Receding capital formation

November 12, 2019


The rapid increase in fixed assets and human resource development provide impetus to economic growth on the back of sound socio-economic policies, which nurture innovative ideas and latest technologies. In this domain, Pakistan lags behind many regional countries and consequently suffers from prolonged structural imbalances.

Measured at current market prices, the Gross Fixed Capital Formation (GFCF), a key indicator of the state of the economy, is growing at the slowest pace in recent years. The GFCF growth rate fell sharply to 1.89 per cent in 2018-19 from 12.83pc in 2017-18 and 13.41pc in 2016-17. When calculated at constant market prices of 2004-05, the growth rate turns negative at 8.87pc against positive 7.09pc in 2017-18 and 10.31pc in 2016-17.

Fixed assets include plant, machinery and equipment purchases, land improvement, construction of roads, railways, hospitals, educational institutions and private, commercial and industrial buildings. Pakistan has abundant labour and natural resources, but it suffers from an insufficient stock of fixed assets because of the sluggish pace of capital formation.

Human resource development is a low priority. The situation gets worse as many professionals and skilled people seek jobs abroad amidst reduced employment opportunities in a slowing economy at home. This is happening when non-tangible assets worldwide are competing with physical capital for a space to build a more productive and efficient new economy.

Gross fixed investment dropped to 13.8pc of GDP in 2018-19 from 15.1pc a year ago

Other significant factors contributing to declining GFCF growth are plummeting rates of domestic savings and investment, liquidity problem and falling production. The latest annual report released by the State Bank of Pakistan (SBP) carries a special section offering a deep insight into the reasons for the poor investment level.

Gross fixed investment dropped to 13.8pc of GDP in 2018-19 from 15.1pc a year ago. Domestic savings fell to 4.3pc from its peak of 8.6pc in 2014-15 (it was 5.1pc in 2017-18). GFCF rose marginally to Rs5,340bn in the last fiscal year from Rs5,241bn a year ago.

Wealth creation is seen by Prime Minister Imran Khan as a key factor for the success of his government. On Oct 31, he told World Bank Group President David R Malpass that the future belonged to wealth creation–enabling governments as that would enable governments to collect more taxes and spend revenues on public welfare. His government is struggling to cope with the issue with no noticeable breakthrough as yet.

Wealth creation in the private sector has become problematic because of an upfront heavy dose of reforms. GFCF growth in the private sector at current prices dropped to 6.51pc in 2018-19 from 11.05pc in the previous year while increasing to Rs3,796bn from Rs3,564bn. But measured at constant prices, it slumped to a negative growth of 4.73pc.

Some private-sector activity will be generated this year from the Planning Commission’s efforts to speed up development spending. By Nov 1, it authorised release of Rs257.17bn for the first four months, which comes to 37pc of the total annual Public Sector Development Programme (PSDP) of Rs701bn. This amount is almost 144pc higher than Rs106bn released for the same period last year. Economists say government spending is the easiest course for an economic revival though the available fiscal space is very limited.

With foreign capital and financial inflows (close to $2bn) lower than expected in the first two months of 2019-20, the need for the creation of more domestic money for smooth working of the financial system has acquired urgency. Nearly two-thirds of the deficit financing is projected to come from external sources, with the IMF estimate of foreign inflows of $20bn that seems difficult to realise. Even the World Bank is reported to have withheld its policy loans because the foreign exchange reserves target has not been met.

While continuing the stabilisation programme, policymakers are seeking certain relaxations from the IMF so that the economy does not get further clogged. That includes the softening of the IMF quarterly ceiling on the creation of domestic money and extending the limit on government guarantees fixed at Rs1.6 trillion up to June 2019-20. Pakistan has met the net domestic assets target for the first quarter, but future targets are stringent and may create liquidity problems in the banking system.

Media reports also indicate that the finance ministry is seeking the IMF’s approval to revise downwards the tax revenue target for this year, which was set on projected tax revenues and not the actual collection in 2018-19 — the difference being Rs318bn.

Since 2018, there has been a continuous and increasing decline in manufacturing, which fell by 7pc in August from 6pc recorded over the previous two months. This reflects the initial risk of an industrial crisis gathering adverse trends in the economy, which may make the achievement of the growth rate of 2.4pc difficult, say an eminent economist. As companies cut back production, non-performing loans of banks have shot up to Rs788bn.

Increasing production and supplies remains a key problem in boosting exports. Whatever efforts the commerce ministry may make, exports cannot grow as per expectations until an exportable surplus is available, says Commerce Secretary Sardar Ahmad Nawaz Shukhera. Briefing the National Assembly’s Standing Committee on Commerce and Textiles on Oct 29, he also stressed that exports would remain uncompetitive owing to duties on raw materials or individual goods.

An interesting feature unique to 2018-19 was that capital formation at current prices was remarkably higher at the level of local bodies as opposed to the performance by the two other tiers of bulging governments. GFCF generated by local bodies was Rs45.40bn, followed by the federation (Rs15.8bn) and the provinces (negative growth of Rs29.19bn).

At current prices, government savings were negative 5.5pc against those of non-government (including public-sector enterprises) at 9.8pc, which too was lower than 10.35pc a year earlier. Public-sector investment fell to 4pc from 4.8pc.

The widening, prolonged gap between local production/supplies and domestic demand has produced many macroeconomic imbalances: trade, current account and fiscal deficits as well as unsustainable debts. Sooner rather than later, the first priority of the government should be to increase domestic savings, investments, production and capital formation to improve the fundamentals of the economy.

Published in Dawn, The Business and Finance Weekly, November 12th, 2019