The euphoria of Saudi Crown Prince's successful visit would subside in due course. Some more visits from friendly countries may be in the pipeline and they may continue to generate some excitement as well. All these are helpful, should be encouraged and be used to build the much-needed confidence among markets and investors. What should be avoided, however, is the belief that this is the panacea for our economic problems. Since coming to office, the new government's inherited economic problems have only deepened; barring a few disjointed actions, systematic efforts to put the economy right have been missing.
Let us present an assessment of some key economic developments to support this assertion. The data for the month of January is out for a number of economic variables. Also, the full data for Jul-Dec is also available.
Most significant is the data on fiscal operations for Jul-Dec 2018 period, released a few days go by the Ministry of Finance. The fiscal deficit was recorded at 2.7% compared to 2.2% for the same period of last year. The deficit amounted to Rs.1029 billion compared to Rs.796 billion, an increase of Rs.235 billion, which is really 0.6% of the GDP. At this rate the annualized deficit would be 5.4%, breaching the target of 5.1% given at the time of mini-budget.
If last year is any guide, the half-year deficit is not a good predictor for the end-year deficit. Last year, the full year deficit was 6.6%, having no bearing with the 2.2% in the first half. While expenditures mount in the next half, revenues also falter, leading inevitably to a rising deficit.
There are other aspects of fiscal operations which point to an alarming state of affairs. First, the entire increase in deficit is on account of rising current expenditures and falling revenues. Last year, development spending was Rs.616 billion which has fallen to Rs.369 billion, showing a decrease of nearly 40%. Yet, the current expenditure has risen from Rs.2545 billion to Rs.2984 billion, showing an increase of Rs.439 billion or 17% over last year. Evidently, the pressure of current expenditure is such that it rose beyond the cut in development spending.
Second, the fiscal deterioration is also contributed by poor revenue collection. The revenue performance could well be the worst in history. Total revenues amounted to Rs 2327 billion during Jul-Dec 18 compared to Rs 2385 billion last year, showing a decline of Rs 58 billion or nearly 2%. The tax receipts increased from Rs 2027 billion to Rs 2083 billion, showing an increase of Rs 56 billion or 2.8%, whereas the non-tax receipts decreased by 32% from Rs 358 billion to Rs 245 billion.
Third, the financing of deficit also poses serious concerns. Of the Rs 1029 billion of deficit, only 218 billion (21%) was financed through external financing and the rest from domestic sources. Last year, 50% was from external sources. Within the domestic sources, Rs 578 billion (71%) was through the bank borrowings and, since all of these were from central bank, through note printing. Last year, the share of bank borrowing was 81% in domestic borrowings. Clearly, a huge amount of monetary hangover is building over the last nearly three years. Some Rs 3.8 trillion has been added to government debt owed to State Bank during this fiscal year. This will have serious repercussions for inflation for a long time through lagged effects.
Finally, the dependence of federal government to meet its expenditures through borrowing is continuing to increase. The net revenues after provincial transfers were Rs 919 billion whereas its expenditures amounted to Rs 2193 billion. This shows actual borrowing, notwithstanding the deficit, was Rs 1274 billion to nearly 3.2%. This looks a more credible estimate of actual deficit as under declining revenue collections, with provinces clamoring for declining transfers, the question of provincial surplus doesn't arise even when some forced savings/surplus may emerge at the close of the month. On this basis, deficit would be at least 6.4%.
This, then, is the state of affairs which doesn't inspire confidence regarding the economic stability so critically required to build real confidence both locally and internationally. This state would not be corrected anytime soon. A long and painful road to recovery would have to be traversed to achieve stability.
The fact that a lengthy road to recovery lies ahead is reflected in some positive developments taking place but not sufficient to make a turnaround. A process to correct the bond market has started with government selling PIBs of Rs 300 billion, the largest sale of such bonds in more than two years. This has to go on for a long time to change the current structure of domestic debt that has developed a dangerous bias towards short-term, posing a high risk of refinancing.
The balance of payments has shown the most encouraging reversal of worsening trend. There was an improvement of $1.7 billion in current account deficit compared to last year, with January showing a monthly deficit of only $809 million, a huge improvement compared to $1.5-$2.0 billion per month deficit that was incurred during most months of 2018. Some caution should be kept in view. The trade account was worse-off by a small margin of $25 million, indicating that the underlying current account deficit was not corrected through a correction of the trade account. Exports showed an increase of 1.6% but so did imports by 1% also. Indeed, the real contributor to correction has come from remittances that showed an improvement of nearly $1.4 billion. One would like to see the correction coming from a major cut back in imports and improvement in trade account.
The large-scale manufacturing has shown continuing contraction. Its growth in the first six months was negative 1.53% compared to 6.59% last year. This is ominous for growth. Agriculture sector is also projected to fall below the target. Foreign direct investment is down by 17% compared to last year. With a massive cut in development expenditure, domestic investment is also falling despite signs that private investment may be increasing.
Evidently, the challenges facing the economy are deepening despite some modest correction in the balance of payments. There is simply no room for complacency. The euphoria of foreign visits should not distract managers from focusing on more pressing short term problems impinging on economic stability.
(The writer is former finance secretary)
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