Stagflation fractured growth momentum in FY19

Updated June 17, 2019


The current approach of balancing the books is vastly different from improving the fundamentals of the economy. — AP/File
The current approach of balancing the books is vastly different from improving the fundamentals of the economy. — AP/File

As foreign debts have hit an unsustainable peak, the mounting risk of default has begun to haunt the PM’s financial team though they feel the eventuality can be avoided by raising revenues, cutting spending and observing financial discipline.

PM’s Adviser on Finance Dr Abdul Hafeez Shaikh has warned that we have the opportunity to address external and internal imbalances or else “we are heading towards a (debt) default and there will be no escape route.” In the past Pakistan has avoided defaults by getting debts written off and rescheduled.

Unveiling Economic Survey 2018-19, he revealed that nearly Rs3 trillion was required just for payment of interests on overall debts next year. The document stated that the total debt and liabilities have increased by Rs5.216tr, or 18pc, since the end of June 2018. Dr Shaikh says we borrow to repay debts.

The current approach of balancing the books is vastly different from improving the fundamentals of the economy on which a relatively stable economic recovery depends

Despite reduction in current account deficit to 4.4pc of the GDP following reduction of an estimated $5bn in imports and improved overseas workers’ remittances, the stubborn external sector woes persist. The IMF deal shows, foreign borrowing is becoming more and more difficult as the overall foreign debt shoots up to $105 billion. The Fund wants a rollover of recent bilateral loans as preconditions for a bailout.

Owing to galloping debt servicing cost, the IMF has set the target for primary budget surplus at 0.6pc of GDP for next fiscal year. It is a tall order with the fiscal deficit estimated at 7pc for the current year. Spending has gone up by 8pc while revenues have recorded zero growth.

Despite the 34pc devaluation of the rupee, dollar earnings from exports remain stagnant and rupee cost of debt servicing is soaring. While the PTI government misses no opportunity to criticise the PML-N for keeping the rupee overvalued during its tenure of office, it tends to overlook the deep impact of a market determined undervalued rupee on the government finances in particular and the economy in general. It is swing to the other extreme with its own perils.

Dr Hafeez says the PTI government is trying to do things differently. But the worsening crisis seems to be immune to the remedies applied so far. Over the past 10 months, stability has been as elusive as ever and the economy is shrinking fast. The current approach of balancing the books is vastly different from improving the fundamentals of the economy on which a relative stable economic recovery depends.

Businesses are worried about what the immediate future holds for them. The measures taken by the government have brought much dreaded stagflation which makes problems much more complicated and difficult to solve. Economy grew by 3.3pc, short of the annual target of 6.2pc and down from 5.5pc last fiscal year.

On the other hand, inflation has shot up to 9.11pc in May though the domestic demand is being depressed by tight monetary policy. In the process coupled with increase in utility prices, it is generating cost push inflation as a result of interest rate hike and rupee depreciation. This is contrary to what happened in the past few years: higher economic growth was achieved with relative price stability. Normally, as the economists say, it is high and not low growth that fuels inflation.

Prime Minister Imran Khan took over the office brimming with confidence that he could fulfil PTI’s electorate mandate through active state intervention while at the same time improving governance through institutional reforms. His government underestimated the market imperatives anchored on traditional international economic and trade ties which could not be tailored in the short-term by administrative fiat to conform to his vision. Similarly, it was not prepared for stiff resistance it would face in carrying out administrative reforms.

This prompted a shift in policy directions whether it was a different approach to the IMF bailout or accountability process turning into amnesty scheme. The U-turns extracted a pretty heavy price: loss of business confidence that amounted to throwing a spanner in the wheels of the chariot. Another important reality check resulted in change of a PM’s trusted financial team for some top unacquainted technocrats. His government is back on the same track traversed by the country’s policymakers so many times. Expecting to get different results in a far more difficult and complex situation would be a folly.

A durable solution for debt-ridden economy lies in boosting low rates of savings, investment and local production/supplies to meet the demand of the domestic market and reduce dependence on foreign goods and services. This is not happening at the required level despite PM’s so much stress on the need for wealth creation/capital formation and policy focus on industrialisation and free economic zones. The industrial policy has been hijacked by financial technocracy empowered by the deal with IMF.

Compared to the targets as well as last fiscal year’s performance, national savings and investment this year were significantly lower as was also the case of more important area of fixed investment. The huge rupee depreciation and massive interest rate hike have made fixed investment costlier and even prohibitive in these uncertain times in some key segments of the economy.

The fixed investment during the current fiscal year fell to 13.8pc, down from 14.8pc of GDP last year. Public sector investment is estimated at 4pc, way behind the target of 4.8pc and last year’s 5pc. The private sector investment of 9.8pc of GDP remained unchanged in much slower growing economy.

Commodity producing sectors — agriculture and industry — posted a negative growth. A sharp deceleration was witnessed in the industrial sector that registered a growth of 1.4pc against the target of 7.6pc despite improvements in power supply.

Also the manufacturing sector slid by 0.3pc and the large-scale manufacturing showed a negative growth of 2pc against the target of 8.1pc. The services sector grew 4.7pc against the target 6.5pc. Agricultural growth of 0.8pc was down from last year’s 3.9pc.

Much of these outcomes can be traced to PM Imran Khan’s efforts to redefine the role of the government. The PTI manifesto threw up a utopian vision with the ultimate aim of setting up a welfare state with government finances in shambles. It did not work .It has been substituted by the IMF programme which can at best deliver a temporary stability that will disappear like soap bubbles in the initial spurt of economic growth owing to deep-seated structural imbalances. It needs be recognised that public welfare has turned into a societal problem primarily to be resolved by financially autonomous local governments and communities, which need to be empowered with rights and responsibilities to deliver.

Published in Dawn, The Business and Finance Weekly, June 17th, 2019