We are seven months into the fiscal year and the shape of how the fiscal year would fare is becoming increasingly clear. We present a brief account of the economic developments for the period July-January FY18, comparing it with the last year as well as the targets that we had for the year.
The SBP in its last monetary policy statement has slightly revised its estimate of growth from 6.0% to 5.8%. This was motivated primarily for two reasons. First, there is the concern on the large-scale manufacturing growth which grew at 5.6% during the period Jul-December 2017 compared to the same period of last year. This growth has fallen during the last two months, largely on account of sugar production, which has been affected due to delayed start of the crushing season. In the next two months, when the LSM data would be used in national account for estimating the national growth rate, last year’s sugar production had pushed the index very high and accordingly a base-effect would be operative in the last two months. This would further reduce the LSM growth compared to the target of 6.2% for the year. Pakistan had a record sugarcane crop and millers are predicting sugar production at a record level of 8 million tons. Even if we discount this level, against a demand of 5 million tons, there would be a significant surplus. Yet, the timing of production is likely to adversely affect the estimate of the growth rate. Second, it was apprehended that the slight reduction in the area under cultivation for wheat, would affect the final crop. While the LSM contribution would indeed be affected because of timing of the national accounts, many international agencies (USDA) have continued to maintain their projection for a record wheat crop.
Inflation has so far remained muted but there are emerging signs of pressures building up. Inflation in January was recorded at 4.0% compared to 3.7% a year earlier. Inflation in December was 4.6%, slightly lower than in January. The average inflation during July-January FY18 was recorded at 3.85%, same as last year. The core inflation (non-food, non-energy), however, is showing stubbornness at 5.0% or more. Thus, all these indicators are pointing to rising inflation. This is in line with the emerging global trends. The complacent inactivity of central banks is suddenly giving rise to panic and many are worried that the crisis of 2008-2009 may be revisiting the world economy. Some economists are viewing the emerging trends with great alarm. The low interest rate regime since 2008 is finally giving way to higher interest rate as the concerns for fighting inflation outweigh the political desire for economic growth. We see clear signs of this trade-off already confronting our policy makers even though it has so far not taken seriously.
Regarding investments, we see continued strong demand both in the balance of payments (discussed later) as well as monetary data. The current account deficit is indicative of higher foreign savings. Also, the robust imports demand led by capital goods, petroleum products (including LNG) and industrial and agriculture raw materials points to significant investment and production activities. On the monetary side, the credit to private sector is rising at about 5%, which is a slightly lower rate than last year, though at a slightly small rate than last year, and has a high share of fixed investment.
The worrying developments on the policy side are deepening. First, the good news on the fiscal side is FBR collections, which are so far on track at about 19% growth. However, for the second consecutive year, there are serious doubts about the collections of the non-tax revenues. The capital gains accrued to the central bank after depreciation of rupee would be helpful in partly making up the shortfall but would not be sufficient to make up the shortfall.
The real worry is the state of fiscal deficit. Even though the details of fiscal operations for Jul-December 2017 have indicated a moderate deficit of 2.2%, the financing data and the increasingly rising current account deficit are telling a different story. From the financing side, the deficit appears to be quite high in the first seven months of the year. The borrowings from SBP at Rs 734 billion up to 9-2-2018 are not only very high but are indicative of deleveraging by the commercial banks. The latest BoP numbers indicate net external borrowings close to $3.8 billion or more than Rs 410 billion. The borrowings mobilized through national savings are estimated at Rs 112 (based on actuals of Rs 96 billion in first six months). The fiscal deficit, thus, works out at Rs 1256 billion, or 3.5% of GDP. At this rate, the annualized deficit is estimated at 6.0%, which is significantly above the budget target of 4.1%. The estimate of deficit from net accumulation of debt is much larger, as reflected in the end December numbers on central government debt, at Rs 1,362 billion.
Equally disturbing are the conditions prevailing in the government debt market (since July 2017). For more than six months no auction for PIBs succeeded in meeting the borrowing targets. Consequently, all borrowings are made in the short-term paper. Even here, things are quite alarming as the entire borrowings are done in the three-month paper. This is causing a significant distortion in the term-structure of the public debt. This situation is due basically due to misalignment of policy rate in line with the expectations of the market. The inflation, exchange rate pressures – underlying balance of payments pressures – and market expectations are signaling that major adjustments in key economic variables are long overdue and should be effected without further loss of time.
Second, the balance of payments is continuing to deteriorate. In January, the current account deficit was $1.6 billion, one of the highest in recent history. The deficit in July-January FY18 has risen to $9.2 billion, which is 48% higher than during the same period of last year. The financing gap to fund the deficit is continuously rising. Reserves are freely used to meet this gap, with the result that they stood at $ 12.8 billion on 9 February 2018. But this comparison misses fresh borrowings undertaken to finance the deficit. In the last about 16 months, the country has borrowed $7.7 billion, none of that has gone to raise country’s reserves. On the other hand, from the high level of reserves in October 2016, the country has lost $6.6 billion of reserves. This shows we have used $14.3 billion in financing the external account. Effectively, this means that we are throwing precious (and borrowed) foreign resources for the sake of maintaining so-called exchange rate stability. It is an untenable position to support an artificial exchange rate, which essentially amounts to subsidizing imports (18.0% growth this year versus only 9.9% last year) while taxing exports (12% growth after 3 years of negative growth). The more we delay this adjustment, the greater would be the required extent of adjustment to bring order in the market.
In this backdrop, it is evident that the policymakers have a tough job in their hands. Whether the Government plans to take corrective actions or would leave it to the next, is not immediately clear. However, it is fairly straight forward that the space for allowing the economy to run on auto-pilot is shrinking fast.