an economic snapshot...an economic snapshot april 12 2013 this month political activities have...
TRANSCRIPT
An Economic Snapshot
April 12
2013 This month political activities have overshadowed Pakistan’s economic landscape. The caretaker set up has been put in place while the ECP is grappling with the myriad issues as it prepares the country for the upcoming elections.
An update of March 2013 Analysis
Developed by:
Spearhead Research - Pakistan
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Table of Contents Overview ........................................................................................................................................ 3
Energy Crisis ................................................................................................................................... 4
Industry .......................................................................................................................................... 5
Foreign Investment ........................................................................................................................ 6
Foreign Assets ................................................................................................................................ 7
Informal versus Formal Sector ....................................................................................................... 8
Management Issues ....................................................................................................................... 9
Conclusion: ................................................................................................................................... 10
Recommended Articles ................................................................................................................ 11
Monetary policy: More of the same ........................................................................................ 11
Financial hara-kiri ..................................................................................................................... 15
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Overview
This month political activities have overshadowed Pakistan’s economic
landscape. The caretaker set up has been put in place while the ECP is
grappling with the myriad issues as it prepares the country for the upcoming
elections.
The economy continues to be plagued by a poor law and order situation, a
horrendous power shortage, political shenanigans, potential militant
threats, ethnic discord, and sectarian strife. Pakistan Army continues to
conduct a decisive operation against the Taliban in Tirah Valley, a short
distance from the city of Peshawar.
The political ramifications of the upcoming elections are significant not just
for Pakistan, but the region as a whole. The United States seeks stability as it
extricates from Afghanistan, and this is hugely dependent on the domestic
stability in Pakistan. The outcome of the elections will define Pakistan’s
future direction and willingness to negotiate with the neighboring countries.
The political “scuffles” during the past five years and the lack of a genuine
desire to bring real economic improvement has brought the country at this
low point. Pakistan’s economy is in dire straits and the Government has
done little to reverse the downward trend. A long list of financial scandals
and court cases continue to be highlighted by the media, as the country
prepares for the next general elections in May 2013, hoping for “change”
and a path out of the present morass.
There continues to be potential for economic growth and change with
professional management, fiscal discipline, and a genuine effort. However,
this will all depend on the outcome of the elections and resiliency with
which the new Government pursues an agenda of real economic reform.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Energy Crisis
32,400MW will be Pakistan’s power generation capacity by 2018, if
the next govt were to do absolutely nothing to prevent or slow
down the progress currently being made on projects that are
already approved and progressing. The power crisis has continued to worsen and is believed to be the single
largest factor threatening Pakistan's economy. The duration of load
shedding has increased to 14-18 hours in urban areas, while in rural areas it
is even more. The situation is anticipated to worsen in the coming hot
summer months. The presence of subsidies has only served to increase
government spending, and the huge circular debt continues to worsen the
situation, with major institutions such as PSO having to be bailed out to
avoid default and collapse. The private sector has taken an initiative to
increase national power production capacity and by 2018, it is estimated
that private sector projects will increase their output to 32,400 MW from
the current 23,500 MW, by targeting cheaper alternatively available sources
of fuel.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Industry
New loans to the manufacturing sector topped Rs136 billion
during the first eight months of the fiscal year ending June
30, 2013, up by a whopping 61% compared to the same
period in the previous year. Financial institutions appear to be taking a positive view of the
manufacturing sector, with funding for some long-term projects, which are
expected to improve employment opportunities. In the first eight months a
61% increase in loans was recorded as compared to the last fiscal year.
Machinery imports are up by 9% in 2012, considering imports shrunk by
10% in 2011 and remained stagnant in 2010.
The expansion in credit to private sector businesses is higher than the last
three-year average of Rs133.4 billion and closer to the five-year average of
Rs159 billion for the first six months of a fiscal year.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Foreign Investment
According to SBP, the first eight months of fiscal 2013 saw
net foreign investment reach $688 million, up more than
63% compared to the same period last year. Foreign investors are once again showing interest in the Pakistani market.
