The state of the economy

Taking a break from the series on ‘Economic Reforms’, let’s review some major developments that are affecting the economy. First, the good news: the real economy is as strong as reflected in the key economic indicators.

The GDP growth remains robust and the SBP’s monetary policy statement (MPS) has reaffirmed its high growth forecast, albeit at a slightly lower rate of 5.8 percent. The recent IMF mission also held a similar outlook on growth. The reason for this is a report stating that the area under cultivation for wheat crop is less than expected. However, there are also mitigating reports and the six percent growth target may still look realistic.

Price stability has begun to weaken as the international oil prices have touched $70 per barrel compared to an average that fell within the lower $50 range for nearly two years. Inflation during the month of December was recorded at 4.6 percent from 4.0 percent a month ago, and 3.7 percent a year earlier. The six-month average inflation for July 2017 to December 2017 was recorded at 3.75 percent – lower than 3.88 percent for the same period in 2016. What is somewhat worrying is the stubbornness of core inflation (excluding the prices of food and energy items), which is being recorded at 5.5 percent for quite some time.

The agricultural sector has performed very well for a second consecutive year. The major summer (Kharif) crops – rice, sugarcane and cotton – have all shown significant growth. The wheat crop is projected to be the biggest ever crop at 26.5 MT. Despite a reported reduction in area under wheat crop, both the USDA and UN-Agriculture reports of January 2018 are optimistic about the target. The weather conditions are also reportedly favourable for the crop.

The large-scale manufacturing sector (LSM) has recorded perhaps its finest performance in more than a decade. Between July and November, 2017, the LSM growth was registered at 7.2 percent as compared with 3.2 percent for the same period last year. The growth rate for leading LSM products was: electronics (55 percent); iron and steel (40 percent); automobiles (24 percent); petroleum products (12 percent); non-metallic mineral, including cement (11 percent); paper and board (six percent); engineering goods (five percent) and food and beverages (five percent). The textiles sector also registered a positive growth. The only significant setback was the 11 percent decline in the production of fertiliser, largely due to the unusually high stocks and gas pricing issues with respect to the use of LNG for fertiliser sector.

The investment demand is also very high. An indirect indicator of rising investment is the demand for imports and the current account balance. Even though there was some deceleration in the demand for imports after the recent depreciation of rupee, the level remains quite high and capital goods, energy and industrial raw materials continue to be our main import items. The machinery growth went down a little (three percent), but the level remained high at $5.5 billion. Petroleum products saw a growth of 33 percent with a significant increase in quantities. Raw materials for the industrial and agricultural sectors also showed growth, with highest growth being recorded by transport (43 percent), metals (31 percent) and agricultural inputs (19 percent).

However, the developments that are worrying are related to economic management. First, even though the state of fiscal affairs for July-December will not be known until the end of February, some indirect estimates are not very encouraging. The SBP’s report on the central government debt for July-November shows a marginal increase in debt (deficit) of Rs.1.1 trillion or three percent of GDP. On the other hand, the MPS has hinted that the deficit will stand at 2.5 percent. Both are off the mark and the main reason behind the weakening of the economy.

Second, the balance of payments (BOP) is still the economy’s main vulnerability. The current account deficit is all set to rise to five percent of the GDP ($15.2 billion) against a deficit of four percent ($12.0 billion) recorded last year. In the first six months, it is already 1.6 times higher than the last year. The pace of growth in imports and current account deficit is slower, possibly due to the recent depreciation of rupee. Exports are, however, rising.

Third, the current account deficit, as we have repeatedly underlined, is not bad for a developing economy. It is, however, the financing of this deficit that poses a challenge. For nearly 16 months the gap has been met by drawing down on our reserves, while we have contracted a significant amount of additional debts as well. From July 1 to January 18 alone, we lost $3 billion in reserves and also borrowed $3 billion. This means we have used up $6 billion to finance the deficit. This is not a tenable situation.

Fourth, the SBP, through its latest monetary policy statement, raised the policy rate by 25 bps. With this, the serenity and placidity prevailing in the financial sector has given way to uncertainty. The decision was inevitable as pressures were rising on the prices as well as on liquidity in the market. The expectations for this policy change were building up in the auctions of government papers. The banks were prepared only to invest in papers for three months and not beyond. As a consequence, the government’s borrowings from the central bank (currency printing) were rising. This will also have adverse effects on the fiscal deficit.

Finally, the credit rating of the country has slightly downgraded. Fitch announced last week that it has changed the outlook for long-term foreign obligations from ‘stable’ to ‘negative’ while maintaining the basic rating at ‘B’. This is the first time that the country has had a negative correction on its international rating since 2013. This would contribute to weakening the outlook of the economy.

To sum it up, we see that the real economy is very strong and robust but the policy framework is weak and stifling. It is understood that the political environment is affecting our economic decision-making. However, whatever space is available to policymakers should be used to contain the damage that is fast undermining the economic gains that the country has achieved. The time to act is now. The twin deficits have to be addressed.

The writer is a former finance secretary. Email: waqarmkn@gmail.com