Conflicting signals

The big changes in the movement of key macroeconomic variables following the spread since March 2020 of COVID-19 have led to some conflicting signals on the nature of short-term trends. Reconciliation of these signals will perhaps require development of new explanations of underlying economic behaviour.

The first apparent mystery relates to the appreciation in the value of the rupee with respect to the value of the dollar at a time when foreign exchange reserves are falling. During the first half of October 20, the rupee has actually appreciated by over 2 percent, implying thereby a big change from the trend earlier of depreciation. Meanwhile, foreign exchange reserves have been showing a declining trend since September 18th and have fallen by almost $1 billion by October 9th. How can we explain the rising value of the rupee in the presence of falling reserves? Is the foreign exchange market behaving rationally?

The second development is on the front of federal finances. The Government has proudly announced that the Federal Board of Revenue (FBR) target for the first quarter of 2020-21 has been met despite COVID-19. Presumably, this target was set so as to ensure that the first quarterly fiscal deficit is limited in such a way that the fiscal target for the year of 7.1 percent of the GDP will be met. But already in the first two months the deficit was Rs 400 billion, and by the end of the first quarter of 2020-21 it is likely to reach Rs 640 billion, equivalent to 1.4 percent of the GDP. This is almost 20 percent of the annual target deficit. Historically, the first quarter deficit has averaged 12 percent of the annual deficit. Therefore, the optimism generated by the achievement of the quarterly FBR revenue target is not sustained by the increase in the fiscal deficit during the quarter to 1.4 percent of the GDP compared to the deficit of 0.7 percent of the GDP in the first quarter of 2019-20.

Another apparent contradiction is the positive growth in production by the large textile sector according to the Quantum Index of Manufacturing (QIM), published monthly by the PBS. The latest data on the QIM is for the month of August 20. The textile sector is shown as having achieved a growth rate of almost 2 percent. But during these two months the volumes of exports of cotton yarn and cotton cloth have declined by as much as 36 percent and 26 percent respectively. Exports account for almost 60 percent of the output of textiles. There is the likelihood that the growth in manufacturing output has been somewhat exaggerated.

Similarly, there is the perception that the construction sector has become buoyant because of the various incentives offered by the Government and the SBP. This is based on the almost 24 percent growth in output of the cement industry in July and August 20. But the production of other complementary construction inputs is actually declining. The output of glass plates and sheets is down by 15 percent in two months. Similarly, production of steel products has contracted by 31 percent and of paints and varnishes by 11 percent. Further, the increase in wages of construction workers is less than the rise observed in the months of July and August 2019 when the sector was in a depressed state.

Another inexplicable development relates to the estimates of the rate of inflation in the CPI. The single largest consumer item is house rent with a weight of over 19 percent. The inflation rate in house rent is reported at below 5 percent in the first quarter of 2020-21. This is not only less than the overall rate of inflation of 9 percent in the quarter but also less in comparison to the increase in rents of 7 percent in the corresponding quarter of the previous year. Why is it that the rate of inflation in rents is so low and falling when the magnitude of housing shortage continues to increase exponentially? Perhaps the objective of showing low housing rent inflation is to keep the overall rate of inflation at single digit.

Another divergence is between the World Bank's projection of remittances following COVID-19 in 2020 and the actual inflow of remittances to Pakistan and Bangladesh. Remittances to Pakistan have increased by 31 percent between July and September 20 while Bangladesh received 36 percent more remittances in August 20. The World Bank had projected an almost 30 percent global decline in remittances including those to Pakistan and Bangladesh, due especially to return of a large number of workers from the Middle East. Why has this fortunately not happened in the case of these two countries?

COVID-19 also has had a big negative impact on corporate profitability. The financial results for the last quarter of 2019-20 have become available for a large number of companies. These include multinational companies. Most companies have shown a sharp decline in net profits. But the surprising finding is that the repatriation of profits is up by as much as 98 percent. Are the MNCs taking their reserves out of Pakistan?

Finally, there is the issue of the level of foreign exchange reserves with the SBP. Even after COVID-19, reserves have been increasing, despite the big outflow of 'hot' money of $3 billion, from $10.8 billion at the end of March 20 to $11.8 billion as of 9th October 2020. How did this happen? The answer lies in the fact that the SBP has quietly engaged in short-term borrowing from the foreign currency deposits of the commercial banks of $5.9 billion. However, the reported level of these deposits does not reflect this borrowing and the overall level of reserves therefore probably includes a big component of 'double counting'. As such, is the reserve position not more fragile than the position indicated by the reserve numbers released by the SBP?

Many of the above conflicting developments does not have immediate and obvious explanations. Hopefully, over time rational explanations will be found for these trends. Perhaps the Government, the SBP and the World Bank will explain clearly the reasons for the apparently conflicting signals.

(The writer is Professor Emeritus and former Federal Minister)

Copyright Business Recorder, 2020