Spate of bad news

As if the bad news on the economic front in 2016-17 was not enough we have had another spate of bad news in the first seven months of 2017-18. Clearly, the economy has destabilized once again and this will begin to introduce strong constraints to the growth process in Pakistan. The negative developments between June 2017 and February 2018 are identified below. Wherever possible an attempt is made to highlight any silver linings in the cloud. The key short-term trends in the domain of growth, investment, inflation, balance of payments and public finances are described below.
Growth There has been some optimism that finally the economy will achieve a growth rate of 6 percent, after a gap of thirteen years. This optimism is based, first, on a big expansion in supply of electricity following the commissioning of new plants, especially in Punjab, based on LNG. Second, that the on-going CPEC infrastructure projects would have a multiplier effect and, third, that exports would pick up again following the announcement of the incentive package.
The expectation was also that the cotton crop would reach the output of 14 million bales once again, attained earlier as far back as 2004-05. The first bad news was that in Kharif 2017 the area under cotton has declined significantly with substitution mostly by sugarcane. The expectation now is of a crop size marginally above 11 million bales. Similarly, the incoming Rabi crop of wheat is likely to be adversely affected by the severe water shortage. Overall, the growth rate of the agricultural sector in 2017-18 is likely to be close to 2 percent, as opposed to the Annual Plan expectation of 3.5 percent.
The big surprise is the plummeting of the monthly growth rate in the Quantum Index of Manufacturing. The year started exceptionally well with a growth rate in July 2017 of 14 percent. By December, the growth rate is down to 5.5 percent. Industries which are showing negative growth rates are sugar, vegetable ghee, chemicals, fertilizer, leather products and engineering goods. If this decline persists than the growth rate of the large-scale manufacturing sector in 2017-18 may be even lower than 5 percent.
However, there are some positive signs. The output of cement and iron and steel has exhibited high growth of 10 percent and 28 percent respectively. This highlights the dynamism of construction activity in the country, partly due to CPEC. Also, with a significant increase in exports, the textile industry should begin to show positive growth.
Overall, the expectation is that the GDP growth rate in 2017-18 will remain close to 5 percent. It is likely to be below the growth rate achieved in 2016-17.
Investment There are some mixed signals with respect to trends in investment. Commercial bank credit to the private sector up to 9th February 2018 has shown a fall of 10 percent. Also, import of machinery has declined, according to PBS estimates, by 3 percent. However, construction activity is buoyant.
The surprise is the negative growth rate of 18 percent in import of power generating machinery. This tends to indicate that investment in CPEC power projects may not be proceeding as fast as anticipated earlier. At this stage, it appears unlikely that the level of investment will exceed last year's level of 15.8 percent of the GDP.
Inflation Since 2014-15, the inflation rate has been low single digit. This has been facilitated by the fall in global commodity prices. From June 2017 to January 2018 the monthly rate of increase in the CPI has risen from 3.9 percent to 4.4 percent. This low rate has continued despite the devaluation of 5 percent and a significant increase in domestic diesel and petrol prices.
The 'core' rate of inflation has remained, more or less, unchanged at close to 5.5 percent. Food prices have been relatively stable, on the back especially of falling prices of atta, pulses and sugar. The likely monthly rate of inflation by June 2018 is likely to be 6 percent, if petrol prices continue to rise and there is acceleration in the rate of monetary expansion as elections approach.
Balance of payments The really bad news relates to recent developments in the external balance of payments of Pakistan. After an increase of 155 percent in the current account deficit, it has risen further by 48 percent in the first seven months of 2017-18 to $ 9.1 billion. In all likelihood, it is likely to approach at least $ 16 billion by June 2018.
Net inflows into the financial and capital accounts have aggregated to $ 5.7 billion in the seven months, enough to finance 63 percent of the current account deficit. The financing would have been lower by $2.5 billion if Pakistan had not successfully floated this amount of Sukuk/Eurobonds.
The consequential fall in foreign exchange reserves has been $3.4 billion and they now stand at $12.7 billion. If present trends continue, they could decline further to below $ 9 billion by end-June 2018. At the time of assumption of power by a newly elected government later this year, reserves could be as low as $ 6.5 billion.
The basic message is that more needs to be done to stabilize the balance of payments. Fortunately, exports have started rising once again with a growth rate approaching 12 percent. But the problem is the continued rapid increase in imports. If a financial crisis of a deep and protected nature by the fourth quarter of 2018 is to be avoided a number of strong and wide ranging actions need to be taken urgently. These have already been identified in an earlier article in this newspaper on A Stronger Trade Policy.
Public finance The Ministry of Finance has reported a fiscal deficit of 2.2 percent of the GDP from July to December 2017. This is high in relation to the annual target for 2017-18 of 4.1 percent of the GDP. Normally, the deficit in the first half of a financial year is about 40 percent of the annual deficit. On this basis, the overall fiscal deficit is likely to approach 5.5 percent of the GDP.
Revenues have performed relatively well and are not very far from the targets. If this performance is sustained the shortfall will be less than Rs 150 billion. The real problem is in the understated expenditure projections in the Federal budget of 2017-18. According to these projections current expenditure was expected to remain nominally unchanged at the level in 2016-17. As opposed to this it has risen by 13.5 percent. Debt servicing has increased by20 percent and defense expenditure by 17 percent in the first six months. At this rate, federal current expenditure is likely to be almost Rs 450 billion higher by the end of the year in relation to the budgeted level.
Fortunately, some respite has been provided by a sizeable cash surplus of Rs 204 billion by the four Provincial Governments combined. But this is seasonal in nature and could largely vanish by June, especially if transfers are held back by the Federal Government in the last quarter.
In summary, the projections for key economic indicators in 2017-18 based on the trends observed are as follows:
-- GDP Growth Rate: 4.8 - 5.0 percent
-- Rate of Investment: 15.5 - 15.8 percent of the GDP
-- Rate of Inflation (average): 4.2 - 4.5 percent
-- Current Account Deficit: 5.0 - 5.2 percent of the GDP
-- Fiscal Deficit: 5.5 to 6.0 percent of the GDP.
(The writer is Professor Emeritus at BNU and former Federal Minister)