Back at square one

All the generosity shown by Pakistan’s friends especially Saudi Arabia, UAE, and China in the shape of financial packages worth $6 billion for balance of payment support has evaporated owing to high current account deficit despite some insufficient measures by the incumbent regime.

When Pakistan Tehreek-e-Insaf (PTI) had assumed power, the foreign currency reserves held by the State Bank of Pakistan were standing at $9 billion. So with this $6 billion they should have reached around $15 billion but the SBP has reported them to be currently over $8 billion.

This double-edged sword of rising foreign debt and falling currency reserves is slashing across the economy in every possible way.

The current account deficit of over $1 billion on monthly basis cannot provide any solution to this, so this bleeding will have to be stemmed. The International Monetary Fund (IMF) minced no words terming the situation as an alarming persistence of imbalances in the country’s economic fundamentals and Islamabad needed to take more remedial measures to fix it.

The PTI-led regime after examining the causes of recurring economic instability and episodic growth in the country has come up with a roadmap that is heavy in measures zooming in on stabilisation and structural adjustment.

The fiscal deficit, which under the IMF program was brought down to 4.6 percent of GDP in 2015-16, has shot up to 6.6 percent in two years in financial year ended on June 30, 2018. The rise was mainly due to lack of effective coordination between the federal and provincial governments. A coordination binding the federation to a consolidated deficit target and the spending binge of the outgoing federal and provincial governments.

In addition, financial losses of state-owned enterprises (SOEs) were at a record high level of 1.4 percent of GDP. The energy sector’s circular debt had crossed Rs1.2 trillion-mark. The overall expenditure of the two tiers of the government increased Rs 1.7 trillion (i.e. by 30 percent) over these two years, with recurrent expenditure increasing Rs1.34 trillion and development expenditure Rs351 billion.

In addition, the financial losses of SOEs, especially those in energy sector, increased the quasi fiscal deficit to 1.2 percent of GDP. High fiscal deficits adversely impacted economy through multiple influences.

First, both a cause as well as an effect of high fiscal deficits is the substantial increase in public debt – foreign and domestic. The former, at $70 billion in 2017-18, has increased by $20 billion (38 percent) over the last three years, i.e. since the close of IMF program. During the same period, domestic debt increased Rs 4.2 trillion (3.7 percent of GDP). The overall public debt at the end of 2017-18 stood at 76.1 percent of GDP, far in excess of the limit of 60 percent of GDP imposed by Fiscal Responsibility and Debt Limitation Act (FRDLA). The public debt and liabilities have crossed Rs33 trillion-mark with foreign debt and liabilities standing at $99 billion till December 2018.

Despite the artificial stability in interest and exchange rates, interest payments on domestic and foreign debt increased 5 percent and 26 percent, respectively, adding to the fiscal deficit. In addition, repayment of foreign debt led to an outflow of $5 billion/annum.

Large borrowing from the banking system crowds out capital market development and creates a number of distortions in the capital market.

First, by guarantying at least a minimum income through its large risk free lending to the government, banks have no incentive to be more competitive or innovative in terms of introducing new products in the market for depositors or lenders.

The short-term nature of government borrowing from the banking system prohibits establishment of long-term yield curve, which in turn impedes development of capital market in the country.

Islamic banking, which has considerable potential in Pakistan, suffers as they cannot lend to the government.

Third, large fiscal deficits are symptomatic of persistently negative government savings leading to low overall savings and consequently low investment. Public dis-saving over the last 5 years averaged 1.5 percent of GDP. In 2017-18, private sector saving amounted to about 12.2 percent of GDP, of which 1.4 percent was preempted by the government to finance its consumption. A significant part of appropriation of private saving for government consumption takes place through the National Saving Schemes (NSS). These schemes use long-term retails savings to finance short-term government expenditures rather than long-term investment in the country. Consequently, savings in Pakistan, at 10.8 percent of GDP, is extremely low, limiting investment and increasing reliance on foreign savings.

The NSS savings represent a key risk as long-term retails savings are being used to finance short-term government expenditures. It is important to focus on measures that would promote long-term savings to be utilised for long-term investments.

Finally, and critically, higher fiscal deficits also contributed to higher current account deficits, adding to the external vulnerabilities.

The PTI led government argues that consumption-driven growth and bottoming out of domestic savings: Since the early-1980s, the preferred strategy has been to generate economic growth through large-scale borrowing and incentivising consumption.

According to the PTI claim, this was also predominantly the case in the last three years of the Pakistan Muslim League-Nawaz (PLM-N) government. The GDP growth accelerated from 4.1 percent in 2014-15 to 5.2 percent in 2017-18. There, however, were two disconcerting features of this accelerating growth. First, the growth in agriculture, but more importantly in large scale manufacturing (LSM), lagged behind the GDP growth. As a result, the share of LSM in GDP declined from 10.9 percent in 2014-15 to 10.3 percent in 2017-18. Second, the share of consumption increased from 90.7 percent of GDP in 2014-15 to 94.5 percent of GDP in 2017-18 - economic growth was predominantly consumption-driven.

Domestic savings thus plummeted from 9.3 percent of GDP in 2014-15 to 5.5 percent in 2017-18 and national savings declined from 15.4 percent of GDP to 10.8 percent. This level of savings is less than half of Bangladesh’s, about one-third of India’s, and almost one-fifth of China’s. Nonetheless, domestic investment showed some improvement (from 15.7 percent of GDP in 2014-15 to 16.4 percent) propped up by foreign savings (as seen in the rising current account deficit).

In order to pin-point as to what led to an alarming increase in the current account deficit it must first be understood that the artificial stability in the exchange rate and interest rate regimes in a period of galloping demand mounted pressure on the balance of payments. Imports increased $17 billion in the last two years (from $50 billion in 2015-16 to $67 billion in 2017-18), whereas the increase in exports was only $2.5 billion (from $27.6 billion in 2015-16 to $30 billion in 2017-18). Consequently, the trade deficit ballooned from $22.7 billion to $36.9 billion.

This large increase in trade deficit was compounded by a flattening of workers’ remittances at about $19 billion. As a result, the current account deficit soared from $2.8 billion in 2014-15 to $19 billion in 2017-18, leading to an outflow of $8 billion from State Bank reserves during the last two years of PML-N government. The central bank reserves at the end of fiscal 2017-18 covered less than 2 months of imports, while the economy was in the jaws of a full blown macroeconomic crisis.

To put things on the record the State Bank reserves are again standing slightly over $8 billion, so the we are essentially back at square one. The diagnosis of “consumption led growth syndrome” is correct, but the PTI’s ‘financial physicians’ have yet not been able to revive the ailing economy that’s inching towards flatlining.

The writer is a staff member