Economy: misplaced govt optimism?

There has recently been a wave of optimism on the performance of the economy. Various indicators have been used to highlight the resurgence from the deep trough in the first quarter after the COVID-19 attack. Prime Minister Imran Khan has said that 'the economy has turned the corner'. The Finance Advisor has asserted that 'there is good news from all four corners'.

There is no doubt that the economy suffered a big negative shock after the pandemic hit Pakistan in late February 2020. Due to production lockdowns and supply interruptions, the level of output, for example, in the large-scale manufacturing sector fell on a year-to-year basis by as much as 23 percent in March, 42 percent in April and 25 percent in May.

Similarly, exports were also hit badly by the breakdown in world trade. A big fall in the level of exports was experienced in the last quarter of 2019-20 of 32 percent. Simultaneously, due to depressed economic activity and the quantum decline in oil prices, the import bill for the quarter also was down by 24 percent.

The informal sector of the economy also bore the burden of the shock. Activities in the wholesale and retail trade, transport and communications, services and construction plummeted. Overall, it is estimated that by June 2020, over 5 million workers had lost their jobs and almost 20 million people had fallen below the poverty line.

Fortunately, the spread of COVID-19 was relatively less in Pakistan. It attained a peak in June when the daily incidence of cases exceeded 6000. By October, the rate had fallen to 600. However, we are seeing the beginning of a second wave with the incidence rate rising once again to almost 3000.

There are, no doubt, signs of recovery today. The Government has highlighted, first, the positive growth in the Quantum Index of Manufacturing (QIM) in the first quarter of 2020-21. Second, the rise in the stock market and growth in foreign direct investment and, third, the emergence of a surplus in the current account of the balance of payments are also the improvements that have been presented as key examples of the recovery of the economy. More recently, the build-up of foreign exchange reserves and the appreciation of the rupee have also been seen as indicators of the achievement of stability by the economy.

There are two fundamental questions. First, are the improvements large enough and sustainable in nature? Second, are there no weak spots in the economy which could retard its performance in 2020-21? An attempt is made to answer these questions below.

The growth rate of the manufacturing sector has been reported at close to 5 percent in the first quarter of 2020-21, compared to the corresponding quarter of 2019-20, when there was no COVID-19. As such, this is considered as a strong indicator of the revival of the economy.

However, what has perhaps not been recognized is that industry was undergoing a slump in 2019-20 even prior to COVID-19. Output in the first quarter had contracted by 6 percent. As such, the growth in the first quarter of 2020-21 is on a depressed level of output. If comparison is made instead with the first quarter of 2018-19 then there has actually been a fall of 1 percent. Consequently, many industries have still not recovered fully. This includes industries like petroleum refining, cigarettes, steel and soft drinks, which have showed positive growth with respect to 2019-20 but negative growth in relation to 2018-19.

A prime example is that of motor cycles. The Prime Minister has quoted the rise in production of motor cycles as a success story. During July to September, the output was 588,765, representing a jump of 19 percent over the production level of 496,150 in the corresponding quarter of 2019-20. But the level of output was much higher in the first quarter of 2018-19 at 650,851. Therefore, the production of motor cycles has not yet fully recovered.

The stock market of Pakistan has also been quoted as one of the best performing markets in Asia. After COVID-19, there had been a big fall in the KSE-100 Index of 29 percent by March 25, 2020. Since then by November 20 there has been a strong recovery in the Index of over 47 percent. On an annualized basis, the level of the Index is 6 percent higher.

However, there are other stock markets which have performed somewhat better. The annual growth rate in the Mumbai BSE index is over 7 percent, while in a number of East Asian countries it has ranged from 9 percent to 19 percent. The lack of restoration of confidence of foreign equity investors in the economy of Pakistan is indicated by the fact that there has actually been an outflow of equity funds of $341 million in the first four months of 2020-21, as compared to a net inflow of $564 million in 2019-20.

