MoF's review of economy: drop in foreign exchange reserves worrisome

The Ministry of Finance, Government of Pakistan, has published a comprehensive review about the performance of the country's economy during July-December,2005 being the first half of the fiscal 2005-06 in the Business Recorder issue of the 1st March,2006.
Although the first half of the current fiscal has seen deceleration in many sectors of the economy, the government is still jubilant over the progress achieved. Let us review a few aspects.
Agriculture sector : The agricultural growth target for the current fiscal has been scaled down to 4.2 per cent as against the growth of 7.5 per cent achieved during the previous fiscal.
This is because the cotton production has fallen from 15 million bales [FY-2004-05] to 12.5 million bales ie 16.66 per cent less than the previous year [some estimates put it at 13 million bales] although the area under cultivation went down merely by 2.2 per cent compared to the previous fiscal.
This has been attributed to the excessive rains at the time of sowing, high temperature at flowering stage and late wheat harvesting and the frost.
Why wheat was harvested late has not been commented upon in the review. It may be because of the late sowing for which the sugar mill-owners are partially responsible because by starting the crushing of the sugarcane late, they compel the farmers to delay the sowing of the wheat.
The position of rice seems promising as the production is estimated to reach 5.5 million tons as against the target of 5 million tons.
The position of wheat also seems satisfactory as the production is expected to be 22 million tons as the area under cultivation is higher by 1.6 per cent when compared to last year and as per Press reports sufficient stock is also available in the government godowns.
The main problem faced in the current fiscal is about sugarcane. The survey mentions that in FY 2004-05, the area under crop was 0.966 million hectares which gave the production of 47.244 million tons which gives per hectare yield of 48.9 tons while in the current fiscal the land under cultivation was 0.9 million hectares and the production is estimated at 40.1 million tons which gives the per hectare yield of 44.5 tons.
Thus the per hectare yield during the current fiscal has gone down by about 9 per cent as compared to the previous fiscal.
THIS HAS HAPPENED DESPITE THE FACT THAT THERE WAS NO SHORTAGE OF WATER: water supply during FY-06 Kharif was 5.4 per cent higher than the normal supply and 19.6 per cent higher than the previous Kharif season. This creates doubt if the reduction in the per hactare production is real?
The print media has been disclosing for quite some time that this year, instead of purchasing the sugar at the mills' gates, some mill-owners had lifted the commodity from the farmers' lands.
This not only ensured prompt payments to the croppers but provided dual benefit to the mill-owners as the latter could show lesser buying of the sugar cane and consequently declaring lesser production thereby not only stealing government levies but also possessing undeclared stock for black-marketing.
Now that the government has given the task of investigating the sugar scam to the National Accounting Bureau (NAB) as the government itself has admitted that the big sharks-even at the ministerial level- are involved, NAB should look into this aspect of the matter as well.
FISCAL DEVELOPMENTS: It has been claimed in the review that the fiscal policy remained decidedly growth-oriented providing for strong public sector spending, declining debt servicing cost, intensification of poverty alleviation spending, and investing in the infrastructure while reducing the overall fiscal deficit from 7 per cent of the GDP in 1990s to 3.3 per cent in 2004-05.
The deficit target for the current fiscal has been upwardly revised to 3.8 per cent of the GDP with a view to financing higher public sector development spending.
The current expenditure during the first half of the current fiscal Rs 537.5 billion is 25.7 per cent higher than the corresponding period of the previous fiscal [which works out to 427.60 billion].The increase in the current expenditure has been attributed to the earthquake related spending of Rs 30 billion.
This sum of Rs 30 billion forms merely 7 per cent of the current expenditure of Rs 427.6 billion during July-December,2004 and 5.58 per cent of the current expenditure during July-December,2005.
The passing on the buck of abnormally high volume of the current expenditure during July-December,2005 to the poor earthquake victims is not at all justified. The government should find out the real reasons and try to address them.
Incidentally, the review does not disclose the quantum of inflows from abroad for earthquake relief/rehabilitation programme, funds collected domestically in the President's/ Prime Minister's relief Funds and from other sources and match it with the expenditure of Rs 30 billion so that the public could know the exact weight the earth-quake has really put on the federal budget.
One feels that funds generated for the purpose may be much higher than the above sum.