Investment recorded in the first eight months of this year was valued at
$688 million (63% rise), and is estimated to touch $1.2 billion by the end of
this year. SBP’s report claims foreign investment to be the largest predictor
of change in Pakistan's growth rate. Therefore a rise in foreign investment
could lead to an overall improvement in the economy. A smooth democratic
transition can be expected to further boost investment.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Foreign Assets
According to policy review, SBP’s foreign exchange reserves
have declined by another $2 billion; from 8.7 billion at end-
January 2013 to $6.7 billion as of 5th April 2013, mainly due
to debt payments.
Debt repayment is a pressing issue and over the course of this year foreign
exchange reserves will fall by approximately $6.458 billion as per SBP. An
amount of $2.3 billion in IMF loan’s has been retired the first nine months of
FY2013, with scheduled payments of $838 million remaining for FY2013 and
$3.2 billion due in FY2014. Even with these loan payments to IMF the rupee
continues to hold its strength. Remittances continue to be a strong part of
Pakistan’s economy, though a drop in remittances is being witnessed - the
first in seven years. This is however, believed to be temporary due to the
current political uncertainty.
Strong positive sentiment regarding a democratic transfer of power, a low
return on deposits, and improved financial reporting by some sectors has
channeled funds towards the stock market and this trend is expected to
continue in the short to medium term.
Timely elections are imperative for Pakistan to be able to negotiate with the
IMF, and political stability will greatly influence its credit rating and
influence the terms of any such negotiations.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Informal versus Formal Sector NEW estimates indicate that Pakistan’s informal economy is larger than
previously approximated, and is expanding at a rapid pace. On the other
hand, the formal sector appears to be on the retreat.
“Substantially larger than previous estimates of between 30 per cent to 50 per cent (albeit using
different methodologies). If correct, this implies that the overall size of Pakistan’s economy, both
reported as well as unreported, is around $420 billion, with private consumption at current prices
amounting to a whopping $365bn in 2012.
The trend of rising informality of the economy is no cause for celebration. While a large informal
sector acts as an important shock absorber for an economy gripped by a fairly lengthy period of
sluggish jobs and income growth, the trend of growing informality — that too from an already elevated
starting point, and at the expense of the documented economy — depicts the operation of very
serious structural constraints for the country’s formal sector, and for its overall, long-run growth
prospects.”
Sakib Sherani
The signs of slowdown and fatigue are beginning to appear in the formal
sector of the economy, with a decline in exports, a fall in the aggregate
demand, reduced power availability, and the fall in the FMCG sector.
The informal economy on the contrary continues its growth trajectory. The
recent Tax Amnesty scheme for smuggled vehicles has provided a huge
boost, even though from the broader economic standpoint such amnesty
schemes have always proved to be disastrous in the long run. The Benazir
Income Support Fund and the PML(N)’s rejoinder in the form of Sasti Roti,
Free Laptops, Ujala and Danish schools are all viewed as politically
motivated with a temporary positive impact, while creating dire
consequences for the broader economy. This is akin to treating a cancer
patient with an injectable saline solution.
Although the economy is not expected to show significant improvement in
the near-term, it is expected to sustain itself in the short term.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Management Issues
Policies guided by “politically motivated” Economists and Bureaucrats, who
have continued to place reliance on external funding, at the cost of
developing internal sustainable sources have created an economic morass
and a huge debt burden. Pursuing short-term goals for political mileage has
jeopardized real economic development and the resultant trickledown
effect on the economy. A continued focus on Consumerism has fueled the
informal economy, at the risk of long-term stability and growth.
There is a genuine need for fiscal stabilization and growth, with some tough
decisions to tackle the economic situation. Again a lot rides on the outcome
of the elections.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Conclusion:
Pakistan’s economy is in need of serious restructuring. The caretaker
government is not in a position to take long-term policy decisions, but it can
in its short tenure set a direction to rectify the damaging practices and chart
out a trend for the future. It is imperative to appoint a caretaker Finance
Minister, a post that still remains vacant. While the caretaker government
will have serious difficulties in managing the country’s finances during April-
June, the 90 days period of the interim set-up is an opportunity to arrest the
process of decline and set the tone for the future.
