The LSM sector

The Khan administration has taken several fiscal and monetary measures during its less than eight month tenure, at an estimated cost of over 150 billion rupees to the treasury as per independent economists, to jump-start the manufacturing sector. The rationale: higher productivity would raise the future stream of revenue and employment, as well as fuel exports that would generate foreign exchange from a desired source rather than relying on external borrowing from friendly countries and/or the International Monetary Fund (IMF).
Has there been any visible increase in large scale manufacturing (LSM) productivity so far - a sector that has a major share in procuring credit from banks, and accounts for the bulk of our productivity and exports? According to the recently released State Bank of Pakistan (SBP) report for the second quarter of the current year, LSM contracted by 1.5 percent during July-December 2018 compared to a 76.6 percent growth during the comparable period of a year before. Four elements were cited in the report as responsible for the decline.
First, contraction in China Pakistan Economic Corridor (CPEC) activities with government sources claiming that the first phase projects have been completed leading to lower domestic outlay for projects and lower import of services however as and when the second phase starts there would be an expansion on both counts; critics claim that the decline is also due to an attempt to bring the budget deficit to sustainable levels.
Secondly, lower Public Sector Development Programme (PSDP) partly accounted for by lower outlay on CPEC large non-energy sector projects, which plays a significant role in supporting private investment.
Thirdly, there has been a slowdown in private sector construction activities and a decline in consumer spending. The Khan administration has unveiled its ambitious 5 million houses for the poor plan which, the Prime Minister argues, would jump-start the construction sector, and around 40 related industries. He praised the SBP Governor, an inherited appointee, for setting aside 2.7 million rupees (a paltry sum for building 5 million houses even if the houses are not be provided with good infrastructure for example a good sewerage system which, in turn, may not jump start 40 additional subs-sectors) at 5 percent for 12.5 years for the following scheme: (i) encouraging investment in the housing sector for the poor, (ii) providing cash loan facility to small growers and small and medium enterprises sector, and (iii) prioritizing agriculture, SMEs and low cost housing project for bank landing. A question that begs an answer not provided by the Governor is why would any commercial bank prefer to lend to the construction sector (especially with foreclosure laws under litigation in the Lahore High Court) instead of in risk free government treasury bills (with Finance Minister Asad Umar increasingly using this source of borrowing to meet the rising budget deficit) as well as in paper where a sovereign guarantee is available for example loans to the poorly performing energy sector. The Prime Minister revealed that Pakistani builders as well as Chinese and Malaysian builders have indicated an interest in investing in low cost housing scheme and here again one cannot help but wonder whether the SBP's scheme would be enough of a lure.
And finally, a higher rate of interest raises costs of production however raising rates has been a standard normal IMF prior programme condition. It is relevant to note that in the past prior programme conditions particularly relating to the discount rate have been adhered to by the SBP but off and on the SBP receives explicit directions from the Ministry of Finance on two counts namely to lending to the government and intervene in the foreign exchange market - directives opposed by the IMF.
Data released by the SBP shows several disturbing trends that are markedly at odds with the claims made by the Prime Minister and his economic team. First off twelve out of fifteen major LSM products showed worse performance in comparison to the year before for the period July-January. They include (i) textiles (negative 0.25 against plus 0.66 percent in the period of the year before) with woolen and worsted cloth output declining by 46.55 percent this year as opposed to plus 25.40 percent the year before; analysts argue that in spite of the depreciation the rupee remained over valued impacting negatively on exports and therefore output; (ii) food beverages and tobacco witnessed a decline of 4.26 percent compared to plus 3.34 percent during the first seven months of 2018; (iii) coke and petroleum products declined by 4.78 percent this year compared to plus 9.45 percent the year before; (iv) pharmaceuticals declined by negative 9 percent against positive 3.76 percent the year before; the reason lag in regulatory adjustment in prices; (v) chemicals declined by 3.9 percent this year compared to plus 1.4 percent the year before; (vi) automobiles by negative 5.24 percent this year against plus 21.2 percent in 2018; however lower sales were due to higher costs due to the rupee depreciation and restrictions on non-filers from purchasing lower end cars; (vii) iron and steel products declined by 9.13 percent as opposed to 33.9 percent rise last year; (viii) paper and board declined by 2.47 percent in 2019 as opposed to plus 10 percent in 2018; (ix) non metallic mineral products declined by 2.23 percent compared to plus 11.98 percent the year before; (x) leather product output witnessed negative 1.5 percent growth this year against a much higher negative growth of 6 percent the year before; (xi) electronics from 92.6 percent growth during the first seven months of 2018 to plus 19.22 percent in the current year with the largest slow down in switch gears (from plus 4.3 percent in 2018 to negative 96.4 percent this year followed by electric bulbs from 15 percent growth last year to negative 22 percent this year; and (xii) rubber products growth declined from 6 percent last year to 3 percent this year.
Production of three LSM items actually increased including (i) fertilizers (from negative 7.3 percent last year to plus 5.8 percent). The reason being the Khan administration provided two fertilizer plants with LNG at subsidized rates; (ii) engineering products output growth rose from 9.28 percent in the first seven months of last year to 12.42 percent in the current year. Interestingly two related ministers have been associated with these two sectors in the past - Asad Umar with Engro that produces fertilizers and Razzak Dawood's Descon produces engineering products though he has resigned from the company and it is now being run by his son (like Trump); and (iii) wood products witnessed negative growth last year of 18 percent while this year the sector has grown by 18 percent.
The government is focused on not only providing fiscal and monetary incentives to this sector (at a cost to the rest of the economy) but also on improving ranking on the ease of doing business. None of these measures indicates out of the box thinking and simply mirror the policies of previous administrations including the Governor SBP's measures as well as proposals for a one-window facility for investors to ease the cost of doing business - proposals that were drafted by the previous administration and approved by the IMF.
To conclude, the Prime Minister needs to revisit his economic team. If he has to eat crow and once again convince the three members of the Economic Advisory Council to assist his administration he should do so - one name was withdrawn for reasons of religion laying bare this administration's claim of giving equal opportunity to all religions and sects and the other two withdrew in support. Failure to do so would further compromise his ability to deliver on this critical front.