What should worry the government?

27 Dec, 2018

In a tweet on 23 December, Finance Minister Asad Umar justifiably expressed satisfaction on significantly higher private sector credit off-take during July-October 2018 compared to the same period last year, which rose from Rs 34 billion to Rs 199 billion, a phenomenal increase of nearly 700%. Indeed, it looks that this increase is continuing as the private sector credit during the period 1 July-8 Dec rose to Rs 357 billion compared to Rs 112 billion for the same period of last year, showing more than a three-fold increase. (There was some mix-up in the numbers cited in the tweet. The numbers here are from SBP officially published numbers).
While granting that this is a positive development, caution is needed before drawing conclusions that may be unwarranted. It is not evident if this is indicative of significant investment activity. The data from Jul-Oct '18 also shows (SBP MPC Compendium) that the business loans amounted to Rs 144 billion compared to merely Rs 19 billion last year for the same period. Of this, Rs 126 billion (86%) was for working capital and Rs 18 billion (14%) for fixed investment. There has been a significant price hike on account of rising prices as well as depreciation of the rupee. This translates into higher prices of raw materials needed to produce the same amount of goods, thus the increase in financing for raw materials could well be on this account. The fixed investment is fairly limited. What is more, it is significantly down as the last year fixed investment was Rs 68 billion.
There is a deeper concern that should be kept in view, namely the deleveraging of banking sector's investment in government securities, particularly in anything other than the three-month treasury bills (TBs). Between 1 July to 7 December, the banks have divested Rs 683 billion from their holdings of government securities. Incidentally, private sector credit has not risen commensurate with this deleveraging hence much of this must have been banks' borrowings from the central bank which stand retired. We would say more on this phenomenon in the later part of this article.
Another statistics that was cited recently was the behavior of the current account, and making the conclusion that it was showing improvements. Undoubtedly, current account deficit (CAD) in the first five months has improved by nearly 11%. There are two points to be kept in view before making a judgement as to whether it is a reflection of improved fundamentals or a result of other factors. First, if we look at CAD excluding official transfers, the improvement is only 9%. Second, and more importantly, if on top of officials transfers the improvement in remittances of about a $1 billion was excluded, the CAD would worsen by 6%. Now, both these items are not related to economic fundamentals, notwithstanding the fact that both are good contributions to lessening the external account pressures, affected by policy actions. The fundamentals relate to the trade account, which was worsened by 5%. While exports were flat, imports were up by 3%, despite a phenomenal depreciation of rupee and large number of regulatory duties imposed both at the time of main and mini budgets. Such a situation has to be seen in a broader context of how the external sector would respond to what is happening in other sectors of the economy.
The real source of aggregate demand is fiscal deficit. The first quarter deficit of 1.4% of GDP was out of line with the target for the year of 5.1% announced in the mini-budget. The first quarter is lean and yet incurring the highest first quarter deficit in 7 years could be ominous. It sure looks that way. There are two important statistics that point in the direction of continuing pressure emanating from the fiscal side.
First, the FBR revenues have posted the lowest growth in five months in last seven years of about 5%. The target of FBR revenues was at Rs 4.4 trillion in the mini-budget, which was about 13% over the last year collection (including revenues from amnesty scheme). In the first five months, the collections have amounted to Rs 1.2 trillion, leaving a balance of Rs 3.2 trillion, to be collected in the next seven months. This means an average monthly collection of Rs 457 billion. This is simply impossible when the average collection was Rs 240 billion in the first five months. Even crossing Rs 4 trillion would be a challenge.
Second, in our previous article we had pointed that significant revenue has been lost in lowering petroleum prices (estimated at Rs 100 billion), telecom taxes withheld due to Supreme Court Order (estimated at Rs 125 billion) and concessions announced by the previous government to individual taxpayers (estimated at Rs 150 billion). The last concession was slightly rationalized in the mini-budget. This is nearly one percentage point of GDP in taxes that is being lost. Without retrieving this tax, it would be hopeless to expect FBR to achieve the budget target.
The dismal state of revenues, together with Government's emphatic denial, after FM had hinted at this effect in a parliamentary committee meeting, of any suggestion for yet another mini-budget, implies a poor outcome for fiscal deficit during the year. This in turn implies continuing pressure on the external outcome, which is quite visible after five months into the fiscal year. More importantly, all this means that the extent of adjustment in both external and fiscal deficit is rising. The prices of petroleum, electricity and gas, as determined by the Regulator, are neither passed on to consumers nor provided in the budget as subsidies. When properly accounted for, the required adjustment would be quite painful for the people but this is inevitable as without settling such liabilities, the viability of these critical services would be doubtful.
Returning to the issues of credit to Government, let us point out that the debt market for more than a year is dysfunctional. The banks and other investors have stopped in investing in the long-term paper since more than a year. It looks as if the banks are investing in government securities only to the extent required under the statutory requirements, and that too in three-month paper. This implies much of the government borrowing is coming from the central bank, which stood at more than Rs 4.4 trillion as on 7 December 2018. In recent weeks it had crossed Rs 5 trillion.
This situation is reflective of a monetary policy that is falling significantly short of the market expectation. Despite an effort of 475 bps in the policy rate, investors' expectations remain of further adjustment and hence nobody is ready to invest in the long term paper.
In view of what has been stated above, it is clear that the economy remains unstable and worrisome. The news of the foreign assistance, even if it is sufficient to carry the day until June 2019, has not helped stabilize the market and lift investors' confidence. The reason is that such assistance acts more like a palliative not removing the symptoms afflicting the body. Only a painful surgery would work to restore the economic health.
(The writer is former finance secretary) waqarmkn@gmail.com

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