an economic snapshot...an economic snapshot april 12 2013 this month political activities have...

An Economic Snapshot

April 12

2013 This month political activities have overshadowed Pakistan’s economic landscape. The caretaker set up has been put in place while the ECP is grappling with the myriad issues as it prepares the country for the upcoming elections.

An update of March 2013 Analysis

Developed by:

Spearhead Research - Pakistan

Pakistan Economic Snapshot – April 2013

www.SpearheadResearch.org

Table of Contents Overview ........................................................................................................................................ 3

Energy Crisis ................................................................................................................................... 4

Industry .......................................................................................................................................... 5

Foreign Investment ........................................................................................................................ 6

Foreign Assets ................................................................................................................................ 7

Informal versus Formal Sector ....................................................................................................... 8

Management Issues ....................................................................................................................... 9

Conclusion: ................................................................................................................................... 10

Recommended Articles ................................................................................................................ 11

Monetary policy: More of the same ........................................................................................ 11

Financial hara-kiri ..................................................................................................................... 15



Overview

This month political activities have overshadowed Pakistan’s economic

landscape. The caretaker set up has been put in place while the ECP is

grappling with the myriad issues as it prepares the country for the upcoming

elections.

The economy continues to be plagued by a poor law and order situation, a

horrendous power shortage, political shenanigans, potential militant

threats, ethnic discord, and sectarian strife. Pakistan Army continues to

conduct a decisive operation against the Taliban in Tirah Valley, a short

distance from the city of Peshawar.

The political ramifications of the upcoming elections are significant not just

for Pakistan, but the region as a whole. The United States seeks stability as it

extricates from Afghanistan, and this is hugely dependent on the domestic

stability in Pakistan. The outcome of the elections will define Pakistan’s

future direction and willingness to negotiate with the neighboring countries.

The political “scuffles” during the past five years and the lack of a genuine

desire to bring real economic improvement has brought the country at this

low point. Pakistan’s economy is in dire straits and the Government has

done little to reverse the downward trend. A long list of financial scandals

and court cases continue to be highlighted by the media, as the country

prepares for the next general elections in May 2013, hoping for “change”

and a path out of the present morass.

There continues to be potential for economic growth and change with

professional management, fiscal discipline, and a genuine effort. However,

this will all depend on the outcome of the elections and resiliency with

which the new Government pursues an agenda of real economic reform.



Energy Crisis

32,400MW will be Pakistan’s power generation capacity by 2018, if

the next govt were to do absolutely nothing to prevent or slow

down the progress currently being made on projects that are

already approved and progressing. The power crisis has continued to worsen and is believed to be the single

largest factor threatening Pakistan's economy. The duration of load

shedding has increased to 14-18 hours in urban areas, while in rural areas it

is even more. The situation is anticipated to worsen in the coming hot

summer months. The presence of subsidies has only served to increase

government spending, and the huge circular debt continues to worsen the

situation, with major institutions such as PSO having to be bailed out to

avoid default and collapse. The private sector has taken an initiative to

increase national power production capacity and by 2018, it is estimated

that private sector projects will increase their output to 32,400 MW from

the current 23,500 MW, by targeting cheaper alternatively available sources

of fuel.



Industry

New loans to the manufacturing sector topped Rs136 billion

during the first eight months of the fiscal year ending June

30, 2013, up by a whopping 61% compared to the same

period in the previous year. Financial institutions appear to be taking a positive view of the

manufacturing sector, with funding for some long-term projects, which are

expected to improve employment opportunities. In the first eight months a

61% increase in loans was recorded as compared to the last fiscal year.

Machinery imports are up by 9% in 2012, considering imports shrunk by

10% in 2011 and remained stagnant in 2010.

The expansion in credit to private sector businesses is higher than the last

three-year average of Rs133.4 billion and closer to the five-year average of

Rs159 billion for the first six months of a fiscal year.



Foreign Investment

According to SBP, the first eight months of fiscal 2013 saw

net foreign investment reach $688 million, up more than

63% compared to the same period last year. Foreign investors are once again showing interest in the Pakistani market.