The incoming government would need to take decisive steps to improve the
law and order situation and the energy crisis, while facing an increasing
fiscal deficit. Managing these factors will help set the tone for the economy
in the longer term.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Some very informative financial analyses are included in this snapshot for
a more in-depth review.
Recommended Articles
Monetary policy: More of the same By Haris Zamir
Analysts expect the upcoming monetary policy to be one of the last ones
wherein the central bank maintains the status quo. In light of the inflation
numbers for March, economists say that there is a remote possibility of a
half percentage point cut.
Monetary policy decisions cannot be taken in isolation. They require careful
consideration of the bigger picture. If the cut is allowed, it will accelerate
depreciation. Some argue that a cut won’t stem growth as banks are already
parking their funds in the government securities. The overall expansion in
credit to private businesses is higher than the last three-year average of
Rs133.4 billion and closer to the five-year average of Rs159 billion for the
first six months of a fiscal year.
However, this increase is still insufficient to stimulate the economy given
the depressed state of investment expenditures. Moreover, the credit to
private businesses as percent of GDP and broad money is also the lowest in
the last five years. This low credit off-take in the private sector is caused by
energy shortages; poor law and order conditions; and a very high supply of
risk-free government securities.
The new government should take decisive steps to address the law and
order situation and the energy crisis. Managed properly, all the factors help
set the tone for the monetary policy stance and shortcomings will be
diluted, rather the State Bank of Pakistan (SBP) may not move towards
tightening of policy.
The new government will also confront a ballooning fiscal deficit, hefty
borrowing from private banks and clinching the share private sector. Since
June08, Pakistan’s total debt exceeds Rs8 trillion. Although the quantum has
increased manifold, Pakistan’s debt position as a percentage of GDP stands
at 61.2 percent, lower than the June08 level of 62.3 percent and well below
the historical average of 76 percent in the last 18 years.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
The domestic debt and GDP ratio has increased from 32 percent to 35.2
percent while external debt has come down from 30 percent in June 2008
to 26.2 percent. While the surplus debt being created by a high fiscal deficit
is being offset by increasing GDP, any downwards revision in GDP numbers
can push up the country’s debt ratios.
Fiscal policy remains important for other macro-economic variables. While
achieving fiscal consolidation is a priority, it is important to know where a
high fiscal deficit is being utilised. A substantial amount of total revenues is
being exhausted in servicing of debt, leaving little for development
expenditure. Surging subsidies represent another expense. On average, the
fiscal deficit would have been lower by 1.5 percent during the last five years
in the absence of power sector subsidies. While the deficit remains high,
any resolution on circular debt can substantially improve the fiscal account
position.
Meeting the FY14 inflation target of 8.5 percent will be tough. Upward
adjustments in fuel prices and lack of structural reforms addressing energy
bottlenecks could add to the inflationary pressures. Add to that the rising
trend in monetary aggregates. Given the mercurial nature of perishable
food items’ prices, recent deceleration in food group cannot be relied upon
in the medium to long run.
More importantly, continuous government borrowing from the banking
system and pressures on exchange rate are likely to increase inflationary
expectations and have a negative influence on medium term inflation
outlook. Therefore, fiscal consolidation and attracting capital flows is the
key to locking inflation in single digits.
The SBP has lowered its policy rate by 450 basis points over the last 18
months. The main reason for adopting this stance was a faster than
estimated decline in inflation. This allowed the SBP to place a higher weight
to its concerns of contracting private investment expenditures in the
economy and weak prospects of sustainable economic growth. However,
while pursuing this stance, the SBP was fully aware of the limited
effectiveness of monetary policy instruments in stimulating growth under
the prevailing circumstances.
The key factors constraining the environment include: substantial borrowing
requirements of the fiscal authority due to a structural gap in revenues and
expenditures, declining foreign exchange reserves due to lack of adequate
foreign financial inflows, and persistence of severe energy shortages
because of delays in reforms.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
The fiscal authority should have contingency plans to adjust expenditures
and/or increase revenues in case the likelihood of not meeting the revenue
targets is high. The burden of adjustment in Pakistan’s case typically falls on
increased domestic borrowings, including those from the SBP. This creates
numerous risks for macroeconomic and financial stability. An average
annual increase of 25.6 percent in government debt during FY09 to FY12 is
one example. At this pace, domestic debt is likely to double in volume terms
by FY15.