The review claims that the debt servicing expenditure is declining. How has that happened: (a) on account of government's political decision in the aftermath of 9/11, Paris Club bilateral debts were rescheduled [ or reprofiled as it has been named] and the lenders also provided relief in the interest rates (b) when fresh loans were taken from abroad in the aftermath of 9/11, interest rates at international level were depressed [however, if these loans were obtained at the "floating" interest rates, the impact will be visible in future as the loans are for longer tenures and the interest rates have already started climbing], (c) the interest rates on the domestic debt were drastically cut down since October,1999 take over- on the debt of 1375.9 billion as on 30th June,1999, interest paid was Rs 178.9 million and the rate works out to 13 percent [ page 134 Table 8.1 SBP annual report for 2001-02] while on the debt amounting to Rs 2129.1 billion [as on 30th June,2005], interest paid amounted to Rs 167.9 billion [ Table 6.1 page 124- SBP annual report for 2004-05] and the annual interest rate works out to Rs 7.88 percent.
The interest rate cut on the domestic debt was broad-based and applied not only to the borrowings under National Savings Schemes (NSS) instruments but also to the government Treasury Bills. The impact was also very broad-based. The retired persons, widows and low-income group persons were affected directly through drastic reduction in the interest rates on NSSS instruments.
The indirect impact was on the bank depositors as the banks receiving nominal interest on Treasury Bills drastically reduced the deposit rates so much so that the larger banks' deposit rate had fallen even below 1 percent in 2003-04. In FY 2004-05, inflation was 9.3 percent while public debt interest rate averaged to 7.88 percent.
Thus the savers got 1.42 percent negative interest while in 1998-99, 13 percent interest rate was 7.3 percent higher then the inflation of that year viz 5.7 percent.
All that has adversely affected the national savings which have sizably come down. National savings [as percentage of GDP] reduced from 18.7 percent in 2003-04 to 15.1 percent in 2004-05. A similar trend is visible in the house-hold savings where the ratio has dropped from 13.2 percent [2003-04] to 10.8 percent [2004-05].
Besides the negative interest rate, high inflation [9.3 percent in 2004-05] may also be responsible for that. But strangely, the survey has ignored this important aspect altogether.
The tax collection figures have increased substantially since October,1999 take over. The comparative details are available in Table A appended: It will be seen from the Table that tax is being collected without equity and justice.
The ratio of direct taxes in total collection is falling while the ratio of the callous sales tax imposed with impunity at the highest rate in the world affecting the poor more is increasing.
The figures of direct tax are also not genuine because they include the withholding tax which, if excluded, will bring the ratio of the tax in total collection down by nearly or over 50 per cent.
The Table 13 of the review under discussion indicates that imports during July-December,2005 are higher by 50.8 percent when compared to July-December,2004. Thus customs duty collection must also have, therefore, risen by over 50 percent during July-December,2005 over the collections during the same period of 2004 as no major change was made in the tariff rates in the 2005-06 budget.
But it is strange that the Table 5 of the review puts the increase in collection under this head merely by 22.2 percent. What does this indicate? Large scale stealing of the custom duty?
EXTERNAL SECTOR: The economic data can be put in two ways giving the absolute figures and as a percentage of the GDP. Our economic managers use one method for one specific data and the second one for another data.
In the review under discussion, tax recovery data has been mentioned in absolute terms as the tax-GDP ratio is falling and is the lowest in the region despite imposition of the callous sales tax at the highest rate as the government has no muscles to bring the affluent in the tax net.
On the other hand, the reduction in the public debt has been given as a percentage of the GDP as the absolute figures depict increase in the debt.
In the State Bank of Pakistan's annual report for the fiscal FY 2001-02, the outstanding stock of the external debt [public and publicly guaranteed debt] as on the 30th June,1999 has been put at $26.025 billion while in Table 20 of the review, it has been shown as $28.3 billion.
Thus there is a vast gap of $2.275 billion between the two figures. The higher 1999 stock may have helped the Ministry of Finance in depicting larger reduction in the external debt as a percentage of GDP.
However, in the absolute terms the outstanding external debt has increased from $26.025 billion [30/06/1999] to $31.084 billion [30/06/2005]. This reflects an increase of $5.059 billion - or 19.44 percent in absolute terms.
This is despite the fact that the US government had written off its debt of $1.5 billion. Other bilateral debts may also have been written off details whereof have not been publicly made available.