Investment recorded in the first eight months of this year was valued at

$688 million (63% rise), and is estimated to touch $1.2 billion by the end of

this year. SBP’s report claims foreign investment to be the largest predictor

of change in Pakistan's growth rate. Therefore a rise in foreign investment

could lead to an overall improvement in the economy. A smooth democratic

transition can be expected to further boost investment.



Foreign Assets

According to policy review, SBP’s foreign exchange reserves

have declined by another $2 billion; from 8.7 billion at end-

January 2013 to $6.7 billion as of 5th April 2013, mainly due

to debt payments.

Debt repayment is a pressing issue and over the course of this year foreign

exchange reserves will fall by approximately $6.458 billion as per SBP. An

amount of $2.3 billion in IMF loan’s has been retired the first nine months of

FY2013, with scheduled payments of $838 million remaining for FY2013 and

$3.2 billion due in FY2014. Even with these loan payments to IMF the rupee

continues to hold its strength. Remittances continue to be a strong part of

Pakistan’s economy, though a drop in remittances is being witnessed - the

first in seven years. This is however, believed to be temporary due to the

current political uncertainty.

Strong positive sentiment regarding a democratic transfer of power, a low

return on deposits, and improved financial reporting by some sectors has

channeled funds towards the stock market and this trend is expected to

continue in the short to medium term.

Timely elections are imperative for Pakistan to be able to negotiate with the

IMF, and political stability will greatly influence its credit rating and

influence the terms of any such negotiations.



Informal versus Formal Sector NEW estimates indicate that Pakistan’s informal economy is larger than

previously approximated, and is expanding at a rapid pace. On the other

hand, the formal sector appears to be on the retreat.

“Substantially larger than previous estimates of between 30 per cent to 50 per cent (albeit using

different methodologies). If correct, this implies that the overall size of Pakistan’s economy, both

reported as well as unreported, is around $420 billion, with private consumption at current prices

amounting to a whopping $365bn in 2012.

The trend of rising informality of the economy is no cause for celebration. While a large informal

sector acts as an important shock absorber for an economy gripped by a fairly lengthy period of

sluggish jobs and income growth, the trend of growing informality — that too from an already elevated

starting point, and at the expense of the documented economy — depicts the operation of very

serious structural constraints for the country’s formal sector, and for its overall, long-run growth

prospects.”

Sakib Sherani

The signs of slowdown and fatigue are beginning to appear in the formal

sector of the economy, with a decline in exports, a fall in the aggregate

demand, reduced power availability, and the fall in the FMCG sector.

The informal economy on the contrary continues its growth trajectory. The

recent Tax Amnesty scheme for smuggled vehicles has provided a huge

boost, even though from the broader economic standpoint such amnesty

schemes have always proved to be disastrous in the long run. The Benazir

Income Support Fund and the PML(N)’s rejoinder in the form of Sasti Roti,

Free Laptops, Ujala and Danish schools are all viewed as politically

motivated with a temporary positive impact, while creating dire

consequences for the broader economy. This is akin to treating a cancer

patient with an injectable saline solution.

Although the economy is not expected to show significant improvement in

the near-term, it is expected to sustain itself in the short term.

http://dawn.com/author/dawnsakibsherani/



Management Issues

Policies guided by “politically motivated” Economists and Bureaucrats, who

have continued to place reliance on external funding, at the cost of

developing internal sustainable sources have created an economic morass

and a huge debt burden. Pursuing short-term goals for political mileage has

jeopardized real economic development and the resultant trickledown

effect on the economy. A continued focus on Consumerism has fueled the

informal economy, at the risk of long-term stability and growth.

There is a genuine need for fiscal stabilization and growth, with some tough

decisions to tackle the economic situation. Again a lot rides on the outcome

of the elections.



Conclusion:

Pakistan’s economy is in need of serious restructuring. The caretaker

government is not in a position to take long-term policy decisions, but it can

in its short tenure set a direction to rectify the damaging practices and chart

out a trend for the future. It is imperative to appoint a caretaker Finance

Minister, a post that still remains vacant. While the caretaker government

will have serious difficulties in managing the country’s finances during April-

June, the 90 days period of the interim set-up is an opportunity to arrest the

process of decline and set the tone for the future.

