Spearhead Analysis – 22.08.2017
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
On August 16, 2017 prominent members of The Pakistan Business Council (PBC) had a meeting with the Prime Minister of Pakistan, to advocate a National consensus around a “Priority Pakistan” approach. The main thrust of the meeting was to propose a way to achieve a strong, sustainable domestic industry built around Jobs, Value Added Exports / Import Substitution, and conducive Tax regime. The PBC members include some of the most prominent businesses in the country, including 24 of the largest Multinational Corporations (MNC’s) from 12 different countries, with a significant contribution to the economy across 13 key manufacturing and service sectors.
The current state of Pakistan:
In a recent article Mr. Sakib Sherani, has aptly summed up the current state of Pakistan:
“The stifling and inept economic policy framework put in place since 2013, under the guidance of the IMF, has suffocated the documented economy (especially manufacturing), given a boost to the informal sector (mainly trading), and run large parts of the industry into the ground — especially the export sector. While predatory revenue collection from existing taxpayers has been masquerading as economic policy since 2013, Senator Dar has combined two other damaging elements in his policy framework — an overreliance on borrowing, and an overvalued exchange rate. This combination of policies has resulted in the export sector losing competitiveness against international competitors, and domestic manufacturing in the formal (i.e., large-scale, documented and taxpaying) sector losing out to cheaper imports as well as to the informal sector which operates without the burden of taxation.”
These are the exact sentiments which have been presented by the PBC in its detailed presentation to explain what ails the economy of Pakistan.
After achieving a high GDP growth of 9% in 2006, and a low of 2% in 2010, Pakistan has been able to improve the picture with GDP growth of around 5%+ in 2016.
Yet, despite the higher growth rate all is not well on the economic front:
- Current Account deficit was US$13.3 Billion in FY2017 (FY2016: US$3.3 Billion deficit)
- Exports were down to US$20.4 Billion in FY2017 (FY2016: US$20.8 Billion)
- Imports were up to US$53 Billion in FY2017 (FY2016: US$44.6 Billion)
- Trade Balance worsened to (-)US$32.6 Billion in FY2017 (FY2016: (-)US$23.8 Billion)
- Remittances were down to US$19.3 Billion in FY2017 (FY2016: US$19.9 Billion)
The fundamental issues have not been addressed and it would appear that Pakistan requires assistance. This at a time when the priorities appear to be skewed towards personal and party survival in the wake of the Panamagate verdict. It is a fact that Pakistan’s share in the global exports continues to decline from 0.16% in 1998 to 0.13% in 2016. This is a reflection of the low ranking of Pakistan on the Global Competitiveness Index of 122nd out of 138 countries.
The decline in key inflows and fiscal deficits have placed considerable pressures on the economy, which have led to an increased level of debt. The Government of Pakistan Debt is at 75.4% of GDP as per PBC (while the Ministry of Finance by moving the goal-posts and re-defining debt has been reporting lower numbers) as opposed to a median debt of 52.8% for B-rated countries. In terms of debt profile, as a percentage of GDP around 32% of the debt is short term while 31% is foreign debt. The debt servicing cost consumes 25% of the export earnings and the cost of debt as a percentage of revenue is 3X B-rated sovereigns. The foreign exchange reserves are sufficient for 3.5 months of imports only, and in recent months the level of reserves with the State Bank of Pakistan have fallen below the US$16 Billion level.
The private sector consumption level is 80% while the public sector consumption level is 11.8% and Investment level is 15.2%. The private and public sector consumption levels are well above peer countries while the investment level is below peer countries. The private sector credit is 14% of GDP, and the high level of lending to government is crowding out the private sector. All this translates into lower availability of funding for boosting the manufacturing sector.
Pakistan’s private consumption levels have remained well above India (59.4%); while the Investment levels are far below India (30.7%).
In terms of foreign direct investment (FDI) the largest component has been in the Consumption sphere, which further reinforces the rapidly rising consumption pattern in the economy.
- Nestle US$450 Million investment in milk chain.
- Coca Cola US$380 Million expansion
- Friesland Campina (NL) bought 51% of Engro Foods for approx. US$442 Million
- Arcelik of Turkey acquired Dawlance Appliances for US$250 Million
As evident by the high levels of imports and the consumption trends for Pakistan, there has been an appreciable decline in the level of manufacturing activity since 2008 and Pakistan appears to be trending towards transitioning into a retail and trading economy. The share of manufacturing sector as a percentage of GDP in the economy which was 18.5% in 2008 has now declined to 13.5% in 2016; while the Large Scale Manufacturing (LSM) after peaking at 14% in 2008 has come down to 12%. These are significant declines and likely to exert negative pressures on the economy. The PBC feels that the exchange rate has not been utilized effectively to gain a competitive advantage as the rate has largely remained unchanged since January 2016, apart from the marginal controversial devaluation recently. Historically the rate of adjustment has averaged 5% per annum over the past 20 years. As per PBC the risk adjusted Interest rate differential and difference in inflation rates would suggest a correction of 7%-8%. A few multilateral agencies as well as some leading Economists in Pakistan have hinted at the Rupee being over-valued against the USD by 8%-15%. This is placing Pakistan at a severe cost disadvantage and robbing the country of millions in lost exports.
Apart from the currency impact the Pakistani exporters are at a cost disadvantage in terms of Gas and Labour costs, which are between 1.9 to 2.6 times higher than those of peer countries. In addition, the power (electricity) cost is higher for Pakistan. Given the higher costs and severe disruptions due to shut-downs and shortages of utilities, the manufacturing industry continues to suffer.
Pakistan’s corporate tax rate is amongst the highest with a host of indirect taxes imposed to meet the government’s revenue shortfalls. The regressive tax regime discourages capital formation and reduces competitiveness.
The manufacturing sector while contributing 13.5% of GDP contributes 58% as percentage of tax revenue; as opposed to Retail which is 18.5% of GDP and contributes 1% as percentage of tax revenue. The dominant service sector is 59.6% of GDP but contributes 37% of as percentage of revenue. The Textile sector, which is the largest contributor to exports is suffering on account of low availability of cotton with production down to 8.25 Million Bales in 2016 from a high of 11.1 Million bales in 2004. In contrast India is at 27 Million Bales. Production trend of cotton in Pakistan has remained relatively static with no major improvement in crop quantity.
As a result of the multiple issues facing the manufacturing sector the share of manufacturing is 20.9% of GDP in Pakistan as opposed to 29.8% in India and 40.3% in Indonesia.
PBC Recommendations for Priority Pakistan:
The PBC has proposed a number of initiatives for the development of a cohesive and consolidated long-term frame-work to facilitate the growth of the manufacturing sector. Some of their key recommendations focus on:
- Tax regime changes, consolidation and harmonization to facilitate capital formation and improving investment and competiveness.
- Cohesive and consistent long term policies for job creation through value-added exports and import substitution.
- Availability of Energy at a competitive cost
- Use of the exchange rate mechanism to create competitiveness
- Prevention of CPEC SEZ’s from undermining the existing local industry
- Creating long term debt market to fund mortgages, project finance and infrastructure
Given the recent write-up by Spearhead Research on the low ranking of Pakistan on key social and economic indicators, the presentation by the PBC highlights the shortcomings which are hampering the growth within the manufacturing sector. It is imperative to build up a sustainable manufacturing base to cater to the rapidly increasing population and to make the sector a meaningful contributor to the development of Pakistan. A road-map has been outlined by the PBC and the Government needs to make Pakistan a priority. There has to be a realization that Pakistan needs to move beyond preservation of personalities and towards a sustainable long-term development road-map, to increase its foot print in the Global economic arena.