The SBP report

The quarterly State Bank of Pakistan (SBP) report - July to September - on the economy reveals disturbing trends in key macroeconomic indicators though it remained largely optimistic about the future trends premised on 'government policy' (prompting many independent economists to lament its continued subservience to the Ministry of Finance.
So what has gone wrong in the first quarter of 2017? Or, more pertinently, what has gone worse in the first quarter of 2017 that was not predicted by independent economists based on the flawed policies of the past three and quarter years? First and foremost, it was predicted that the budget deficit would be the first casualty after the completion in September 2016 of the 6.64 billion dollar Extended Fund Facility of the International Monetary Fund (IMF). To quote the report "in terms of Gross Domestic Product the fiscal deficit reached 1.3 percent in Q1-FY17 - the highest first quarter level since FY12". And the rise could not be laid at the doorstep of the provinces as they showed "an exceptional growth." So why did Ishaq Dar-led Finance Ministry show such a marked increase in the fiscal deficit? Revenue collection, under the administrative control of the Finance Ministry, was lower than the 20 percent normally collected during the first quarter. And expenditure did not decline significantly to keep the budget deficit within limits. Poor performance of the same three major indicators, as in the last three years and a quarter, accounted for the higher deficit notably decline in tax and non-Tax revenue, with no significant reduction in current expenditure accounting for a massive slash of development expenditure.
Tax revenue shortfall was witnessed due to incentives offered to encourage new investments, though indirect taxes reportedly recovered sharply, so states the SBP report. However, the six-monthly data (July-December) recently released by the Federal Board of Revenue (FBR) indicates a shortfall of 127 billion rupees in collections and this, independent research indicates, is due to the proliferation of cash transactions and exchange of parchis (a cheque to be paid in cash is being used multiple times in response to the tax on banking transactions). Large scale manufacturing sector growth is down which accounts for lower tax collections - to 2.2 percent from 3.9 percent in the comparable period of last year. Withholding tax and more specifically the difference in the rate as applied to non-filers, a main revenue generator envisaged by the government, is being paid at the non-filer rate even by those groups who are not liable to file returns notably housewives, pensioners, students etc who do not have the capacity to file returns themselves or the resources to hire an accountant to file on their behalf. There is no one window facility to refund those exempted from filing as is available at airports in the West for tourists not liable to pay value added tax.
A sharp decline in non-tax revenue which the SBP report partly attributes to zero inflows under the Coalition Support Fund (CSF) in the first quarter - around 170 billion rupees was budgeted under this head for the current year, an amount that is far from guaranteed given the uncertainty in terms of traditional US foreign policy divergence expected when President-Elect Trump's tenure begins on 20 January; drop in dividends from public sector energy enterprises due to low oil prices reducing their profitability - with the continued poor performance of the sector leading to a sustained rise in circular debt not explicitly stated in the report though there is frequent mention of the need to sustain the reform agenda; and lower profits from SBP due to lower government debt stock with the central bank, though sadly the government began to rely heavily on borrowing from external and domestic commercial banking sector. Not mentioned in the report is the fact that Dar since 2014 has shifted dedicated taxes like the Gas Infrastructure Development Cess (GIDC) and natural gas development surcharge from non-tax revenue to other taxes to show a better tax to GDP ratio then is in fact the case - an amount equivalent to 180 billion rupees in 2016-17 budget.
With respect to expenditure, the SBP report maintains that "the government was more prudent as current expenditure registered a marginal decline (no doubt due to a marginal decline in subsidies possible due to low oil prices)". The decline in interest payments was from 415.9 billion rupees in the first quarter of 2016 to 414.3 billion rupees in the first quarter of the current year; however, under the head "others" the report highlighted a negative 9.1 percent decline during the two periods though unfortunately the SBP explanation in footnote 12 for this significant is shoddy at best: "other expenditures mostly consist of salaries and wages and subsidies. As salaries and pension benefits were set to increase after the announcement of 10 percent increase in basic pay and pensions from 1st July 2016 in the FY17 budget this decline was more probably due to reduction in subsidies in Q1-FY17." Lower subsidies are budgeted - from 196.5 billion rupees realised last year (though 137.6 billion rupees was budgeted) - with 140.6 billion rupees budgeted this year though given the political considerations relating to the ongoing Panama Papers hearings as well as the scheduled 2018 general elections it is likely to exceed the budgeted amount. Instead I would argue that data on current expenditure could have been manipulated - a tendency exhibited by Dar-led Finance Ministry again and again in these columns.
