Government dominated investment

No doubt that the economy is back on growth momentum as the country goes through an expansionary phase. But the question remains what is driving growth? Unlike FY03-07 high growth era, when both domestic and foreign investments were private sector driven; the momentum this time around is owed to public sector spending helped by tailwind of lower oil prices and CPEC related investments. However, public sector reforms have been the casualty in the process.

One factor behind high growth is the rising consumerism due to rising GDP per capita of urban middleclass. But the phenomenon was prevalent even in the low growth era of FY09-14 which is clear from the nominal GDP numbers. Thanks to low oil and other commodity prices, inflation has remained low, resulting in higher real growth numbers.

The other factor is that low commodity prices have created fiscal space, this coupled with CPEC phenomenon increased public sector investment. In gross capital formation, which is an indicator of where the capital investment is made for future consumption/exports, the share of government, in growth at constant prices, is exceptionally high during FY15-17 - averaged at 4.5 percent versus minus 0.8 percent during FY08-14 and 2.8 percent in FY03-07.

In FY17; it is primarily public investment that is building gross capital formation - out of 8.3 percent growth, 5.2 percent is contributed to public investment while the private share is a meager at 3.1 percent. In simple words, the power projects by government, gas pipelines expansion, road, mass transit and other infrastructure projects are highlights of last year investment which are even higher than cement, steel and other private sector expansions.

On the flip, private sector is driving the consumption based growth which, on expenditure basis at 2006 constant prices, contributed 7.5 percent growth. The government real consumption contributed 1.3 percent growth, to the toll to 8.9 percent. The point is that public sector is investing for the consumption of the private sector. The question is that how sustainable is the trend.

Anyhow, the story is no different when the credit growth is taken into equation. Thanks to low inflation, the real M2 average monthly growth stood at 9.7 percent since July 2015, versus 2.3 percent during FY08-15. The good news is that due to the falling fiscal deficit, the delta of government borrowing to delta of M2 has decreased from an average of 97 percent during FY09-14 to 55 percent in FY15-17. This has created space for private credit whose incremental share in M2 increased from an average of 19 percent (FY09-14) to 28 percent (FY15-17).

However, in FY17, the real gain is observed in public sector entities (PSEs) borrowing. Its share in Jul-Mar17 stood at a whopping 18 percent. What has triggered the sudden hike? There are number of PSEs such as SSGC and SNGPL, where borrowings for north south and other gas pipelines swelled. Ironically, GIDC collection is meant for such purposes; but that has been used for fiscal financing and new projects are eating the pie of private sector and consumer is paying double tax.

Apart from gas companies, clearance of circular debt has its share in borrowing as PSO and other power sector companies are having the pie. Then new PSEs are being formed for installing power projects.

It is quasi fiscal financing that is crowding out private credit. The sudden growth in quasi fiscal operations is a dangerous sign and the real problem unearths by incorporating contingent liabilities into the equation. New sovereign guarantees issued in Jul-Dec 16 are unprecedented - Rs368 billion (1.2% of GDP) guarantees have been issued in just six months which is higher than the combined guarantees of previous two years. The overall toll has increased from Rs626 billion (domestic: Rs355bn; foreign: Rs271bn) to Rs838 billion (domestic: Rs742bn; foreign: Rs95bn) in the PMLN regime.

The foreign part has dried out while the domestic guarantees increased by 7.8 times in 3.5 years of the government. This one number summarizes Dar style of fiscal operation, which revolved around hiding the debt in quasi fiscal operations and issuing guarantees in bulk. A few years back, the IMF had stopped this practice; and now right after its exit, it is back and could not be more blatant.