No stability without sustainability
Aided by the International Monetary Fund, Pakistan is again on a mission to acquire economic stability. The focus in the next couple of years will remain exclusively on restoring economic stability.
As expected, economic growth has moved towards a lower trajectory. Experts see the economy growing at a rate between 2.4pc and 3pc in 2019-20 down from 5.4pc in 2017-18.
In accordance with State Bank’s report for the second quarter of FY19, and measures suggested by the IMF, monetary policy tightening, exchange rate adjustments, reduction in PSDP spending, regulatory measures and the run for tax collection will remain critical factors in shaping the economic outcome in FY20 onward.
Lack of businesses’ confidence in the government’s economic policy and the impact of rising input prices on Small and Medium Enterprises (SMEs) in general and poor manufacturing sector performance may compromise higher growth in the agriculture sector, which many experts are eying.
Contraction in domestic consumption and investments, manufacturing and service sector production have brought growth rate to even lower than most predictions. The adverse impact of efforts to curb the twin deficits on industrial activity and crop production, already highlighted in SBP’s third quarter report for FY19, is likely to aggravate further. Reduction in the PSDP spending will further aggravate the contraction of the economy.
The SBP has already met IMF’s tight monetary policy condition, raising the interest rate beyond 13percent. The policy rate was set at 13.25 percent in July 2019 and remained unchanged in September 2019. Consumption, particularly household consumption, finances roughly 95 percent of economic growth in the country. Squeezed consumption has led to a sharp decline in the rate of growth. Regulatory measures, which mainly include cut in subsidies, raising the tariffs/prices of energy products, and imposing new taxes, are likely to compromise the inflation-control impact of monetary policy. Inflation, therefore, may reach 12-13 percent by December 2019.
Revenue collection is falling short of the target and the government is finding it increasingly hard to meet IMF’s Rs 5.5 trillion goal. In the first two months of FY2019-20, July and August 2019, FBR was able to collect Rs 576 billion against a target of Rs 644 billion. This is a shortfall of Rs 68 billion during the period. Overall, the government is falling short of the first quarter revenue target by around Rs 100bn, which may push the government to further cut PSDP expenditure.
Domestic debt-servicing amid rising interest rates will further increase, leading to higher current expenditure. This, in turn, will neutralise the impact of the cut in PSDP expenditure on one hand and add to budget deficit. Government’s interest payments for domestic borrowing are likely to inflate by around Rs 800-to-1000 billion compared to the outgoing year. This will offset the expenditure, minimising the impact of austerity and further strengthening the negatives of austerity.
The trade deficit is expected to shrink significantly by the end of FY20. However, the cut is predominantly sponsored by a steep fall in imports because of an economic slowdown. Energy price hike and cut in government expenditures coupled with a tighter monetary policy have slowed down the economy, reducing the size of economic activity. Naturally, low growth periods are associated with lower deficits. Though difficult, sustainable recovery requires shrinking deficits with a minimum cut on economic activity.
The factor of an economic slowdown in bridging the trade deficit is already visible. Slipping to a growth rate of 3.3 percent in FY19 from 5.2 percent in FY17 has led to a decline in machinery and other input imports. The imports of construction machinery and textile machinery have gone down 16 percent and 12 percent, respectively, since June 2018. Trade deficit shrank 11 percent to $21.5 billion in July to Feb 2019 compared to $24.2 billion in the same period of FY18. Most importantly, imports continued $2.4bn to the total reduction of $2.7bn.
Contracting large-scale manufacturing which registered negative growth of 1.5 percent in the first half of FY19 compared to 6.6 percent growth in the corresponding period of FY18 cut the demand for input imports significantly. The sector registered a further 2.4 percent contraction in the second quarter, as SBP noted in its second quarter report.
Recent reports show continued negative growth in the sector. All this lowered the trade deficit. The contractions are going to be more significant in FY20 leading to reduced trade deficit. This will have negative implications. Unemployment and poverty are likely to increase and the trend will persist for the next two to three years.
Budget deficit is also likely to shrink in FY20 and the following years. But it has three key implications. First, the bulk of new revenues will be coming from the cut in subsidies. The subsidies to industry are likely to be reduced by half. This will have an adverse impact on the cost of production, leaving the firms/industry more uncompetitive. Particularly, the export industry will suffer and exports may witness a dip or stagnation.
Second: revenue generation through energy price hike will further lower competitiveness. Increase in customs duty on the import of LNG will further erode competitiveness through increasing electricity prices and cost of industrial output. The same holds true for agriculture. Higher electricity and petrol/diesel prices coupled with reduced subsidy on fertilizer and other inputs will leave the farmer with higher cost of agriculture production.
Third: taking tax exemption to the salaried class in May 2018, the budget considerably reduced the purchasing power of many. The real impact will be much bigger amid inflation reaching double digits. Experts believe these factors may push around 8 million people below the poverty line. Around 1.2 million may become underemployed in FY20.
The actions to meet tax revenue target— Rs 5,500 billion in FY20 compared to collection of Rs 3,950 billion in FY19 which is 38 percent growth — backed by electricity and gas tariff hikes, exchange rate adjustments, and other tax measures have social implications.
Public service delivery may be affected because of reduction in the PSDP spending. Reduction in development expenditures coupled with privatisation of state-owned enterprises will reduce opportunities in public sector employment. In the private sector, job opportunities are already few. The reduction in demand and rise in prices make small businesses vulnerable. This will cause more labour cuts to offset revenue losses.
The recent focus on hot money may bring portfolio investment. It may be important in terms of Forex building for the stability of rupee. In the long term, however, hot money has no impact on economic growth. To revive economic growth, Pakistan needs to seriously focus on attracting FDI, promoting exports and gain the trust of local investors. Stability, without sustainability, is short-lived. Pakistan has experienced it many times.
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The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.