Spearhead Analysis – 28.03.2017
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
There has been scathing criticism of the Pakistan economic performance by some leading economists of the country, who continue going hoarse trying to raise some pressing economic issues facing the country. At the same time the government has received ‘glowing’ accolades from multi-lateral and rating agencies on the different facets of economic performance. The Government too has been providing clarifications on the debt situation of the country in an effort to allay fears over a situation that has been termed alarming by some quarters. For the layman it becomes increasingly difficult and confusing to decipher the economic indicators and determine where we actually stand. The economic statistics portray a mixed trend and it is important to understand how the country has fared over the past three years, in comparison to when the present Government assumed power. It is no mean feat that institutions such as Bloomberg, PWC, Reuters, Fitch, S&P, and Moody’s have not only praised the economic performance of Pakistan, but cited it as one of the potentially fastest and higher growth economies. Pakistan stock market has been also highlighted as one of the best performing indices in the region and the country has received stable ratings. All positives that need to be recognized.
Table-1 provides a snapshot of the economic performance of the Government from 2013 to 2016:
TABLE-1: ECONOMIC SNAPSHOT
(Converted to USD using that years’ Rupee rate)
SOURCE: Global Economy; Trading Economics; PBS; Ministry of Finance; UNDP
Pakistan has accumulated around USD 40 Billion of additional debt (internal and external) during the period 2013 to 2016. This figure is based on the data provided by the Ministry of Finance and confirmed by the Finance Minister in a recent write-up. As a result, the debt to GDP ratio has crossed the stipulated threshold of 60%, while the government has approved a waiver to bring the ratio within the stipulated level by 2018. It is important to note that while the debt to GDP ratio is estimated at 65% (2013: 63%) as per government estimates, this is based on ‘modification’ of the parameters and the actual ratio is estimated to be closer to 70%.
The Circular Debt continues to hover around Rs.325-350 Billion (2013: Rs.500 Billion) and while it has been reduced, claims of eliminating the balance have proved to be false over the past three years. Debt servicing is eating up around USD 5.3 Billion, down from USD 6 Billion plus in 2013, with lower interest rates and refinancing. With the rising debt it is expected that the pressure from repayments would also rise in the near future. Whichever way one looks at the situation, that fact remains that Pakistan continues to pile on additional debt to meet its financing needs. In addition, developmental priorities appear to be skewed towards vote-gathering initiatives rather than real economic development, which is resulting in providing subsidized services as in the case of Metro, Speedo and other such ventures. The country continues to assume more debt for this purpose, which will have to be repaid at some point, placing increasing pressures on the economy in the absence of viable revenue-generating projects.
Inflows and Outflows:
The forex reserves increased by some USD 15 Billion in three years (2013-2016), built up mainly through acquisition of debt. However, the reserves have started to come under strain in recent months with the rise in the import bill, falling exports, stagnant remittances and rising repatriations. The export decline is a significant factor with a fall of almost USD 7 Billion in the past three years. There has been no significant improvement in the Competitiveness Index in the past three years, which shows that no efforts have been made to improve the global standing of Pakistan’s exports. In recent years a number of the larger export houses have changed direction and are looking inwards at the retail sector, where they can charge higher margins to off-set the decline in export earnings.
With a robust and growing middle class the inward strategy appears to be working well for many of the larger export houses. At the same time the construction sector continues to thrive with mega projects underway within the residential and commercial spheres. This has been a boon for the construction materials industry which is churning out record profits. Consumer goods companies are also capitalizing on the middle class growth with manufacturers in the electronics, food and clothing sectors expanding rapidly. Foreign companies have also showed interest and there have been investments from Turkey, Denmark and within Pakistan from the Fauji Group.
The trade deficit has continued to rise and has touched a level of USD 24 Billion, which is a rise of USD 4 Billion over the past three years. The Foreign Direct Investment (FDI) growth, despite a modest pick-up in 2016, has been fairly insignificant and the country has been forced to shift its focus to financing through debt accumulation. Recently, the government in an effort to stem the decline in outflows has imposed 100% margin requirement for import of 404 consumer items. Rather than making efforts to improve competiveness and access to markets for exports the focus appears to be on implementing further controls. A competence, productivity, and governance gap is creating problems in terms of improving the inflows and stemming the outflows from Pakistan.
