SBP’s report on economy

Learning from mistakes

State Bank of Pakistan’s (SBP) report on the economy is now out and makes an interesting read. It is a well researched and comprehensive work which covers country’s economic outlook, growth, energy, monetary policy and inflation, fiscal policy, debt, external sector and a special section to discuss root causes of key concerns facing the economy, such as why our credit-to-GDP ratio is falling, comparisons with regional economies, deflation analysis, and reasons for stagnation in exports. All and all a fair commentary on how things stand today, but then as expected – since SBP still falls short of desired level of autonomy cum independence in its working – the report also falls short of explicitly pinpointing areas that have fallen victim to pure mismanagement by the PML-N government or in highlighting those poor financial policy measures where the SBP itself can found to be complicit. While the list of discussion areas can be rather long, let’s analyse a few key ones for the scope of this article.

First, Growth: As per the report the real GDP growth rate for the FY 2015 was 4.20% with 2.90% coming from agriculture, 3.60% from industry and 5.0% from services. Clearly this 4.2 falls short of 5.20%, the benchmarked target, but then from government’s perspective its defence could be that this is a better showing than in FY 2013 — when they took over — and that it has performed well to put the growth back on an upward trajectory. In FY 2013 we witnessed a fall in growth to 3.70% from 3.80%, but thereon it has been rising, 4.0% in FY 2014 and now 4.20% in FY 2015. A reasonable argument, but the problem is that when we dissect this growth performance, a rather troubling picture emerges. Pakistan, a country with high mix of existing employable youth and a population growth rate that requires more than 200,000 new jobs a year, essentially needs to grow in sectors that optimise job creation, meaning industry and agriculture.

However, these are the very sectors where we either saw stagnation or a decline: growth rates in industry fell to 3.60% from 4.50% (a staggering 3.20% off the target) and in agriculture a marginal movement of +0.20% (but 0.40% off the target). Even worse, the decline in industry came largely on the back of falling exports (not ‘stagnating’ exports as being claimed in the report) and that too in textiles – the most labour intensive industrial sector. Exports from developing economies, as we know, basically capitalise on cheap labour to gain competitive edge in international markets, in turn directly touching the lives of low-wage labourers and serving the twin purpose of mass employment generation cum distribution of income to low-income strata.

The simultaneous erosion of industry and exports depicts a dangerous trend, which if not quickly arrested can lead to serious social unrest. Add to this the dismal performance of agriculture in 2015 — the largest employment providing sector — and the picture becomes even gloomier. The mess-up in agriculture actually makes up for a perfect storybook tale of corruption, incompetence and neglect, qualifying for criminal investigation. A story of greed of seed and insecticide/pesticide mafia resulting in devastating outcomes where nearly one third of Punjab’s cotton crop stands wiped out and its quality badly bruised, once robust fields of sugarcane now reduced to low yield harvests, and the image of legendary Pakistani Basmati rice seriously dented.

Second, Financial Industry, Debt and Credit-to-GDP ratio: This dodgy saga of underlying growth does not end at the poor showing of industry and agriculture, but also goes on to manifest itself in the services sector, which presumably in 2015 has been the economy’s engine of growth. The services sector grew by 5%, up 0.60% from the previous year and with it taking the overall growth to a respectable level. But then again, scratch the surface and beneath it one finds the malaise of our banking and financial industry. Its growth mainly came on the back of governmental services, finance (debt) to the government, and insurance that also primarily catered to governmental borrowings. Nearly 1.90% out of the 4.20% GDP growth or 75% of the service-sector’s growth can be attributed merely to the government. And this policy of high state loans from commercial bank — in the process crowding-out the private sector — by itself is very counterproductive since in essence capital flows away from the efficient user (private sector) to the less efficient user (government). Moreover, it retards investment, employment generation, and creates an incremental debt in the economy, which otherwise could have been avoided.

To make matters worse, these loans by the government were obtained at high interest rates – making a mockery of the very notion of sovereign debt being cheap – and not only increased domestic debt significantly, but also the portion of expensive debt in our total debt portfolio. Today as much as 35% of our debt is estimated to be on commercial rates. In addition, this high state borrowing is causing irreparable damage to operational capability of Pakistani banking industry. With banks being in a comfortable position where nearly 80-85% business consistently comes from the state, an inherent complacency and decadence is setting into their work-culture. In other words, they have forgotten how to fish. Meaning, tomorrow if the government withdraws this lifeline and decides not to borrow or to borrow visibly less, these banks may very well fail to successfully divert the resultant capital surplus, leading to their failures/closures.

Already, owing to years of consistent government patronage they seem to have lost touch with a vast diaspora of potential private sector customers, because in recent years they haven’t felt the necessity to build new relationships. Pakistani banking industry has always been our pride and if it is to be saved from this suicidal model of merely acting as a mere conduit of governmental borrowing, it is the responsibility of the SBP to devise a strategy to gradually take it off this ventilator.

Last but not least, Energy: SBP’s outlook on the energy sector comes across as being most prudent, where it argues that Pakistani government was too quick and too generous in passing on the fruits of low global oil prices directly to end users – nearly double what India for example did in comparison. The result being a higher import demand as CNG users switched to petroleum products. Take a further deep dive into the woes relating to the energy sector and the management inefficiencies of this government surface yet again. More disappointingly, some very poor policy decisions were taken in this sector during 2015.

Whereby, the government not only failed to address operational anomalies in order to produce cheaper power, in turn improve national manufacturing competitiveness and address the underlying structural issue of circular debt, but also that it made the glaring mistake of reducing country’s dependence on imported RFO (during a historically low price-point) in the power generation mix that meant a reduction of RFO by as much as 5.30% in the overall fuel mix. Almost reminiscent of how the advantage of low global capital-cost-cycle was squandered away by Shaukat Aziz by promoting needless consumerism at the time.

As already mentioned above, the SBP report comes across as being a useful and in-depth document on the state of the economy and provides for some useful insights cum suggestions. It is now really up to this government to learn from this paper and not repeat the same mistakes in 2016.