Economy faces hesitant recovery amid major risks

It is difficult to come out of the vicious circle of relying more on consumption-driven growth rather than investment-driven growth. The ingredients required for recovery of commodity producing sectors are not there, so we can’t expect miraculous performance of the major crops as in 2008-09

By Zafar-ul-Hassan Almas

In recently concluded review of the economy meetings held in Dubai, both Pakistani authorities and the IMF seem to be unanimous about a slight recovery in the economy and betterment of the macroeconomic indicators. However, several serious downside risks cast a shadow over the fragile recovery of the Pakistan economy. Acute energy shortages are still hurting the economy with great intensity. No denial of the fact that political uncertainty has a serious bearing on macroeconomic stability. One manifestation of this political instability is weaker governance which has had some serious consequences for the economic activity in the last few years. The assistance provided by the IMF is working well but the structural rigidity of Pakistan’s economy is a great impediment for long lasting recovery.

The present regime has always remained critical of the “consumption driven” growth and time and again emphasised its preference to reinvigorate growth originating from the commodity producing sector. The present economic managers have criticised the “jobless” growth on the back of a consumption boom. In 2008-09, the growth was predominantly driven by consumption and in the commodity producing sector; the agriculture sector was the only saving grace. The government has generated a rhetoric that the agriculture growth was because of its policies. Unfortunately, the prospects for the agriculture sector are bleak because major crops are likely to witness serious reversal.

Pakistani authorities are making a case about first ever positive growth in the large scale manufacturing sector since May 2008 in the month of August 2009, to prove a recovery in the LSM sector. However, they forgot the fact that the positive growth in the Quantum Index of Manufacturing (QIM) is thanks to a massive fall in the index in the base months of July and August 2008. The real worry about the QIM of the first two months of the current fiscal year is that it has dropped by almost 4.8 per cent from its June 2009 level.

The base effect is likely to persist for another two months but then the QIM index will definitely face a higher base which may throw it back to the negative route. The signs of recovery in the large-scale manufacturing are not so bright in the near future, especially the current energy situation. In this backdrop, the existing positive growth in the LSM should be taken with great caution. Energy supplies are a crucial determinant of the activity in the manufacturing sector.

The service sector growth was driven by telecommunications, financial sector and wholesale and retail trade during 2000-07. Telecommunication and financial sectors are already facing saturation and their growth prospects are no more relevant. WRT sector growth originates from agriculture, manufacturing and import sector. Massive negativity in imports is likely to hurt the growth prospects of WRT. The growth prospects of the service sector are hampered by poor performance of the financial sector and a host of uncertainties on the security issue.

The growth prospects of the economy are also hampered by an investment climate full of security concerns. Then investment climate cannot be improved in the current law and order situation. The domestic demand has to attract investment and compensate for the external demand compression. The SBP has overreacted in the current climate of uncertainty to the fragile signals of demand compression. There is enough evidence that inflationary pressures are mounting on the economy. The CPI index has not witnessed any compression since February 2009 and persistent build-up in the index is not being noticed in the policy circles, rather they are cheering on the year-on-year fall in the inflation. SPI index has already seen its lowest in October 2009 at below 7 per cent and rebounded to enter into double digit level in November 2009. This implies that beyond November 2009, a reversal in CPI inflation is most likely. The average build-up in the CPI index in the last year was 1.04 per cent per month and the average build-up in the first four months of the current year was 1.16 per cent.

This implies that the intensity of the inflation is likely to hurt with even more severity to the people. At the time of signing the IMF sponsored SBA, the underlying assumption for inflation for 2009-10 was just 6 per cent but now IMF and GoP are unanimous about the 11 per cent inflation projection.

Independent estimates place it at around 13 per cent with an incoming electricity price-hike. The WPI has again started rebuilding, after touching its lowest level in September 2009.

The single-digit inflation is now a far-cry and with the current inflationary pressures and level of macroeconomic imbalances, macroeconomic stability is not possible. Macroeconomic stabilisation is a pre-requisite for economic recovery and the process of stabilisation that started in the aftermath of SBA remained fragile and distant. Weaker economic management and governance are the ultimate outcomes of political instability. If Pakistan is to regain macroeconomic stability, it has to take some important decisions regarding containing inflation, reducing fiscal deficit and at the same time boosting economic growth.

External demand for our products could weaken much more sharply and commodity prices could decline, if the fallout of the financial turmoil is to keep the United States and developed world into a recession as evident from recent economic data of the US. Resultant free fall of US dollar may complicate recovery in Pakistan’s external sector. A weaker dollar would benefit developing countries like Pakistan with huge dollar debt, but impose losses also because of holding dollar denominated assets. The external debt denominated in Japanese yen and euro will face pressure on debt servicing.

The downward trend in imports is encouraging but the contraction in exports is even more disturbing. The prolonged period of negative growth in exports has shattered the confidence of export based industries. For a sustained economic recovery external demand is crucial. The recent recovery in the international market is unable to rejuvenate our exports industry which implies loss of competitiveness. One can imagine the likely impact of incoming electricity tariff hike on domestic industry. In import sector too there exists enough room for rationalisation. The recent contraction in imports is driven by fall in demand for raw materials, lower oil and commodity prices and shrinkage in demand for consumer durables.

Pakistan’s economic recovery has always remained sensitive to the foreign inflows and the present outlook is not encouraging. The modus operandi for FODP pledges and Kerry-Lugar bill commitments is not yet clear. Multilateral and bilateral inflows are not likely to be materialised as per plan. Pakistan has to actively pursue debt creating inflows as well as non-debt creating inflows. The outlook for the future is more uncertain in a volatile security environment.

In this situation, it is difficult to conclude that the economic recovery is a reasonable plan. There are enormous risks to the economy such as falling revenues, growing expenditures, building inflationary pressures, widening fiscal imbalances and weaker performance of the commodity producing sectors. It is difficult to come out of the vicious circle of relying more on consumption driven growth rather than investment driven growth. The ingredients required for recovery of commodity producing sectors are not there, so we cannot expect miraculous performance of the major crops like 2008-09.