Economic contradictions

There are a number of economic events and happenings in Pakistan which are difficult to find immediate and rational explanations for. This is the result of contrasting developments, some positive and others negative. Consequently, the net impact is unpredictable.

Further, there are problems with some estimates by the Pakistan Bureau of Statistics (PBS). They appear to be in contradiction with observed developments at the ground level in the economy.

The objective of this article is to highlight some apparently contradictory developments on the economic front in the country.

The first such surprising development is that of an economy like that of Pakistan which is in the grip of severe ‘stagflation’ today. The inflation rate is in the mid-20s, and the GDP growth rate is likely to be in the range of only 2 to 2.5% in 2023-24. However, it is truly remarkable that over the last one year the stock market has shown a very strong recovery despite the weak economy. The KSE-100 index has risen by as much as 59.4% since end-February 2023. Earlier, from end-February 2021 to end-February 2022 it had declined cumulatively by 12.2%.

Why has the stock market demonstrated such buoyancy? A large part of the index consists of corporate entities in the large-scale manufacturing sector. This sector has been plagued by cost-push inflation, due particularly to the extremely high rate of increase in electricity and gas tariffs, very high cost of capital because of the extremely high interest rates and either high imported input costs or shortages. Consequently, in the first six months of 2023-24, the Quantum Index Manufacturing has shown near zero growth.

The latest data by the SBP on corporate profitability of non-financial companies for the first quarter of 2023-24 reveals that profits have increased most in the fuel and energy sector and in petroleum refining. There is only a marginal increase in profits in the textile sector. Combined with the quantum jump in profitability of commercial banks, the share prices of these entities have witnessed a veritable boom since February 2023.

The other apparent contradiction is the new-found stability in the value of the rupee. According to the SBP, the real effective exchange rate (REER) index of the rupee has approached 100 in January 2024. This implies that the rupee is correctly valued currently and has appreciated in real value since February 2023 by 15.6%.

This has happened surprisingly at a time of low foreign exchange reserves of close to only $8 billion since July 2023, adequate to provide import cover of only one-and-a-half months. The last time the REER index approached 100 was in June 2021, when Pakistan had the peak level of reserves of $17 billion, enough to provide import cover for three months.

A strong rupee is clearly the consequence of physical controls over imports. Consequently, there has been a fall in the level of imports by over 11% in the first seven months of 2023-24. The agreement with the IMF was that Pakistan would follow a market-determined exchange rate policy. Apparently, the IMF has acquiesced to the lack of adherence to this policy in the face of the likelihood of falling reserves.

The consequence has been a big reduction in export profitability in the presence of higher energy and interest costs and withdrawal of various incentives. This has led to a fall in textile exports of 3% and in other manufactured exports of 2%. Fortunately, total exports have increased by 8%, due to the near doubling of rice exports because of higher export prices.

The big question is what will be the IMF’s perspective on the appropriate exchange rate policy in the event Pakistan decides to negotiate a new three-year IMF program? Import controls have led to market distortions, reduced production and, in some cases, caused a catastrophic increase in prices.

The third but fortunately positive economic contradiction is the extraordinary growth in income tax revenues of 43.5% in 2022-23. This has happened at a time when the nominal growth in the non-agricultural economy was much less at 24.4%.

The question is how the growth in income tax revenues exceeded by so much the rise in the tax base. The answer is to be found in the 66% growth in revenues from the advance tax payments, due to higher profitability in sectors like banking. Also, there is an increase due to some effective enhancement in tax rates and extraordinary jump in the tax bases. For example, the extraordinary hike in interest income on deposits has led to an increase of 106 % from the withholding tax on this source of income. Similarly, the withholding taxes on salaries and electricity have shown increases of 40% and 38%, respectively.

The next area is that there are some apparent contradictions in the sectoral estimates of growth in the GDP estimates for 2022-23. These include the following:

(i) The agricultural sector showed a positive growth rate of 2.3% in 2022-23 despite the massive devastation caused by the floods recording to the PBS. This was due to the livestock sector showing a much higher growth rate of 3.7% compared to 2.2% in a normal year likely 2021-22. There are estimates that in the floods there was almost a 2 million loss of livestock. As such, the high growth rate of the livestock sector in 2022-23 is highly unlikely.

(ii) There was apparently a 9.8% growth rate in the electricity and gas sector in 2022-23. According to the recently released State of the Industry Report by power regulator NEPRA there was actually a big decline in electricity generation of over 10% in 2022-23 and a 9% in the sales of electricity. The near double-digit growth rate of the sector is substantially overstated.

(iii) Extremely high growth rate of over 9% in value-added by the small-scale manufacturing sector. This is unlikely given the 10% decline in the exports by this sector.

Overall, the economic contradictions highlighted above have generally led to better economic outcomes than might have anticipated. However, there is evidence that the GDP growth rate in 2022-23 reported by the PBS is significantly overstated. This should be taken care of in the revised estimates.

Copyright Business Recorder, 2024