The incoming government would need to take decisive steps to improve the

law and order situation and the energy crisis, while facing an increasing

fiscal deficit. Managing these factors will help set the tone for the economy

in the longer term.



Some very informative financial analyses are included in this snapshot for

a more in-depth review.

Recommended Articles

Monetary policy: More of the same By Haris Zamir

Analysts expect the upcoming monetary policy to be one of the last ones

wherein the central bank maintains the status quo. In light of the inflation

numbers for March, economists say that there is a remote possibility of a

half percentage point cut.

Monetary policy decisions cannot be taken in isolation. They require careful

consideration of the bigger picture. If the cut is allowed, it will accelerate

depreciation. Some argue that a cut won’t stem growth as banks are already

parking their funds in the government securities. The overall expansion in

credit to private businesses is higher than the last three-year average of

Rs133.4 billion and closer to the five-year average of Rs159 billion for the

first six months of a fiscal year.

However, this increase is still insufficient to stimulate the economy given

the depressed state of investment expenditures. Moreover, the credit to

private businesses as percent of GDP and broad money is also the lowest in

the last five years. This low credit off-take in the private sector is caused by

energy shortages; poor law and order conditions; and a very high supply of

risk-free government securities.

The new government should take decisive steps to address the law and

order situation and the energy crisis. Managed properly, all the factors help

set the tone for the monetary policy stance and shortcomings will be

diluted, rather the State Bank of Pakistan (SBP) may not move towards

tightening of policy.

The new government will also confront a ballooning fiscal deficit, hefty

borrowing from private banks and clinching the share private sector. Since

June08, Pakistan’s total debt exceeds Rs8 trillion. Although the quantum has

increased manifold, Pakistan’s debt position as a percentage of GDP stands

at 61.2 percent, lower than the June08 level of 62.3 percent and well below

the historical average of 76 percent in the last 18 years.



The domestic debt and GDP ratio has increased from 32 percent to 35.2

percent while external debt has come down from 30 percent in June 2008

to 26.2 percent. While the surplus debt being created by a high fiscal deficit

is being offset by increasing GDP, any downwards revision in GDP numbers

can push up the country’s debt ratios.

Fiscal policy remains important for other macro-economic variables. While

achieving fiscal consolidation is a priority, it is important to know where a

high fiscal deficit is being utilised. A substantial amount of total revenues is

being exhausted in servicing of debt, leaving little for development

expenditure. Surging subsidies represent another expense. On average, the

fiscal deficit would have been lower by 1.5 percent during the last five years

in the absence of power sector subsidies. While the deficit remains high,

any resolution on circular debt can substantially improve the fiscal account

position.

Meeting the FY14 inflation target of 8.5 percent will be tough. Upward

adjustments in fuel prices and lack of structural reforms addressing energy

bottlenecks could add to the inflationary pressures. Add to that the rising

trend in monetary aggregates. Given the mercurial nature of perishable

food items’ prices, recent deceleration in food group cannot be relied upon

in the medium to long run.

More importantly, continuous government borrowing from the banking

system and pressures on exchange rate are likely to increase inflationary

expectations and have a negative influence on medium term inflation

outlook. Therefore, fiscal consolidation and attracting capital flows is the

key to locking inflation in single digits.

The SBP has lowered its policy rate by 450 basis points over the last 18

months. The main reason for adopting this stance was a faster than

estimated decline in inflation. This allowed the SBP to place a higher weight

to its concerns of contracting private investment expenditures in the

economy and weak prospects of sustainable economic growth. However,

while pursuing this stance, the SBP was fully aware of the limited

effectiveness of monetary policy instruments in stimulating growth under

the prevailing circumstances.

The key factors constraining the environment include: substantial borrowing

requirements of the fiscal authority due to a structural gap in revenues and

expenditures, declining foreign exchange reserves due to lack of adequate

foreign financial inflows, and persistence of severe energy shortages

because of delays in reforms.



The fiscal authority should have contingency plans to adjust expenditures

and/or increase revenues in case the likelihood of not meeting the revenue

targets is high. The burden of adjustment in Pakistan’s case typically falls on

increased domestic borrowings, including those from the SBP. This creates

numerous risks for macroeconomic and financial stability. An average

annual increase of 25.6 percent in government debt during FY09 to FY12 is

one example. At this pace, domestic debt is likely to double in volume terms

by FY15.

