The economy reality check

What is the state of the economy? Most ordinary people, media commentators etc are quite despondent about its present condition and future prospects.

Government circles, on the other hand, are carrying a different view – expressing satisfaction and showing optimism for a turn-around already taking hold. We now have the data for the first quarter of the fiscal year and therefore an informed discussion is possible.

Briefly, the government view is that the economy has been stabilized and an economic turnaround has taken place. The key indicators cited in support of this assertion are the declining current account deficit (CAD), rising foreign investment, declining fiscal deficit, increased remittances, rise in the stock market, stable exchange rate and rising reserves.

Many of the above indicators are indeed moving in the right direction though many are quoted on an inconsistent basis, such as the rise of 17 percent in remittances , which happened in the month of September but there is a small decrease in the Jul-Sep quarter. In our view, however, the more fundamental question is whether these indicators, together with those not cited by the government, are pointing to an overall revival of the economy or whether the risk of recession is increasing.

Let us point out what may be wrong with the government’s interpretation of results. For instance, the CAD is almost entirely on account of decreased imports, which fell from $14.3 billion to $11.0 billion, a reduction of about $3.3 billion, which is nearly the amount by which the trade account has been reduced. This is because exports have increased only by a paltry $140 million. More importantly, the CAD is down by $2.7 billion, which means on the services and income accounts there was a higher deficit of about $600 million. Three notable items were: (i) increase in services deficit ($127 million); (ii) primary income (interest, profits etc) deficit ($362 million); and (iii) fall in workers’ remittances ($79 million).

What the state of CAD, therefore, conveys to us is that it improved exclusively at the expense of cutting imports (demand) without expanding exports (supply) in any significant measure. One positive development is that the reserves have stopped falling.

But curiously, the improvement here is not equivalent to improvement in the overall BOP, despite a hefty upfront disbursement of $1 billion by the IMF in July, net incurrence of liabilities of $1.1 billion and arrival of $375 million in portfolio investment. Compared to $7,280 million as on June 30, 2019, the reserves increased to $7,937 million as on September 30, 2019, showing an increase of only $657. It is clear that enough flows have not arrived on the financial account to beef up reserves.

The foreign investment of $375 million is in the form of treasury bills (TBs), which is a domestic security. As on Oct 18, 2019, investment in TBs by foreign investors was reported at Rs59.1 billion. Curiously, there is negligible investment in long-term Pakistan Investment Bonds (PIBs), which stood at Rs0.6 billion. With policy rate at 13.25 percent, investment in TBs is highly lucrative for foreign investors when they don’t face much risk of devaluation. The government should consider whether TBs are the best instrument for attracting such investment. If it is restricted to PIBs, such investments would considerably remove the present uncertainty.

On the fiscal side, the Q1 results are not fully known and as such not much can be assessed. It is, however, significant to note that in a recent presentation before the NA Finance Committee, the Ministry of Finance has disclosed that debt accumulation targets for the year will be missed. But this would happen only if deficit targets are missed. Therefore, the fiscal performance is uncertain at this point.

Now look at what has been missed in the government’s narrative. The most significant is the state of economic growth. The production data is pointing to a continuing contraction of the economy. The July-Aug LSM figure shows a 6 percent reduction in production, a trend that is punctuating from the last year and broad-based across nearly all sub-sectors.

These included: automobiles (30 percent), food & beverages (13 percent), petroleum products (18 percent), iron & steel (18 percent), cement (5 percent), and chemicals (5 percent). This production performance is the mirror image of imports where except for the machinery group which showed a paltry growth of 2 percent, all groups (food, petroleum, transport, textiles, agriculture machinery, metal and miscellaneous) have shown major declines ranging from 17-33 percent. This alone should allow policymakers to ponder whether CAD improvement is worth the cost it is exacting on the economy.

The reports on agriculture are more depressing. Cotton crop, which was targeted at 15 million bales, is now reported at less than 10 million bales. Reportedly, the farmer has sown much less than the assumed area simply because the lint prices were insufficient to cover their cost. A proposal from the Ministry of Food Security – to set an indicative price for farmers – was not approved by the government.

Cotton is a value-added crop with a long value-chain contributing nearly 8 percent of GDP. The loss of five million bales will have to be made up by imports, which would be a massive drain on the country’s reserves. More significantly, the loss of the crop would have a major impact on growth as it contributes 1.5 percent of GDP. Besides cotton, early reports suggest that rice and sugarcane crops may also face a fall below the targets.

The monetary expansion has been nearly zero. Credit to the private sector was negative at Rs28 billion as opposed Rs165 billion last year during the same period. It is clear that investment activity is also very slow. When production is suffering declines for the second consecutive year, thinking of investment is out of order. There are reports of rising inventories, business failures (also reflected in 23 percent increase in bad loans, highest in eight years) and labour lay-offs. In a nutshell, growth prospects are not bright. Dr Hafiz Pasha has estimated that by the end of this fiscal year, two million workers will have lost their jobs and eight million people will be pushed into poverty.

We are of the firm opinion, as are many other economists, that the country has done more than what was required to stem the excess demand. The fresh dose of economic contraction under the Fund programme is misplaced, and is therefore imposing an unbearable burden on the people. The risks of recession have increased.

The writer is a former finance secretary.

Email: waqarmkn@gmail.com