Number Crunching – The Economic Conundrum

“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.” - Ogden Nash

There is an urgent need to declare an economic emergency in the country as the government continues to finance its deficit through foreign debt and local bank borrowings. The excessive government borrowings coupled with increased interest rates has resulted in crowding out effect as the growth in private sector lending has declined sharply. This phenomenon has in effect dented the private sector investments largely, and economic growth remains stunted as a result.

Pakistan’s GDP growth has been the lowest in the South Asian region since 2008. Analysts have been giving various reasons for the dismal economic performance including war on terror, international oil prices and global financial crisis. In my opinion, the center point of current economic fiasco lies beyond the mentioned factors considering the historical performance (average GDP growth rate of Pakistan from 2001 – 2007 averaged at 6.15%) as well as the growth of the regional economies.

The core cause of the crippled economic growth has been the massive financial indiscipline of the current financial managers. The fiscal deficit (as a % of GDP) has been constantly above 6% since 2008. The government has been funding the ever growing deficit by Debt and printing money.

The increasing demand of the Government to fund its deficits have resulted in a total debt of PKR 10 trillion (up from PKR 5 trillion in 2007), out of which PKR 5.4 trillion is Domestic Debt while PKR 5 trillion (USD 58.3 billion) is Foreign Debt. The data released by the State Bank of Pakistan indicates that Broad Money Supply growth (M2) has averaged 11.5% over the past 3 years.

The recently released “Quarterly Performance Review of the banking system 2010” by the State Bank of Pakistan indicates that there has been growing evidence of banks’ flight for the government securities which now constitute around 30.4 percent of banks’ assets compared with 19.3 percent in Dec-08. Share of advances has witnessed a concomitant drop, from 60.8 to 52.0 percent during the past two years. Unsurprisingly, return on government paper now accounts for 34.5 percent of banks’ gross mark-up/interest income, compared to 28.8 percent in Dec-08.

The consequences of Unsustainable borrowings

The phenomenon mentioned earlier has very important implications on our economy both in the long run and in the short run. The persistent demand for funding on Government’s behalf (through debt and printing money) has fuelled inflation and thereby NOT allowed the State Bank of Pakistan to lower the interest rates. Pakistan currently has the highest inflation and interest rates in the region.

Additionally, the State Bank data suggests that growth in government borrowings, in a rising interest rate scenario, has been crowding out the private sector lending significantly. The shift in asset mix, from advances to investments in government papers for the Banks has only channelized the flow of funds towards the Government.

The Short Run Consequences:

The currently prevailing interest rates are significantly beyond the comfort zone of the business community. As a result, the business community looks to consolidate and defer their projects that require significant capital deployment. It is very important to note that despite high interest rates prevailing in the country, the inflation rate has been soaring and no respite is expected in the short run as the Government continues to borrow from the State Bank to plug their funding gap. The General Inflation this year has been 15% while the food inflation reported by Federal Bureau of Statistics stood at 19%.

It is very safe to assume that currently our economy is in the state of Stagflation and it is expected to remain so in the short run.

The Long Run Consequences:

The long run consequences of ongoing budget deficits are drastic and will be felt in times to come. Firstly, the current budget deficits are NOT as a result of deficit spending towards Public Sector Development, instead only PKR 300bn out of the budgeted PKR 610bn were spent by the government in the previous year (as opposed to the case in India where the budget deficit is a result of massive Public Sector Development Spending). As a result, the infrastructure development necessary to promote economic growth remains ignored in toto. It is now a matter of grave concern that the Government has not been able to fully utilize the allocated PSDP fund over the last 3 years.

On the other hand the crowding out of private sector lending has impacted the private sector investment in infrastructure projects severely. A classic example is the delay in a number of power projects undertaken by the private sector. Data from various banks suggest that there has been on average 2-3 years of delay from the scheduled timeline for such projects to get commissioned. The result is the prolonged power outages and expensive electricity. If the current scenario prevails, WAPDA expects that the power suffering could continue beyond 2018. Not to mention the economic loss associated.

The Bottom line:

The center point of all the economic vows lies in the sharp increase in Government Borrowings over last 3 years without the government spending towards infrastructure and public development. Assuming 170 million of population, each citizen is under the debt of PKR 59,000/- per capita. How it will be repaid is a million dollar question.

The Government has to take the following actions immediately to set the economy on track:

1. Improve Tax to GDP over a period of next couple of years through urgent tax reforms. Currently Pakistan’s Tax to GDP is the lowest in the region. A 1% improvement in tax to GDP ratio adds approximately PKR 200bn to the national kitty.
2. Revamp the Public Sector Enterprises (PSEs) since they suck at least PKR 250bn annually, which is approximately half that of the total PSDP fund allocation last year
3. Efficient and targeted utilization of subsidies instead of a blanket subsidy like in the case of CNG, Sasti Roti scheme etc
4. Plug the leakages of about PKR 400bn of corruption in the system on an urgent basis
5. Serious belt tightening and reduction in day to day operational spending by the Government

The bottom line is that unless the Government takes strict measures towards spending cuts, seize additional borrowings, and utilize the deficit spending towards the infrastructure development, our economic nightmares will continue.