On the external front, the overall balance of payments position is stressed
due to lack of financial inflows and high debt payments. While private
financial inflows remain weak, official government inflows are barely
sufficient to meet the amortisation of medium and long-term loans. In
addition, the SBP has retired $2.3 billion of IMF loans during the first nine
months of FY13. There are also scheduled payments of $700 million in the
remaining months of FY13 and $3.2 billion in FY14.
Taha Javed Khan, head of research at Taurus Securities, said that the SBP is
to maintain policy rate at the current level in the upcoming monetary policy.
Though inflation is expected to dip in FY13 from the current 6.6 percent
level, going forward in FY14, it will increase as high base effect ends in FY13.
Core inflation is still high at nine percent, while external issues seem to be
increasing with dwindling forex reserves.
The previous government brought inflation down to a single digit after four
consecutive years of double-digit inflation. “Entry in an IMF programme will
likely follow reduction in subsidies, which will push end product prices
higher,” said Khan.
The government cannot control international commodity price fluctuation
but a key reason for persistently high inflation is continuous government
borrowing from the SBP. To control inflation, the fiscal deficit must be
checked by increasing the tax base, curtailing subsidies and extra
expenditures.
The process of determining interest rate should follow the natural supply
demand route. Foreign sources of financing the deficit should be identified
instead of direct borrowing from the central bank. Price control of essential
commodities at the retail level will also keep inflation and interest rate
levels in check.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
In the absence of fiscal reforms, the prospects of sustainable
macroeconomic stability appear weak. The banking system will continue to
feed the government’s demand for funds instead of lending to the private
sector. The revenue side deficiencies and expenditure excesses cannot be
sustained through high levels of borrowing for long. Therefore, structural
reforms such as broadening of the tax base and limiting unproductive
subsidies are necessary for financial stability.
“We expect interest rates to remain unchanged at 9.5 percent and
continuation of fiscal borrowings from the banking system will remain a key
concern,” said Farhan Mahmood, head of research and business
development, Sherman Securities. Besides bank borrowings, SBP is expected
to keep a watchful eye on decisions by the interim political set up, which
may affect monetary policy. The interim government may take some
unpopular measures to bridge the fiscal deficit by raising gas, electricity and
oil product prices, which could elevate CPI numbers.
One key reason for high inflation is the supply side bottlenecks. This can be
gauged by the fact that between FY08 and FY12, average Large Scale
Manufacturing (LSM) growth stood at only 0.6 percent versus growth
between FY03 and FY07) of more than 12 percent. This is attributed to a
growing energy deficit and circular debt.
An area of concern for investors is the outlook on interest rates, which is
fueled primarily from fiscal deficit. To tackle interest rate, the new
government will have to increase tax revenues and reduce losses of public
sector enterprises (estimated to be more than Rs300bn per annum).
Tax collection can be raised through proper implementation of tax system,
resolution of pending tax issues or levying taxation on new sectors.
Interestingly, there are a few sectors, which are not in the ambit of taxation.
This includes the milk and meat markets. If only these two are targeted,
more than Rs300 billion can be collected in taxes.
The writer is the head of the business desk at GEO TV.
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
Financial hara-kiri Dr Ashfaque H Khan
Tuesday, March 05, 2013
One thing that distinguishes the current regime from its predecessor is the
extent of its fiscal indiscipline. Never in the history of this country has the
nation seen such a fiscally irresponsible government. They have maintained
a large budget deficit year-after-year over the last five years, and
accordingly more than doubled the country’s public debt ably assisted, of
course, by the exchange rate depreciation. Accordingly, they damaged a
relatively robust economy in a short span of five years without guilt and
shame.
Because of unwillingness to mobilise resources on the one hand and
reckless spending on the other along with an unconsidered NFC Award,
Pakistan’s fiscal balance has been destroyed thoroughly in the last five
years. The nation will witness further instances of financial hara-kiri in the
last two weeks of the present regime the impact of which will continue to
haunt the economy in the years to come.
