Growth momentum to be slowed down

Economic activity moved up the trajectory in the second half of the last fiscal year – while its good news, it is bad for the economy, simultaneously; the momentum has to be slowed down by using policy measures, or time is not far before the slowdown would be implicit. The problem is that in the absence of incremental foreign exchange earning avenues, the growth is simply not sustainable.

A look at the flow of the economy is needed here. The monetary easing cycle started in Nov’14 and by Sep’15, the interest rates had come down by 350bps to 6.5 percent; today, the policy rate is at 6.25 percent. The monetary easing impact comes with a lag of 6-18 months, which has been probably fully incorporated by now. This, coupled with government push on growth during FY15-16, helped the private sector credit to grow. Of course, suppressed commodity prices played their role in boosting economic growth as well.

The private sector credit grew by 16.8 percent in FY17, which is the highest yearly growth since FY07. The private growth was Rs208 billion in FY15, which increased to Rs512 billion in FY16 and further moved up the ladder to Rs748 billion in FY17.

In usual circumstances, the second half of the fiscal is sluggish and credit off take is much less than the first half; but FY17 was an exception as 2HFY17 private credit figures surpassed 1HFY17 numbers. On yearly basis, credit in 2HFY17 grew by 143 percent as compared to 2 percent in 1HFY17.

The LSM grew by 5.6 percent in FY17, which surpassed the provisional growth expectation of 4.9 percent based on 9MFY17 numbers, implying that growth was boosted in the last quarter. The LSM growth was 3.1 percent in FY16. “The financing flow seems to be well connected with economic activity as growth in the major segments of Large Scale Manufacturing Sector Index (July16 –June17) coincides with several key borrowing sectors of the quarter”, SBP noted in its recent banking performance quarterly report.

Wow! It seems that the jewel of the economy is really shinning. But hold onto your horses; there is no free lunch. In the absence of structural reforms, this came with a cost, which might become too heavy for the economy. What other changes did the economy observe in the 2HFY17? The most obvious ramification of higher growth momentum is burgeoning current account deficit - it soared to 2.5 percent of GDP in 2HFY17, which is the highest deficit since 1HFY09. The number is 68 percent higher than the first half and 194 percent more than the corresponding period last year.

That’s alarming since the reserves started falling with the growing pace of CAD. This trend has to be arrested before the reserves come down to a level that cannot be controlled by SBP interventions. The other element, apart from monetary easing that is fueling both private credit and CAD is expansionary fiscal spending, especially by the provincial governments.

The consolidated PSDP spending stood at whopping Rs1.13 trillion in 2HFY17, which is 40 percent higher than corresponding period last year, and 1.5 times of what the government spent in 1HFY17. The numbers are talking - the sudden growth in both private sector credit and public sector development spending simply explain higher current account deficit. The multiplier effect of higher development spending in 2HFY17 must come on the private sector in coming months and quarters.

However, the issue is that the federal government does not have much levy to control fiscal spending, if the government desires to do so. Provincial surplus was Rs137 billion in 9MFY17, while the full year deficit was Rs163 billion, which implies spending of Rs300 billion in the last quarter alone. The provinces still have deposits of Rs332 billion with banks, which they have accumulated over the past few years and they may not shy to spend close to the elections.

Hence, the problem of twin deficit (current account and fiscal) may continue in FY18. The private sector financing spree may continue as well, because the multiplier effect of government spending would induce banks to lend more. This has to be controlled somehow by policy tools before it’s too late.

With the elections approaching soon, it’s hard to have contracting fiscal policy, or to let the currency to depreciate as the former would hurt growth momentum, while the latter has inflationary consequences. The most viable choice left with SBP is to tighten the monetary policy, and the ministry of finance should take further administrative measures to curb imports and enhance exports.