The annual report of SBP is a comprehensive document narrating the ground realities of the economy with a few boxes summarizing historic and regional comparison to explain a few problems. However, not many policy level solutions have been offered.
The crux of the report is that the central bank has finally conceded the external woes and has realistic forecast on current account and fiscal accounts deficits. However, this wasn't the case a few months ago. For instance, in the state of the economy report for 1HFY17, which was probably published in Feb17, the CAD was projected at 1-2 percent of GDP for FY17 while fiscal deficit was forecasted at 4-5 percent of GDP. On the contrary, the actual numbers came at 4 percent and 5.8 percent of GDP, respectively.
One may wonder how can the central bank that has all the updated knowledge on external flows and has a battery of economists running sophisticated macroeconomic models sway so much in numbers. There could be two explanations to such an anomaly - either there is something seriously wrong in SBP's modeling assumptions; or the reality was not exhibited earlier under the pressure of the ministry of finance.
Whatever the case is, the monetary and exchange rate policies decisions based on far-from-reality forecasts were simply not right. In the latest annual report, however, the forecasts are no more artificially rosy. SBP expects CAD and fiscal deficit to be at 4-5 percent of GDP and 5-6 percent of GDP, respectively in FY18. These two indicators, in spite of benign inflationary forecast (4.5-5.5%), warrant some tightening in monetary and exchange rate policies. However, the annual report has not hinted on any hawkish stance, going forward.
With GDP expected to grow between 5-6 percent of GDP in FY18, SBP emphasized on having export oriented policies. "...switching away from consumption-led to investment-cum-export oriented growth; reducing current account deficit to manageable levels", lamented SBP. It's easier said than done; the question is how?
In a box within the report, SBP explained that sluggish efforts of industrial liberalization since 1990, relative to regional export competitors, amid undue protection to domestic industries have created an anti-export bias amongst the manufactures. Additionally, the tariff structures have been applied disproportionately with final goods facing stricter controls than raw materials and intermediates, which impeded the development of backward industrial linkages over the period of time.
The outcome is that whenever the domestic demand drives the economy, the industries catering to domestic needs start importing more intermediaries to produce final goods; meanwhile, the import bill soars in the process - classic example is of domestic auto industry. The other disadvantage from the consumer protection perspective is that the quality of goods produced at home are inferior with higher protection to domestic industries.
The other element SBP highlighted to promote export is to look for the avenues to export services. In another box, SBP narrated that over the past few decades, the services contribution to GDP has increased; but its share in total exports have fallen. On the contrary, Indian and Philippines share of exports move in tandem with services share in GDP. On the scale, Pakistan is relatively much weaker in people skill and availability. The focus of policy making should be on how to enhance exportable services.
The problems are old and nothing has been done as such to rectify them, and any policy shift would take years to reap fruits; other economies have accumulated experience and have gained competitive advantage. However, the balance of payment vulnerabilities need immediate attention and policy level decisions to avert crisis.
SBP is hopeful that with improved world economic forecast, chances of growth in traditional exporting sectors are high. But seeing the widening gap between the imports and the exports, it's imperative to curb imports growth to reduce the CAD. This isn't happening anytime soon as SBP expects CAD to be around 4-5 percent of GDP in FY18. The bottom line is that the benefit of CPEC has to be realized in the form of high FDI, or otherwise expensive debt would remain the only option to plug in the external gaps.
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