Real and monetary

The monetary policy has divorced itself from the real sector. The interest rate and the exchange rate have been subordinated to a single goal: accumulation of reserves, irrespective of what happens to production, consumer demand and poverty. The result is that the real economy is in shambles and a turnaround is not on the horizon.

The stabilization agenda fashioned in varying measures since FY2019 has ostensibly focused on a cumulative devaluation of 45 percent (with minor improvements since June), doubling the policy rate (from 6.5 percent to 13.25 percent) and imposing heavy taxation (tax effort of Rs750 billion) all aimed at suppressing the demand. There is little in the policies to mitigate the ensuing adverse consequences.

Every two weeks one looks at the key indicators of the real economy – output in industry and agriculture, prices, investments – in the hope that there would be some good news. Unfortunately, the economy continues to present a bleak outlook. The real economy doesn’t seem to feature on the dashboard of policymakers as the focus has concentrated on monetary stability.

The decline in production of large-scale manufacturing is unprecedented. In January 2019, the quantum index of manufacturing (QIM) was recorded at 169.28 which has declined uninterruptedly to 128.34 in November 2019, representing a loss of nearly 25 percent in production. It would not be misleading to construe that one quarter of industrial output has vanished. In Jul-Nov alone, the decline in LSM is nearly 6 percent.

The industries that have registered negative growth include automobiles (38 percent); electronics (16 percent); iron and steel (14 percent); petroleum products (13 percent); pharmaceuticals (8 percent); food, beverages and tobacco (7 percent); and chemicals (6 percent). These industries cover 35 percent of industrial value-added.

The other 35 percent has shown a marginal increase led by fertilizer (8 percent) but the largest value-added industry – textiles, with a weight of 21 percent – was nearly flat at 0.27 percent. Evidently, all key industries except fertilizer are facing major loss in production. What factors are responsible for this decline?

There are three major factors responsible for this: devaluation, interest rate hike and heavy taxation. The biggest factor that has directly affected production is devaluation through a steep rise in the cost of significant components of imported raw materials. Their cost of production has increased to a point where consumer demand has vanished; consequently, production cutbacks are inevitable.

The second factor is the level of taxation. Besides the impact of devaluation, additional taxation has broken the back of imports. New taxes imposed include ‘additional import duty’ and ‘regulatory duty’. Furthermore, for the purpose of levy of duty and sales tax the value of imported goods is taken at the retail price. All these measures have led to a significant increase in the cost of imports.

The third factor that has made domestic production and new investment unviable is the interest rate, which has been doubled since July 2019. Everywhere, the cost of finance has risen dramatically, hurting profitability and making future investments unviable. The SME sector has been particularly affected as its margins are thin and finance cost shock is unbearable.

Agriculture is reportedly facing a bad year. Two of the kharif crops, cotton and sugarcane, are reporting negative growth. The rice crop is better than expected while wheat will also fall short of the target. It is therefore suggested that the overall growth in agriculture would be negative. Consequently, even the projected growth of 2.4 percent would be difficult to realize.

On the other hand, the tight monetary policy is affecting flow of investment. Until Jan 10, 2020, credit to private sector was recorded at Rs138 billion which was about a quarter of Rs496 billion registered last year. There is virtually no growth in fixed investment during the Jul-Nov period. The opening stock as on June 30, 2019 was Rs1791 billion which rose to Rs1827 billion as on Nov 30, 2019, showing a paltry growth of 2 percent. Even the overall monetary expansion remains anaemic at 3.2 percent. Growth in domestic credit remained negative at Rs328 billion compared to a positive Rs1.1 trillion. Reportedly, easing of the monetary policy is not on the cards.

The policy inconsistency is evident: with massive fall in industrial production and consumer demand, tax collection is nowhere close to the target. Against the required growth of 45 percent, tax collections in the first six months amounted to 16 percent only. After the first review, the IMF has lowered the target by Rs310 billion to Rs5238 billion. Unless growth is accelerated, end-year collection will not exceed Rs4443 billion, thus leaving a huge gap of about Rs800 billion even compared to the reduced target. This could well jeopardize the Fund programme; or the government has to take additional tax measures, which would be impossible.

Inflationary pressures unleashed by the above policies are also unprecedented. Unfortunately, food inflation, running at around 20 percent, has severely affected low-income groups. Combined with job losses due to fall in production and closure of businesses, there is strong evidence that poverty is rising. Nothing proves this point more than the recent advertisement run by the tractor manufacturers pointing out loss of production from 80,000 units capacity to only 30,000 units, leading to the closure of 200 SME vendors associated with this industry.

This is an awful scenario and one feels terrible at how an elected government can make policies that have brought such misery to the people. And there is no hope for improvement any time soon. There is nothing on the agenda that can spur growth and create jobs.

As it is, chances are the Fund programme will face challenges and attempts to correct it will invite further tightening of monetary variables. The real economy would then face a further squeeze. This is an untenable situation, and there is an urgent need to redraw the economic strategy, as we have been arguing now for some time.

The writer is a former financesecretary.

Email: waqarmkn@gmail.com