The GDP has improved over the past three years, as has the GDP per capita. The government has also been striving to improve the tax collection rate which has increased to 10.5% of GDP (2013: 8.5%). However, a lot more needs to be done on this front as there is considerable potential to expand the tax net. With vested interests, a culture of non-payment and tax evasion, and corruption; it is an uphill task that requires an unbiased and objective strategy for genuine improvement. The growth rate of Pakistan has improved to 4.7% and is projected to cross the 5.0% threshold by 2018, which is encouraging.
The country continues to operate in a low-interest rate environment with key SBP interest rate maintained at 5.75% (2013: 9.0%). While there was an expectation that low interest rates would spur investment and economic activity, that has not been the case. The manufacturing sector has all but stalled and the major beneficiary of bank lending has been the Government of Pakistan. Money has continued to flow into the stock market, which touched the unprecedented level of 50,000 and has attracted Chinese investment; and, also into real estate sector, which has seen significant rises. These improvements appear to be at the cost of building-up capacity in the manufacturing sector.
The USD and Pak Rupee conversion rate has risen to around Rs.104.50 in 2016 from Rs.99.50 in 2013. In recent months there has been increasing pressure on the Pak Rupee as it touched levels of Rs.108 against the USD. This has been the result of the deteriorating fiscal situation in the wake of declining exports, stagnant remittances, low levels of FDI, and the weakening reserves position. The government continues to control the exchange rate and in the absence of such controls the Rupee is expected to fall to Rs.110 plus against the USD.
Pakistan continues to lag in terms of investment in the Education, Healthcare and Social Services sectors; and, the Human Development Index (HDI) has remained stagnant at around 0.54. This places Pakistan at around 147th amongst 188 nations. It is truly unfortunate that while mega projects are being commissioned within the sphere of transportation and road networks, very little budgetary allocations are being made for social sector reforms. Given the rapidly rising population and meagre and depleting resources it is absolutely imperative to institute policies and budgets to raise the standard of living and the HDI.
The competitiveness index has stayed at a level of around 3.5 during the three-year period and this is reflected in the declining levels of exports, low productivity, negligible FDI, and an all but disappearing manufacturing sector. Despite the record low interest rates there is little interest in terms of investment in the manufacturing sector. Unless efforts are made to improve the competitiveness and productivity of the local industry Pakistan would be marginalized in the global context. The local industry has the benefit of a huge and expanding domestic middle class market with good margins and many are shifting their sales focus inwards as opposed to outwards. This, however, is not a viable strategy as Pakistan needs Foreign Exchange to meet its fiscal needs and the competitive standards would further decline if the focus is inwards only.
There has been a decline in the terrorism index in the wake of Zarb-e-Azb. The start of 2017 saw a rise in terrorist incidents and it is expected that with the new initiative under Radd-ul-Fisaad there would be further improvement in this context. Military initiatives have to be supported by robust policy changes by the Government to bring about meaningful structural changes. Unfortunately, there appears to be a big gap in this regard and the Government does not appear to have followed up on the areas for improvement as identified in the National Action Plan (NAP).
Pakistan continues to lag in terms of building up its educational system, which is absolutely crucial for the development of any nation. The low quality of education is in turn producing an ill-equipped workforce, which is unable to meet the demands for improving competitiveness and productivity. Healthcare is a serious issue that has not been tackled for a long time and the hospitals are over-burdened and unable to cope with the demands of a rapidly growing population. There appears to be little focus towards constructive improvement in these two sectors as the high-profile high-visibility projects such as Metro, Speedo, and road building, appear to take precedence over the social sector reforms and capacity build-up.
Water shortage is a pressing issue that has long been neglected. There are estimates that in the not too distant future Pakistan would be a water starved country. However, no efforts are underway to assess the issue or develop alternatives or educate the people in the context of water conservation. Energy is another vital issue where the government has repeatedly reneged on its promises to eliminate shortages. It is now firmly stating that load-shedding would be eliminated by 2018 election year. Multiple failures in different projects have highlighted the fact that the whole process has been ill-planned and perhaps the promises and targets were over ambitious.
