shape of key economic variables at the close of the fiscal year?

The Monetary Policy Committee (MPC) of the State Bank of Pakistan met on January 31, 2019 and decided to continue tightening monetary policy by increasing the policy rate by another 25 basis points (bps) to 10.25 percent. Since January 2018, the MPC has increased the policy rate 450 bps. This is a modest increase signalling the central bank’s assessment that stresses facing the economy remain persistent.

In the monetary policy statement, after expressing some satisfaction on the effects of corrective measures, the MPC noted: “However, challenges to Pakistan’s economy persist: (a) despite narrowing, the current account deficit remains high; (b) fiscal deficit is elevated; and (c) core inflation is persistently high. This situation calls for continued consolidation efforts”.

The bank should have further pointed out that foreign reserves are also continuing to fall, despite intermittent injections from friendly countries. This is the lifeline of the economy and its continued bleeding is an unmistakeable sign that economic instability is obstinate. Notwithstanding the advice of the MPC, no consolidation efforts are on the cards. Under the circumstances, it would be useful to analyse where the key variables are headed.

After jumping to 6.8 percent in October, the year-over-year (YoY) inflation has slowed down to 6.2 percent in January, thanks mainly to the decline in international oil prices and the government’s failure to recover applicable taxes on petroleum products. But the greater role in this slowdown has been played by food inflation (with a share of 27 percent), which was less than one percent.

Non-food inflation (with a share of 63 percent) was 9.8 percent for the second consecutive year. It has persisted for a long time and seeped into core inflation (non-food, non-energy), which was recorded at 8.3 percent and has been rising uninterruptedly for more than a year.

The average inflation during July-January was recorded at six percent, well above the 3.8 percent recorded for the same period last year. Even more concerning is the double-digit inflation in the wholesale price index (WPI), which was recorded at 11.6 percent and has also been rising.

The upshot of the above review is that inflation looks all set to hit double-digits, even with the low oil prices, as a host of other factors are impacting its rising trend. In fact, the rate is vulnerable to food supplies and any disruption in supplies would exert a significant effect on inflation.

The factor that is most threatening is money supply. The monetisation of the fiscal deficit has never been as pervasive as it has been in the last two years. In 2017-2018, 50 percent of the deficit was financed by borrowing from the central bank (printing money). During 2018-2019, up to January 25, the SBP has provided Rs3.781 trillion in deficit-financing, out of which Rs3 trillion were the divestment (substitution) of commercial bank lending (part of which were borrowed from the SBP). This gives a net funding for a fiscal deficit of at least Rs781 billion from the central bank.

The outstanding stock of government borrowings from the central bank has risen to an unprecedented level of Rs7.3 trillion, a five-fold increase from Rs1.4 trillion as on June 30, 2016. This massive increase in high-powered money may have already started impacting inflation, as we noted above. But the relationship between money supply and inflation has a lagged effect so the increased stock will continue to exert pressure on prices in the coming years. Double-digit inflation would most likely become a norm, barring the stable supplies of food that help temper overall inflation.

Inflation affects economic growth and the process has, in all likelihood, already started. All international agencies, as well as the SBP, have lowered their growth forecast from 6.2 percent to less than four percent for the current year. Large-scale manufacturing growth is negative while agriculture would not meet most of its crop targets.

The factor that is really responsible for economic disruption is the fiscal deficit. Here, things look precarious. On the revenue side, the data for July-January is disappointing, with tax revenues showing a growth rate of only 3.5 percent as opposed to the required growth of 14.5 percent. The tax gap during the year looks all set to exceed Rs350 billion, close to one percent of GDP. Mercifully, starting this January, the government has decided to recover full taxes from petroleum products.

The February price adjustment was also sensible as the recommended decreases in prices were not allowed and instead recouped to make up for some of the tax shortfall in the first half. The loss of revenue from telecom taxes (Rs125 billion) has to be plugged by approaching the Supreme Court and requesting a review of its earlier decision to suspend these taxes, of course by incorporating whatever reforms the court would recommend.

On the expenditure side, things are no less precarious. The single most pronounced expenditure that is out of line with the budget is debt-servicing. The policy rate increase of 375 bps by the new government will cost more than Rs900 billion in additional debt-servicing, which was only partially accounted for in the first mini- budget.

The growth in public debt during July-November at Rs2.2 trillion is about 10 percent, which is unprecedented. This comprises Rs1.2 trillion in exchange-rate loss on existing external debts and Rs1 trillion in deficit-financing. At this level of deficit in five months, the year-end deficit would be Rs2.4 trillion or 6.0 percent of GDP. Chances are that it would be significantly higher as no corrective measures are planned.

The balance of payments is facing equally intense pressure as it did last year. In six months, there was a marginal decrease in the current account deficit, thanks entirely to an exceptional increase in remittances. With regard to its main elements, exports were flat and imports were up three percent, leading to an increase of five percent in trade deficit. At this rate, it

is again heading for a repeat of last year.

The malaise described above cannot be cured through friendly help. It is a temporary fix, not a solution. With each passing day, the need for economic correction is intensifying and so is the pain for when the final adjustment would be made.

The writer is a former finance secretary.

Email: waqarmkn@gmail.com