The reckless doling out of the country’s financial resources and jobs and the
arbitrary appointments of ineligible people to key institutions including
financial ones are unprecedented in magnitude. The extent of financial
damage in the shape of power sector subsidies, bailout packages for the
rotten PSEs, BISP, circular debt, etc will not be fully known until several
months have passed after the exit of the present regime.
A race has begun between the federal and provincial governments to
implement senseless policies. Recent examples include abolishing the
condition of having a National Tax Number (NTN) to purchase a new car – a
move, which is contrary to the rhetoric of broadening the tax base;
appointing unqualified people in the board of directors of the State Bank of
Pakistan (SBP); making hundreds of thousands of contractual employees
permanent; and giving hundreds of thousands rupees interest free to the
so-called youth.
The planning commission has become a hub for ministers and key
parliamentarians, as they are seen moving around on different floors
seeking approval for their projects and release of funds. The deputy
chairman of the planning commission is obliging them.
Doling out resources in such a fashion in the name of bestowing benefits to
the people of Pakistan at the fag end of the tenure is shameful. Can the
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
exchequer of this poor nation afford to bear the burden of such reckless
spending? They are destroying the country’s finances for ‘winning’ elections
and even if they ‘win’, there will be hardly anything left to govern. The only
available source of funding would be the printing machine to ‘print’ local
currency. Is this what we are waiting for?
A government that indulges in reckless spending in the name of helping the
people at the end of its tenure is acknowledging its own failure. Since its
leaders have failed to deliver during their tenure, they are attempting to
curry favour by securing votes through reckless spending in the last few
days of the government’s term. This is nothing short of an admission of a
grand failure.
What will be the consequences of this financial hara-kiri for the budget
deficit of the ongoing fiscal year? The present regime inherited a budget
deficit of 7.4 percent of GDP in 2007-08. They would certainly leave the
government by making a much bigger hole in the budget 2012-13 – an
unprecedented void in Pakistan’s fiscal history.
In my article printed on September 25, 2012, I analysed budget 2012-13 in
greater depth. In my view the budget was prepared in a casual manner with
fragile numbers. The budget makers were not serious; did not do their
homework, and simply tried to put together irrelevant numbers in a hurry.
It was clear that the budget for 2012-13 would die its natural death within a
few months of being made public. Based on the assessment of revenue and
expenditure and keeping in view the election year, fiscal deficit for the year
was projected in the range of 8.0-8.5 percent of GDP. The recent
developments have defied even my cautious assessment. It is therefore safe
to argue that budget deficit in the current year may reach a level not seen
before in Pakistan, with severe macroeconomic consequences. There are
calculations made by different sources, which suggest that budget deficit
could swell to 11 percent of GDP in 2012-13.
As stated above, the extent of damage caused by the current financial hara-
kiri will not be known until next year. This is a horrendous development in
the making. In such eventuality, Pakistan may face a Greece-like debt crisis.
In fact, Pakistan is already facing a serious debt repayment crisis. The SBP’s
own statistics show that Pakistan will witness net drains on foreign currency
assets in terms of loan repayments during January-December 2013 to the
extent of $6.458 billion. Against the SBP’s foreign exchange reserves of $8
billion, it has bought $2.325 billion in forward market from commercial
banks. In other words, to protect its reserves, the SBP has borrowed $2.325
Pakistan Economic Snapshot – April 2013
www.SpearheadResearch.org
billion from commercial banks and continues to refinance it. Hence, either
the SBP’s or commercial banks reserves are overstated to the extent of
$2.325 billion.
Is there still any doubt that Pakistan is not facing a debt crisis? The governor
of the SBP has not only misguided the Ministry of Finance but also the
political leadership by not revealing the truth. I would urge the readers as
well as the governor to read Dr Muhammad Yaqub’s article ‘The office of
denial’ (March 2) to ascertain the facts.
The current financial hara-kiri will simply speed up the crisis. The caretaker
government will have serious difficulties in managing the country’s finances
during April-June. The post-election government will face the real music of
unprecedented profligacy and the people of Pakistan will continue to suffer
in years to come. In the meantime, the rot continues and the race to the
bottom goes on.
The writer is principal and dean at NUST Business School (NBS) Islamabad.