Development expenditure, the report points out, increased by 12.4 percent in Q1-FY17 on year on year basis, on top of the 47.4 percent rise recorded in Q1-FY16. But here's the clincher: provinces increased allocation on public sector development programme (PSDP) by 37.2 percent in the first quarter of the current year (from 75.1 billion rupees to 103 billion rupees) while the federal government reduced the allocation on PSDP by 10.1 percent (from 71.3 billion rupees to 64.1 billion rupees) during the first quarter of the current year in comparison to the comparable period of the year before. In this context, it is disturbing to note that disbursements for the China Pakistan Economic Corridor (CPEC) have been budgeted at only 130 billion rupees for 2016-17, which would negatively impact on the rate of its implementation.
Second, disturbing trend, other than a rise in deficit, is the rise in borrowing. The stock of debt rose from 18.1 trillion rupees in September 2015 to 20.5 trillion rupees in September 2016 - a rise of 13 percent while the flow rose from 762.5 billion rupees to 866.1 billion rupees - also a rise of 13 percent. Domestic debt rose by 759.8 billion rupees in July-September 2015-16 to 759.8 billion rupees in the first quarter of the current year. External debt payable in rupees, rose from 4952.7 billion rupees to 5515 billion rupees during the first quarters of 2015-16 and 2016-17 - a rise of 11 percent; however disturbingly the largest net inflow of external loans was not from China (279 million dollars), nor from the IDB (158.2 million dollar inflows), nor from the Asian Development Bank (with negative 121.1 million dollar), nor IBRD, (with negative 53.2 million dollars) but from commercial banks abroad with a net inflow of 624 million dollars procured at high rates of interest and for the short term. This turned negative by the end of 2016 calendar year as repayments became due. How did Dar opt to deal with this situation? Through directing the SBP to keep the rupee exchange at below the real rate through market intervention/purchase of dollars (to understate the foreign debt) and reducing the interest on national savings instruments (to understate the domestic debt). The real effective exchange rate was around 120 in April last year, with the rate through market intervention at 104.67 during the same month as per SBP data.
And finally, exports continued to decline as did foreign direct investment - two major coveted sources of foreign exchange earnings. Remittances as had been predicted by independent economists because of recession in oil producing countries also declined.
And yet Dar continues to express satisfaction over the state of the economy and his flawed policies - claims that one would be compelled to assume are only believed by the Prime Minister. Being a Finance Minister for Dar has implied never having to admit failure of his policies and he cites a buoyant stock market and the large foreign exchange reserves as proof of the success of his policies (reserves that have also begun to decline during the first six months of the current year). The equity investments, as per the SBP report, improved during Q1-FY17 as compared to Q1016, when the increase in overall portfolio investment was mainly attributed to an inflow of US $500 million from a Eurobond issued in September 2015 at a rate well above the interest prevailing in the West. One would have hoped that the SBP had identified Eurobond as equity debt investment.
The Sharif administration has been extremely fortunate during its tenure to date as it witnessed a massive decline in the international oil prices, a major import item for the country, but it has frittered it away by: (i) heavy borrowing from the commercial banking sector, and manipulating the budgeted interest and principle repayments through manipulating the rupee value and reducing the interest payable on government saving schemes with serious negative repercussions on exports and tax revenue; (ii) failure to reform the tax system from indirect to direct taxes and has desisted from taxing the stock market at a rate comparable to that of other countries including India thereby generating only around 5 billion rupees from this source rather than the potential 100 billion rupees - the objective being to keep the 40 odd important stock market players compliant enough to manipulate the market as and when the Finance Minister faces criticism; and (iii) continued reliance on slashing development expenditure to keep the deficit at sustainable levels thereby compromising growth.
It is disturbing, however, that in spite of a fairly accurate quarterly report SBP forecasts improvement in Large-Scale Manufacturing (LSM) growth for 2017 "on the back of supportive policies like low interest rates, reduced cost of energy with improved availability, strong domestic demand, healthy corporate margins, and a conducive investment environment" - words that belie not only international assessment of the poor investment friendly environment in Pakistan but also the repeated concerns voiced by the local business community known to have politically supported the PML-N in 2013.