The going gets tougher

As new data comes in, the bitter reality is sinking. The global economic slowdown is expected to be worse than what was earlier expected. There could be further downside risks to global economic growth outlook of minus 3 percent in 2020. No economist in the world could claim that he' told us so, that the economy shall recover quickly'. Seeing the Chinese experience of subdued demand after opening up, the fear of 2021 to be a bad year is growing.

Pakistan is not an exception. Reading between the lines, one can sense that SBP is sharing a similar pessimism in its monetary policy statement and communication with the analyst community. The phrase SBP has employed is 'cautiously optimistic'; but the data is showing more caution while optimism is missing.

High frequency data is not showing a positive outlook by any metric. The upcoming economic numbers could be uglier than what were earlier thought. Recent releases are scary. LSM fell by 23 percent in March-20. Profitability of 300+ listed companies is down by 24 percent in Jan-Mar and a few also posted losses. Exports fell sharply too.

And let's not forget that the lockdown began only during the last ten days of March. Think about April when the large part of the economy was at a complete standstill. There were no car sales in April. Cement domestic sales are down by 60 percent. Exports fell by 47 percent in April on monthly basis and 54 percent against the same period of last year. Few big exporters are of the view that May is going to be worse than April.

Growth and external account are the major concerns. Output gap is widening. Inflation is no more a prime consideration in decision making. With depressed demand, inflation is bound to fall. This explains the rationale for 525 bps cut in the last eight weeks. Yet the business community is not happy. The businesses were demanding 300 bps cut on Friday to take rates down to 6 percent. If it had happened, some seths would have quickly converted their savings into foreign currency.

There is a trade-off between low rates and external account balance. The central bank has to tread with care. The key is to provide stimulus to the economy along with maintaining financial stability. Too much and too early easing could result in currency depreciation. Nevertheless, it appears there is still more room. Inflation could be lower than SBP expectation of 7-9 percent in FY21. Interest rates (depending upon inflation outlook) are likely to be down to 6-7 percent in next 2-4 months before the easing is paused. Some say to do it at once, but it is better to wait.

Budget making is in the process. Negotiations with the IMF are ongoing. The economic outlook depends upon what kind of budget government has to offer. Seeing the high frequency data, the finance minister is keen on preparing a pro-business budget. The budget should look at how to bring ease in pain-ridden businesses. The fiscal deficit could be north of 9 percent this year and next year target could be similar.

That seems to be the right approach. There is a limit to what monetary easing can yield. Pakistan businesses are not highly leveraged. Private credit to GDP in Pakistan is one-third of what is in India and Bangladesh. But the direct and indirect taxes imposed on formal businesses are higher. There is excess fat in government machinery running expenditure. The catch is in rationalizing these. There is a myth that one percent decline in interest rate can create Rs300-330 billion of fiscal space. Not all the government domestic debt is short term and around 40 percent of banks' income on interest is taxed. Moreover, SBP profits in non-tax revenues are proportionate to interest rates.

One option is to lower the GST and other indirect taxes. These can be partially compensated by higher tax on petroleum products in days of low oil prices. But running too high a fiscal deficit is a problem. Sooner or later this has to be unwound. There should be some new measures of revenues such as one-off wealth tax.

These are fluid times. Economic revival and job creation ought to be the objective while maintaining a delicate balance of financial stability. The next decision of monetary policy is dependent upon what kind of budget government is going to offer and what current account position may look like in coming months. All these have bearings on inflation and external account. These are difficult times, and no one action alone can bring life back to the economy.