The wide and deep slowdown

The process of slowdown of the economy continues in an uninterrupted manner. The initial signs of a loss of momentum in economic activity first became visible from December 2018 onwards. The leading sector in experiencing a decline in production has been manufacturing. In 2018-19, there was a drop of 3.5 percent in the Quantum Index of Manufacturing (QIM). This has become deeper and in the first five months of 2019-20 production has plummeted by almost 6 percent.

The QIM has 15 industry groups. The textile sector is the largest with a weight in the index of 30 percent. It has demonstrated near zero growth up to November. Being an export-oriented sector this implies that the overall volume of textile exports has also remained, more or less, unchanged. Six industries have experienced negative growth, ranging from as much as a fall in production of 38 percent in the case of automobiles to 5.5 percent in chemicals. Other industries which have suffered a decline in output are food, beverages, tobacco, petroleum refining, pharmaceuticals, iron and steel products and electronics. Over 80 percent of the large-scale manufacturing sector has shown either near zero or negative growth.

The large-scale manufacturing sector has strong backward and forward linkages with other sectors of the national economy. It is linked to the small-scale manufacturing sector through the value chain. For example, a fall in the output of automobiles leads to a decline in production by auto parts vendor industry, which is labor-intensive in character and unemployment is the consequence for a large number of workers.

The major forward linkages of manufacturing are with large sectors in the national economy like wholesale and retail trade and transport. The former sector markets the inputs and outputs of manufacturing while the latter sector transports them. According to the PBS almost 50 percent of the income from trading margins is from domestically manufactured goods. Therefore, a 6 percent decline in industrial production has the concomitant implication of an over 3 percent decline in the value added in wholesale and retail trade, the largest sector of the national economy. A similar negative impact is registered on the transport sector. In fact, the consumption of petrol and HSD by goods transport vehicles has fallen by 7 percent during the last six months.

The overall impact on GDP growth of a 6 percent fall in the QIM is sizeable, if it persists. Combined together the direct and indirect impact on the GDP growth is a fall of almost 1.5 percent. This implies that the loss of employment could be almost 900,000. Further, the large-scale manufacturing sector is the biggest contributor to revenues of the FBR. It is estimated that almost 70 percent of FBR revenues are generated from the sector on inputs, outputs and profits combined.

Major revenue contributors are industries like petroleum refining, cigarettes, cement, sugar, beverages and iron and steel products. Therefore, it is not surprising that FBR is experiencing an increasing shortfall in the achievement of its revenue target for 2019-20.

Very importantly, the slowdown in the manufacturing sector has been a major factor in the decline of imports of raw materials and intermediate goods. For example, the fall in the output of iron and steel products of over 5 percent has been accompanied by a decline in metal imports of 20 percent. Similarly, the decline tea production of 18 percent has meant 14 percent less imports. The production fall of 46 percent in cars has led to a decrease in CKD imports of 47 percent. This import compression has contributed to the big reduction in the trade deficit.

The agricultural sector is the other sector which is beginning to experience a secular decline. Last year, the growth rate of this sector was below 1 percent and output of major crops collectively fell by almost 5 percent. The first indications are that the sector could experience even negative growth in 2019-20. The cotton crop has failed and output could be down by almost 20 percent. Almost 6 million bales will need to be imported. Activity in cotton ginning will be depressed. Overall, the direct and indirect impact of the plummeting of cotton output on the GDP growth rate is estimated at 0.5 percent. Further, the outlook for the sugarcane crop is also not positive. The overall growth rate in major crops will hinge on the size of the forthcoming wheat output.

There is need to understand why there has been a precipitous decline in the primary and secondary sectors of the economy. First, costs of production have gone up sharply due to the rise in cost of inputs due to the large devaluation. This negative impact has been augmented by the big increase in gas and electricity tariffs and by jump in costs of working capital due to the hike in the interest rate. On top of all this, the Budget of 2019-20 saw tax rate escalations and withdrawal of exemptions in a number of industries. The purchasing power of consumers has simultaneously been reduced by the high rate of inflation.

The construction sector is characterized by a large number of linkages. Development spending on projects in the public sector and investment in housing by households provide the primary impetus for construction activity. The former has been retarded by the low level of releases for PSDP projects both by the federal and provincial governments in an effort to meet the fiscal deficit target agreed with the IMF, while housing finance has been severely constrained by the extremely high interest rates. As highlighted by the Prime Minister, the fastest and perhaps most effective way to reverse the slowdown in the economy is to push up construction activity in the country. But this will have to wait for a big decline in interest rates and creation of more 'fiscal space' for development activity.

Overall, the outlook for GDP growth in 2019-20 is depressing. As highlighted above, significant negative impacts on the performance of the economy have already been observed and quantified. Even the modest GDP growth rate of 2.4 percent projected by multilateral agencies is beginning to look unattainable. This will inevitably have a big negative impact on the level of employment and poverty in the country.

(The writer is Professor Emeritus at BNU and former Federal Minister)