The slowdown in real economy

Over the past month, it seems that the feel-good factor has returned. The stock market is in a bullish run and the currency is relatively stable.

There are some small steps towards reforms such as crackdown on smuggling and formalization of exchange companies, gas prices rationalization, and efforts towards privatization.

However, scratching the surface reveals that the real economic activities are in shambles. Demand suppression is becoming widespread, and economic slowdown has deepened its fangs, ranging from discretionary food consumption to buying automobiles. While no business group or industry is planning new investment.

At a macro level, this is resulting in the reduction of the current account deficit due to lower imported demand which is a desired outcome. However, on the other hand, this is resulting in widespread unemployment, which is a negative outcome in any economy.

The lower the income strata, the greater the suffering. A poor household is short on cash after buying basic food, paying rent, and utility bills. There is nothing left for discretionary spending. Not a good sign.

Channel checks across various industries depict that the demand suppression is real. Last year, in various industries, the supply shortage was the main issue, as imports were restricted. Now the story is the other way round, as demand is weaker than the available supply.

This was expected to happen. This writer repeatedly wrote last year that high inflation would result in significant demand destruction, and that is a reality today.

Different income segments have suffered from varying impacts. For example, people in relatively affluent classes are no longer buying new cars and phones as they used to.

Car sales have been reduced to one-third (down by 70 percent) from their peak, across the industry – be it a small or a big car. Companies are now closing production, as they do not have enough demand to meet the restricted supply. That is why some car makers are offering cars on installments and lowering prices.

The story of 2/3 wheelers is not much different either. Sales of motorbikes have shushed to 60 percent from their peak, while 3-wheelers’ sales have fallen by more than half.

The white goods industry is facing the brunt, as the industry-wide sales are down by 25-30 percent last summer from the peak levels recorded in 2021. The hit is higher in air conditioners sales while refrigerators have seen decline in double-digits, as well. The story of mobile phones is similar where the imports (CBU and CKD both) have shrunk to one-third from their peak.

The construction industry is not doing any better. It is hard to find any new project coming up, and those in progress, cost overruns have brought projects to a halt. Construction companies are uncertain on the currency outlook and refraining from committing to new projects.

The story of investors is not different as they are shying away from buying. The employment has been reduced to less than half and the outlook is uncertain.

Then the government spending on the development projects is almost dead as the head is first to be hit when all the efforts are on curtailing the deficit, and the situation is not likely to improve anytime soon.

Overall energy consumption is on a fall which depicts a widespread slowdown. Power consumption on the grid is down by 8 percent on a 12M rolling basis from its peak. The decline in petrol sales is over 20 percent from its peak and diesel is down by over 30 percent.

In textiles, there is no significant uptick in exports, and future orders are falling due to a potential slowdown in the buyers’ economies. In the domestic market, there is an interesting trend.

Demand of synthetic fabric, which is used in making shalwar qameez for lower incomes classes, is significantly down, and so is the case for women clothing in the segment. However, the brands, which are primarily catering to relatively affluent classes, are doing better. These brands’ sales are growing as they are not fully passing on the cost impact on prices while taking a hit on margins.

The demand hit is for high ticket items (like buying cars and foreign travel) for the affluent class while the poorer segments are finding it hard to meet basic needs. They are spending less on clothing. The spending on cola and other discretionary spend on food and beverages is down too. The cola and juices volumetric sales are down by 30 percent or more.

The only better performance is in the agriculture sector (mainly crops) where the supply is better this year from the last, as last year was adversely hit by floods. And the soil is generally better after floods and that is resulting in better yields this year. Interestingly, prices are slowing down in the agriculture sector. This contrasts with what was happening a few months back.

There are a few explanations: one is crackdown on smuggling, which is slashing overall demand. Then the international prices are moving down as well. And the third is that the domestic consumption is falling. This may imply that the demand is bottoming out.

The demand bottoming could be the case in many other industries discussed above, and there are cases of downward price revision in many cases. Others may follow. That bodes well for the inflation outlook, as in October, for the first time since May 2020, the wholesale price index registered a decline on month-on-month basis.

The question is when the economy isn’t doing any magic, why the stock market is moving up. First, the stock market is not a true reflection of the economy – especially, in a country like Pakistan where the informal economy is large, listing on the exchange is low, and trading is thin.

Then the stock market is catching up. It did not perform to the potential since 2017, and the valuation is dirt cheap. Even if the KSE100 index doubles, the market would still be at a discount to its historic PE ratio. And lastly, the interest rates are expected to come down (due to inflation coming down) and the long-term bond yields are already down- as there is an inverse relation of stock market and 10-year PIB yields.

The point of concern is the significant dent in demand and slowdown of the real economy where the issue of rising unemployment is becoming chronic. The economy needs to grow higher than 4 percent to generate employment. However, the balance of payment vulnerabilities are restricting the growth to 1-2 percent, and the situation is likely to remain the same unless new investment starts coming in -especially FDI. There are no signs of it yet, as businesses confidence has not shown any signs of improvement.

Copyright Business Recorder, 2023