The investment slump

The year, 2023-24, has witnessed the lowest ever level of fixed investment in Pakistan. It is estimated at 11.4% of the GDP. This is in comparison to 15.4% of the GDP in 2017-18 and even higher at 16.3% of the GDP, as far back as 2007-08. Both private and public investments have declined sharply in 2023-24.

Public investment stands at 2.8% of the GDP, as compared to 4.6% of the GDP in 2017-18. Private investment has plummeted to 11.4% of the GDP from 15.4% of the GDP in 2017-18.

There have also been simultaneously big changes in the sectoral composition of investment by the private sector. The share, in particular, of manufacturing has declined sharply from almost 20% in 2017-18 to 11% in 2023-24.

The absolute magnitude at constant prices has fallen by over 51%. Similarly, investment in the transportation, information and communication and other sectors has declined by 60%, 47% and 21%, respectively.

Fortunately, the momentum has been preserved in the agricultural sector, with a share in total private investment of over 35%. There has been an annual growth rate of almost 3% in investment in this sector since 1999-2000.

The big surprise is that while there is an investment slump, the real estate sector is experiencing a veritable boom in new projects. The share of private investment in this sector has risen to 22% and, in 2023-24 the sector saw twice the level of investment as in the manufacturing sector.

While the annual growth rate of private investment has been 2.5% since 1999-2000, it has been significantly higher at almost 4% in real estate. This diversion of investment away from manufacturing to real estate, due to much lower tax burden, does not portend well for export-led growth.

Turning to public investment, this is undertaken either by public sector entities, like the SOEs, or by the Federal and Provincial governments through the annual development programme. Currently, the dominant share of 83% is by government ministries.

Similarly, to the path of private investment, there has been a big slump in public investment. Investment by the public sector enterprises has fallen by 64% since 2017-18.

The development expenditure by the federal and provincial governments combined in 2023-24 has declined, at constant prices of 2015-16, by 36%, compared to the level in 2017-18. In particular, federal government development spending has fallen by more than 40%.

There is need to recognize that strong policy measures have been taken in recent years to retard the level of private investment in the economy. The objective was to close the investment-savings gap, which is reflected primarily in the size of the current account deficit.

The investment-savings gap was as high as 7.9% of the GDP in 2007-08 and 5.4% of the GDP in 2017-18. The current account deficit was exceptionally high at $ 13.9 billion in 2007-08 and $ 19.2 billion in 2017-18.

The gap was virtually eliminated in 2023-24 and the current account deficit was only $ 0.7 billion.

Therefore, given the high level of external financial vulnerability of the economy in recent years, the policy framework has focused on reducing the level of investment as a % of the GDP. It is not surprising, therefore, that interest rates were raised to an all time peak of 22% by the SBP in 2022. Further, the quantum depreciation of the rupee in 2022-23 added substantially to investment costs.

The quantum jump in electricity and gas tariff has also sharply reduced profitability, and thereby deterred new investment.

The return on equity of public limited companies has fallen sharply. It was only 10.5% in 2023 as compared to almost double at 21% in 2021.

There has also been another factor limiting the level of private investment. This is the colossal increase in bank borrowing by the federal government to finance a rapidly growing budget deficit. Consequently, bulk of the bank deposits have been pre-empted for the acquisition of government bonds with high returns and zero risk.

In FY 2023-24, borrowings for budgetary support from the banking system were of Rs 7,477 billion as compared to credit to the private sector of only Rs 364 billion. In fact, up to the 6th of September 2024, there has actually been contraction in credit to the private sector of Rs 376 billion.

The bottom line is that with the big fall in the level of investment in the economy, there has inevitably been a major loss of buoyancy in economic growth.

Historically, the incremental capital-output ratio in Pakistan has been close to between 3 and 3.5. Consequently, with the current level of investment of 11.4% of the GDP, it is unlikely that the sustainable GDP growth rate will be above 3.5%.

This brings us to a comparison of the level of investment in other South and East Asian countries. It is generally been between 25% and 35% of the GDP, with the share of private investment at over 70%. For example, the level of total investment in India was above 33% of the GDP in 2022-23, and the prevailing interest rate is below 9%.

The drying up of government investment in the form of development spending is attributable to the increasing share of expenditure on debt servicing and defence, in the presence of lower revenue to GDP ratio. In 2017-18, development spending was 22% of total public expenditure. It has now fallen to only 10%.

Clearly, the revenue-to-GDP ratio has to be significantly augmented if there is to be a return to sizeable investments especially in key sectors like education, health, water resources, electricity distribution and highways.

What are the prospects for investment in the presence of a new three-year IMF Programme? The IMF has recognized the role of the SBP in bringing down the interest rates in response to the quantum decline in the rate of inflation. Will further cuts in interest rates be supported?

There are indications that the IMF wants a return to a market-based exchange rate policy and no artificial controls. Also, electricity tariff increases will be required to prevent the growth of circular debt.

Therefore, it is unlikely that in the short run there will be a significant recovery in both the level of private and public investment in the country. The low rate of economic growth is likely to persist with a high rate of unemployment.

Copyright Business Recorder, 2024