By: Dr Hafiz A. Pasha
There are visible signs that the economy is beginning to slow down. During the last five years, the growth process had gradually begun to gather some momentum. The Pakistan Bureau of Statistics had, no doubt, been compelled to exaggerate the GDP growth rate. But the evidence was convincing that the economy had moved up from a growth rate of 3.7 percent in 2012-13 initially to above 4 percent and approached 5 percent in 2017-18.
The tenure of the IMF Programme did affect the pace of growth. There was heavy additional taxation and restriction on the size of the Public Sector Development Programme (PSDP) in an effort to control the size of the fiscal deficit. The limit to borrowing from the SBP by the Government led to ‘crowding out’ of private investment due to pre-emption of commercial banks’ funds in the purchase of government paper. Further, the policy of a, more or less, fixed nominal exchange rate precluded completely the possibility of export-led growth, while eventually leading to a veritable explosion of imports.
The end of the IMF Programme led to a large-scale removal of policy-imposed restraints to growth. The economic environment also became favourable. Tax revenues were bolstered and imports remained relatively low because of a precipitous drop in international oil prices. Inflation also remained low due primarily to the fall in energy prices.
From 2015-16 onwards, strong expansionary policies were followed on the fiscal and monetary fronts. The spending on the PSDP combined of the Federal and Provincial Governments was raised in real terms by 17 percent in 2015-16 and by as much as 29 percent in 2017-18. Originally, in the budget estimates, total expenditure on the development front was expected to be further augmented by another 30 percent in 2017-18.
There is need to recognize that development spending not only enhances the growth potential of the economy but, as estimated from the BNU Macroeconomic Model, has a more or less short-run multiplier effect of almost two in terms of the impact on the economy. In other words, a 100 billion increase in the size of the national PSDP leads to an almost Rs 200 billion increase in the GDP. A further boost to development spending was provided by the implementation of CPEC infrastructure projects with a large quantum of concessional bilateral Chinese assistance.
Monetary Policy also was aggressively pursued in the aftermath of the Fund programme. In 2016-17, Government borrowing from the SBP reached an all-time high level of Rs 908 billion. This record was broken once again in 2017-18. The policy rate was brought down to the lowest rate of 6 percent in living memory.
There were also fortunately other favourable factors. According to the State of Industry Report for 2016-17 released recently by the Nepra, there was a quantum reduction in load shedding by June 2017. Apparently, in comparison with the peak levels of outages in the earlier years of this decade, load shedding had come down by almost 60 percent in 2016-17. It has probably diminished somewhat more in 2017-18. This has not only facilitated more production but also attracted some more investment.
The initial euphoria after the end of the IMF Programme was, therefore, very visible and strongly articulated by the government. But the effect of expansionary policies was beginning to exert a negative effect by the end of 2016-17. The fiscal deficit went up sharply from 4.6 percent of the GDP in 2015-16 to 5.8 percent of the GDP in 2016-17. The current account deficit of the balance of payments spiralled up from less than $5 billion in 2015-16 to $12 billion in 2016-17.
Towards the end of the third quarter of 2017-18, there was a strong realization that the growth path chosen was becoming unsustainable, especially in the light of the depleting foreign exchange reserves. These were down by $6.4 billion by end-June 2018.
The first punitive actions were largely taken during the tenure of the caretaker government. Releases for the PSDP projects were slashed. In fact, perhaps after a long time, development spending in the last quarter of 2017-18 was actually brought down by as much as 39 percent in relation to the expenditure in the corresponding quarter of 2016-17.
This can be considered the beginning of the slowdown process. The large-scale manufacturing sector was quick to respond. The Quantum Index of Manufacturing was growing at the rate of over 6 percent in the better part of 2017-18. However, in June and July 2018, it grew by less than 1 percent. The stimulus provided by development spending and its absence thereof after March 2018 is visible in the precipitous decline in production of cement and iron and steel. The former industry achieved a growth rate of 37 percent in July 2017. This has fallen to only 1 percent in July 2018. Similarly, production in the latter industry showed exceptional dynamism in July 2017 of over 46 percent. In contrast, output of iron and steel fell by 3 percent in July 2018. Other industries which are witnessing a big slowdown are vegetable ghee, cigarettes, pharmaceuticals, automobiles and fertilizer.
Another visible indicator is the over 70 percent reduction in the current account deficit in August 2018 compared to the level in July 2018. This is due largely to the tapering off of imports. In particular, there has been a sharp decline in imports of machinery by 25 percent in the first two months of 2018-19 as compared to the level in the corresponding period of last year.
There is evidence also that the implementation of CPEC is slowing down. Imports of machinery for electricity generation are down by 40 percent. Further, the flow of Chinese assistance for CPEC infrastructure projects has remained at a very low level. Hopefully, this is not any reflection of any strain in the Pakistan-China ties.
If there are not enough indications of a slowdown, tax revenues of FBR have shown a visible decline in growth rate in the first quarter of 2018-19 to 9 percent from 14 percent in 2017-18. Clearly, the underlying tax bases are no longer so dynamic. To top it all, there is the unprecedented fall in foreign direct investment of 40 percent in July and August 2018-19. This may also be CPEC-related.
Recent actions will cause an even bigger slowdown. The Revised Budget has cut the Federal PSDP by 28 percent in relation to the original Budget for 2018-19. The SBP has jacked up the policy rate to 8.5 percent . It will be surprising if the GDP growth rate significantly exceeds 4.5 percent in 2018-19.
The unfortunate reality is that the slowdown of the economy is not necessarily seen as a bad outcome. If this leads to a continuing decline in the growth rate of imports it will facilitate a quantitative reduction in the current account deficit and reduce the external financing needs for supporting the balance of payments. But the new Government may have to pay a price with regard to unfulfilled expectations regarding more jobs and housing.