The State owned enterprises (SOEs) such as Pakistan International Airlines, Pakistan Steel Mills, and Pakistan Railways continue to underperform and accumulate massive losses, with the Steel Mill having been closed. These organizations are virtually bankrupt and despite eating up billions of Rupees in grants and subsidies have failed to improve their performance. Unless the government can privatize or turn these enterprises around they will continue to be a massive drain on the economy. Unfortunately, genuine reforms are not being initiated and the losses have continued to pile up.
There have been massive Metro projects at a cost of Billions of Rupees in the major cities of Pakistan The latest being the almost Rs.30 Billion project in Multan. Recently around 200 red buses have started plying the congested roads of Lahore under the name of Speedo. The Orange line is another project that in underway and similar initiatives are being taken up in Karachi. The national highways are being further enhanced and developed.
CPEC is being termed as a game-changer and the answer to Pakistan’s economic woes. One fervently hopes that it will deliver on its promises. Questions continue to be raised over the issue of transparency and the actual cost burden on the economy. While Gwadar is being hailed as a jewel in the crown of CPEC, it still lags in terms of basic amenities and massive development efforts are required to bring it up to international standards as a major port city.
In an article, “Growth Vent and Anchored in History and Geography” (April 2013) Ijaz Nabi, explored the growth drivers for Pakistan both in terms of history and the geographical linkages. He used the approach of looking at episodes of rapid and sustained economic growth and identification of the big ideas (vents for growth), which stimulate the “animal spirits” and result in both higher investment and higher productivity growth. Mr. Nabi, reviewed the different ‘rapid’ growth episodes for Pakistan since 1947, mainly associated with changes in technology, institutions, and legal systems that support the rolling out of a big idea (growth vent). According to him, those growth vents have run their course, and Pakistan now has to seek a growth vent that results in geographically balanced growth and which can be sustained politically for a prolonged period of time. He thus proposes the development of Pakistan as a trade facilitator for China on the one hand, and between the countries to the East and West of Pakistan on the other. This article appears to be well in line with the strategy adopted by the Government of Pakistan with regards to the China Pakistan Economic Corridor (CPEC) initiative; and, the initiatives for facilitating trade with the Central Asian countries.
The improving regional prospects underscore the importance of Pakistan’s centrality as a connector of the regional markets. The reopening of the historical East-West trade routes to trade in goods and energy will provide a renewed strength to the Indus Basin market by increasing the flow of economic transactions. It will also help restore the economic and cultural vibrancy of the sub-regions and will promote more equitable growth. The new growth vent, one that will give sustained growth for several decades, thus entails Pakistan re-occupying its centrality as a hub for regional trade via CPEC. This, in turn, requires stabilizing the Durand line and re-engaging with Baluchistan in a mutually advantageous economic relationship. Becoming a regional hub also entails normalizing economic relations with India. Finally, to realize the full benefits of a regional trading hub requires strengthening international competitiveness to become a manufacturing hub. This will create regionally balanced, high productivity, high-wage employment and will result in welfare improvements for the citizens of Pakistan. The opportunity is there for Pakistan; time will tell if we capitalized on it or not.
There is no doubt that the Pakistan economy is being burdened by huge amounts of debt as the government struggles to meet its fiscal shortfalls in the face of dwindling inflows. The fiscal pressures are likely to increase in the near future, and one stark indicator is the decline witnessed in the forex reserves. There is a possibility that the government might be forced to devalue the Rupee and approach a Multi-lateral agency for support in the near future. This in itself is not bad, but has to be supported with genuine fiscal structural reforms to achieve real and long-term improvement. In the absence of that it would again serve as a short-term patchwork of policies with no lasting impact and additional debt for the people of Pakistan to pay. Pakistan has to understand and realize that the geo-political situation around it is evolving and it needs to capitalize on this and develop the growth vents based on its strategic location. CPEC provides that ray of hope, provided it is managed for the benefit of Pakistan. With a robust economic driver in place Pakistan would then have the leeway to address the multiple economic, social and political issues it faces and perhaps turn a corner.