As opposed to this, there has indeed been a sizeable increase in foreign direct investment of 17 percent between June and October 2020. In 2019-20, the level had fallen by 47 percent. The flow of investment funds has been in the electricity generation, information and communications and in the financial sector. However, this is still significantly below the level attained in 2017-18.

The indicator of success which has been perhaps most frequently quoted is the emergence of a surplus in the current account of the balance of payments. This is undoubtedly a major step forward in stabilizing the economy. Three years ago the annual deficit was as large as $20 billion.

The surplus is $1160 million in the first four months of the on-going financial year as compared to a deficit of $1419 million in the corresponding period of last year. The improvement is, more or less, entirely due to the phenomenal growth in remittances of almost 27 percent.

Meanwhile, exports have dropped by over 10 percent, imports have contracted by 4 percent and the trade deficit has improved only marginally by 3 percent. The growth rate of remittances is now beginning to decline. It was 31 percent in the first three months and has fallen to 14 percent in October. Therefore, for the balance of payments position to remain sustainable it is vital that export receipts start growing once again.

A negative development that has generally not been highlighted is the conversion of the financial account in the balance of payments from being in surplus to a deficit. The surplus was $2242 million in the first four months of 2019-20. There is now a deficit of $1336 million in the corresponding period of 2020-21. This has, more or less, neutralized the positive development in the current account.

Why has the financial account position deteriorated? First, there has been a big decline in the net inflow of foreign assistance. Second, there has been an exit of equity funds, as highlighted above, as compared to a sizeable net inflow in the first four months of 2019-20. Overall, the external balance of payments is in deficit of $220 million as compared to a surplus of $1230 million in 2019-20. Consequently, there has been a decline in foreign exchange reserves.

Turning to the persistent negative features of the economy, the lack of growth in exports has already been highlighted, which is essential for stabilization of the economy. This problem is compounded by the deterioration in the state of public finances in the first quarter of 2020-21. Revenues have shown zero growth, while expenditure has grown faster at 13 percent as compared to the target growth rate of 5 percent at the Federal level. Consequently, the budget deficit was 1.1 percent of the GDP as compared to 0.7 percent of the GDP in the first quarter of 2019-20. If this trend continues, the annual deficit could be significantly higher than the target level of 7 percent of the GDP and this could begin to exert pressure on the balance of payments.

The Achilles heel of the real economy today is the agricultural sector. Last year, the wheat crop was down by almost 10 percent and this year the cotton crop is likely to be lower by as much as 15 percent to 20 percent. The downstream implications of this fall for the textile sector are worrying. The prospects for GDP growth are diminished by the debacle in agriculture and projections for 2020-21 range from only 0.5 percent to a maximum of 2 percent.

Finally, the big concern remains about the on-going rate of inflation in the economy. The overall rate is close to 9 percent, while the increase in food prices is almost 17 percent. Claims are being made that inflation in the key prices of wheat flour and sugar is beginning to moderate. This is not borne out by the PBS data. The year-to-year inflation in price of wheat flour was 20 percent in September which has risen to 25 percent in October. Similarly, the rate of inflation in the price of sugar has increased from 25 percent to 33 percent. Overall, the rate of inflation in food prices was 12 percent in September which has gone up to 15 percent in October. Clearly, there has been no success in limiting the ravages of the big jump in food prices.

Overall, while there has been some recovery from the low point reached by the economy in the immediate aftermath of COVID-19, there is now the risk of a second wave. There are no grounds for complacency at this stage about the state of the economy. A big question mark relates to the future of the IMF Program, which will determine the magnitude of inflow of external funds into Pakistan in coming months and the resulting position of foreign exchange reserves.

Finally, an appeal is made for the poor people of Pakistan. The Government has done excellent work in expanding the coverage of cash transfers to over 14.8 million beneficiaries through the Ehsaas/BISP program. Now it is proposed to bring down the number of recipients to 7.5 million. The plea is that it is too early for poverty to have come down substantially after the big increase since March 2020. The coverage needs to remain unchanged in the next round of transfers.

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

Copyright Business Recorder, 2020