On the external front, the overall balance of payments position is stressed

due to lack of financial inflows and high debt payments. While private

financial inflows remain weak, official government inflows are barely

sufficient to meet the amortisation of medium and long-term loans. In

addition, the SBP has retired $2.3 billion of IMF loans during the first nine

months of FY13. There are also scheduled payments of $700 million in the

remaining months of FY13 and $3.2 billion in FY14.

Taha Javed Khan, head of research at Taurus Securities, said that the SBP is

to maintain policy rate at the current level in the upcoming monetary policy.

Though inflation is expected to dip in FY13 from the current 6.6 percent

level, going forward in FY14, it will increase as high base effect ends in FY13.

Core inflation is still high at nine percent, while external issues seem to be

increasing with dwindling forex reserves.

The previous government brought inflation down to a single digit after four

consecutive years of double-digit inflation. “Entry in an IMF programme will

likely follow reduction in subsidies, which will push end product prices

higher,” said Khan.

The government cannot control international commodity price fluctuation

but a key reason for persistently high inflation is continuous government

borrowing from the SBP. To control inflation, the fiscal deficit must be

checked by increasing the tax base, curtailing subsidies and extra

expenditures.

The process of determining interest rate should follow the natural supply

demand route. Foreign sources of financing the deficit should be identified

instead of direct borrowing from the central bank. Price control of essential

commodities at the retail level will also keep inflation and interest rate

levels in check.



In the absence of fiscal reforms, the prospects of sustainable

macroeconomic stability appear weak. The banking system will continue to

feed the government’s demand for funds instead of lending to the private

sector. The revenue side deficiencies and expenditure excesses cannot be

sustained through high levels of borrowing for long. Therefore, structural

reforms such as broadening of the tax base and limiting unproductive

subsidies are necessary for financial stability.

“We expect interest rates to remain unchanged at 9.5 percent and

continuation of fiscal borrowings from the banking system will remain a key

concern,” said Farhan Mahmood, head of research and business

development, Sherman Securities. Besides bank borrowings, SBP is expected

to keep a watchful eye on decisions by the interim political set up, which

may affect monetary policy. The interim government may take some

unpopular measures to bridge the fiscal deficit by raising gas, electricity and

oil product prices, which could elevate CPI numbers.

One key reason for high inflation is the supply side bottlenecks. This can be

gauged by the fact that between FY08 and FY12, average Large Scale

Manufacturing (LSM) growth stood at only 0.6 percent versus growth

between FY03 and FY07) of more than 12 percent. This is attributed to a

growing energy deficit and circular debt.

An area of concern for investors is the outlook on interest rates, which is

fueled primarily from fiscal deficit. To tackle interest rate, the new

government will have to increase tax revenues and reduce losses of public

sector enterprises (estimated to be more than Rs300bn per annum).

Tax collection can be raised through proper implementation of tax system,

resolution of pending tax issues or levying taxation on new sectors.

Interestingly, there are a few sectors, which are not in the ambit of taxation.

This includes the milk and meat markets. If only these two are targeted,

more than Rs300 billion can be collected in taxes.

The writer is the head of the business desk at GEO TV.



Financial hara-kiri Dr Ashfaque H Khan

Tuesday, March 05, 2013

One thing that distinguishes the current regime from its predecessor is the

extent of its fiscal indiscipline. Never in the history of this country has the

nation seen such a fiscally irresponsible government. They have maintained

a large budget deficit year-after-year over the last five years, and

accordingly more than doubled the country’s public debt ably assisted, of

course, by the exchange rate depreciation. Accordingly, they damaged a

relatively robust economy in a short span of five years without guilt and

shame.

Because of unwillingness to mobilise resources on the one hand and

reckless spending on the other along with an unconsidered NFC Award,

Pakistan’s fiscal balance has been destroyed thoroughly in the last five

years. The nation will witness further instances of financial hara-kiri in the

last two weeks of the present regime the impact of which will continue to

haunt the economy in the years to come.