In case these write-offs are taken into account, increase in the external debt would be still higher.[ Likewise, the domestic debt also has risen from Rs 1375.9 billion [30/06/1999] to Rs 2129. 1 billion [30/06/2005]- a hefty increase of 54.74 percent; nevertheless the debt-GDP ratio shows the marked reduction].
The most worrisome aspect of the external sector is widening trade/current account deficit. This has resulted in the drop in the foreign exchange reserves to the extent of $957 million during July-December,2005.
In the aftermath of 9/11, there has been much improvement in the external sector so much so that by the end of June,2003 the country's reserves were sufficient to cover 33.1 weeks' imports (Table 9.8-page 103 - statistical annexure- SBP annual report for FY 2004-05).
The situation has moved quite adversely and the foreign exchange reserves of $11.7 billion ( as on 31st December,2005) will cover merely 22.5 weeks' imports based on an estimated import figure of $27 billion for the current fiscal.
THE FOREIGN DIRECT INVESTMENT: FDI during July-December,2005 has been put at $1103.3 million while portfolio investment amounted to $359.3 million. The government has been including in the FDI data, the funds received on account of sale of government entities. It is not clear how much amount of sale proceeds is included in the FDI amounting to over $1 billion.
The increase in the inflow on account of portfolio investment does not provide any opportunity for complacence or joy as it represents hot money and can be withdrawn at any time jeopardising the foreign exchange position of the recipient country.
It neither creates fresh employment nor adds to the industrial base of the recipient country. It only creates opportunities for a few dozen/hundred big sharks-local or foreign- to make billions of tax free money at the cost of the small investors.If one would recall, in 1997, large scale withdrawal of the portfolio investment was one of the factors that had ruined the strong economies of the far-Eastern countries.
INFLATION: The year-over-year inflation has decelerated from 9.3 per cent (June,2005) to 8.4 per cent (December,2005).The half-yearly review under discussion mentions that "inflation is like toothpaste, once out from the tube, it is difficult to put it back".
This is indicative of the situation where the economic managers' utmost effort is directed at (merely)containing the inflation rather than reducing it. One gathers similar impression by reading the Monetary Policy Statement for January-June, 2006 issued by the SBP in January,2006.
Recently, Dr Ashfaq Hasan Khan, Advisor in the Ministry Finance had clarified vide his letter published in another English daily that the toothpaste example given in the "review" merely meant that reduction in the inflation takes time.
STOCK EXCHANGES: The "review" is highly appreciative of the performance of the stock exchanges in Pakistan. This is despite the fact that the bourses had created a scam in March,2005 depriving the small investors of billions of rupees.
It appears that similar situation is again being created by the big sharks, and if it so happens, the economic managers will be as helpless in safeguarding the interest of the small investors as a year back.
BANKING SECTOR: In 2001, the banks' collective profit was Rs 7 billion which has risen to Rs 60 billion in 2005. This has happened because of increasing spread between lending/ deposit rates at the cost of millions of depositors for the benefit of a few thousand large sized borrowers.
As per Table 8 of the review, the spread was the highest in July,2002 viz 8.06 per cent. It started declining and was the lowest at 3.42 per cent in mid-2003. It then again started inching up and stands at 6.97 per cent by the close of 2005.
The State Bank of Pakistan (SBP) had been boasting of creating improvement/efficiency in the Banking sector through continuous reforms during the last over 6 years but it did not take any step to safeguard the interest of the millions of depositors nor did it take any measure to control the increasing spread between lending/ deposit rates.
The "review" under discussion has for the first time come up with the confession that the large banking spread reflects the inefficiency of the banking sector.
Will the newly-appointed SBP Governor take notice of the Ministry of Finance's comments and initiate measures to remedy the situation in a manner that the depositors' interest is justifiably protected notwithstanding whether it results in lesser filling of the banks' coffers through unjustified profits.

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Table A        Tax collection comparison      [amount in billion Rs]

Category       July, 1998-June,1999+     July, 2005- December, 2005@

               Amount     Ratio to total  amount      Ratio to total

1                2              3           4                      5

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Direct taxes   112.00     36.36%          119.5               32.68%

Customs duty    61.30     19.90%           71.5               19.55%

CED*            62.00     20.13%           25.4                6.94%

Sales tax       72.70     23.61%          149.3               40.83%

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TOTAL          308.00      100 %          365.7                 100%

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