The reckless doling out of the country’s financial resources and jobs and the

arbitrary appointments of ineligible people to key institutions including

financial ones are unprecedented in magnitude. The extent of financial

damage in the shape of power sector subsidies, bailout packages for the

rotten PSEs, BISP, circular debt, etc will not be fully known until several

months have passed after the exit of the present regime.

A race has begun between the federal and provincial governments to

implement senseless policies. Recent examples include abolishing the

condition of having a National Tax Number (NTN) to purchase a new car – a

move, which is contrary to the rhetoric of broadening the tax base;

appointing unqualified people in the board of directors of the State Bank of

Pakistan (SBP); making hundreds of thousands of contractual employees

permanent; and giving hundreds of thousands rupees interest free to the

so-called youth.

The planning commission has become a hub for ministers and key

parliamentarians, as they are seen moving around on different floors

seeking approval for their projects and release of funds. The deputy

chairman of the planning commission is obliging them.

Doling out resources in such a fashion in the name of bestowing benefits to

the people of Pakistan at the fag end of the tenure is shameful. Can the



exchequer of this poor nation afford to bear the burden of such reckless

spending? They are destroying the country’s finances for ‘winning’ elections

and even if they ‘win’, there will be hardly anything left to govern. The only

available source of funding would be the printing machine to ‘print’ local

currency. Is this what we are waiting for?

A government that indulges in reckless spending in the name of helping the

people at the end of its tenure is acknowledging its own failure. Since its

leaders have failed to deliver during their tenure, they are attempting to

curry favour by securing votes through reckless spending in the last few

days of the government’s term. This is nothing short of an admission of a

grand failure.

What will be the consequences of this financial hara-kiri for the budget

deficit of the ongoing fiscal year? The present regime inherited a budget

deficit of 7.4 percent of GDP in 2007-08. They would certainly leave the

government by making a much bigger hole in the budget 2012-13 – an

unprecedented void in Pakistan’s fiscal history.

In my article printed on September 25, 2012, I analysed budget 2012-13 in

greater depth. In my view the budget was prepared in a casual manner with

fragile numbers. The budget makers were not serious; did not do their

homework, and simply tried to put together irrelevant numbers in a hurry.

It was clear that the budget for 2012-13 would die its natural death within a

few months of being made public. Based on the assessment of revenue and

expenditure and keeping in view the election year, fiscal deficit for the year

was projected in the range of 8.0-8.5 percent of GDP. The recent

developments have defied even my cautious assessment. It is therefore safe

to argue that budget deficit in the current year may reach a level not seen

before in Pakistan, with severe macroeconomic consequences. There are

calculations made by different sources, which suggest that budget deficit

could swell to 11 percent of GDP in 2012-13.

As stated above, the extent of damage caused by the current financial hara-

kiri will not be known until next year. This is a horrendous development in

the making. In such eventuality, Pakistan may face a Greece-like debt crisis.

In fact, Pakistan is already facing a serious debt repayment crisis. The SBP’s

own statistics show that Pakistan will witness net drains on foreign currency

assets in terms of loan repayments during January-December 2013 to the

extent of $6.458 billion. Against the SBP’s foreign exchange reserves of $8

billion, it has bought $2.325 billion in forward market from commercial

banks. In other words, to protect its reserves, the SBP has borrowed $2.325



billion from commercial banks and continues to refinance it. Hence, either

the SBP’s or commercial banks reserves are overstated to the extent of

$2.325 billion.

Is there still any doubt that Pakistan is not facing a debt crisis? The governor

of the SBP has not only misguided the Ministry of Finance but also the

political leadership by not revealing the truth. I would urge the readers as

well as the governor to read Dr Muhammad Yaqub’s article ‘The office of

denial’ (March 2) to ascertain the facts.

The current financial hara-kiri will simply speed up the crisis. The caretaker

government will have serious difficulties in managing the country’s finances

during April-June. The post-election government will face the real music of

unprecedented profligacy and the people of Pakistan will continue to suffer

in years to come. In the meantime, the rot continues and the race to the

bottom goes on.

The writer is principal and dean at NUST Business School (NBS) Islamabad.

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