Business Recorder (BR) Research
Have the interest rates bottomed out? That should not be the question; rather the quest should focus on the efficacy of the 350 bps of easing that has already taken place. The efforts should be deployed on creating conducive environment to enhance both supply and demand of private credit for boosting economic growth.
The GDP growth has been stuck between 3-4 percent for the past four years (FY11-14). It was even lower (2-3%) in the preceding three years (FY08-10). In FY15, growth has marginally improved to 4.2 percent but continues to lag well behind the target of 5.1 percent; despite excessive monetary easing and better business sentiments.
What keeps on dragging us behind the regional peers? The energy shortages, poor law and order situation, inconsistent economic policies and weakened macroeconomic indicators largely explain the prolonged poor-growth era. The situation is improving, virtually on every front, but fruits are yet to be reaped.
Macroeconomic picture is brightening; energy situation is improved due to low oil prices and it will be better once new projects start coming online. Economic policies; whether they are good or bad, are consistent, ever since Dar assumed the office of Finance Minister. And then there is the improving security situation.
The policy of keeping exchange rate artificially appreciated can only work in the country’s favour in the long-run; if and only if, the domestic production and labour productivity rise. The bet is on the China package to do the magic. Let’s see how this will work out in the window of 18-24 months as FY18 onwards, the pressure of debt repayments and probable commodity prices reversal will be too much to sustain without inclusive growth.
The need is to jack up the private sector and incentivize banks to lend to them. Currently, that is not happening as the government remains the primary customer for banks and is contributing heavily in the growth. Hence, inherent inefficiencies of government projects and misaligned priorities explain the sluggish economic growth.
The situation worsened in FY15 while the previous year was better. In FY14, the annual growth in government borrowing from banking system declined from 30 percent to 10 percent. The private sector credit grew from nothing to 11 percent. The picture reversed in FY15 – government borrowing jumped to around 20 percent, while the private growth shrank to five percent.
The numbers narrate the tale; as to why the excessive easing and improved sentiments have failed to deliver growth in FY15. A mere look at GDP based on expenditure method unfolds the details – consumption grew by 5.1 percent in FY15 (FY14: 4.9%). Within it, government consumption bloated by 16 percent growth (FY14:1.5%), reducing the private consumption growth to 3.6 percent (FY14:5.14%).
This number needs to reverse. Now, with interest rates down to 44-year low; banks have higher chances to increase their consumer lending portfolios; amidst lower return on fixed-saving instruments. That should drive higher consumption by households.
The economy will benefit from this in the long-run provided domestic production is enhanced to match the consumption growth. Otherwise, the pressure will mount on imports to meet demand. The gross fixed capital formation has to be picked by private businesses. The fixed capital formation growth accelerated to 8.3 percent in FY15 (FY14:4.2%). But the onus remained on public plus general government. It increased by 25.1 percent as against fall of 1.9 percent in the previous year. While the private fixed capital formation declined from 6.2 to 3.2 percent.
The overall investment to GDP ratio stagnated at 15 percent in FY15 and is targeted to increase to 17.7 percent in FY16. That is a stiff task but extremely important to attain growth momentum. And that can only be meaningful, if the private sector makes up the lion’s share – targets are envisaging it as well. But the means to do so is by government swaying away from commercial banks for fiscal financing. It is a hard task.
Then the growth needs a broad-base for employment generation. LSM performed poorly in FY15 – growing by 2.4 percent in Jul-Apr. The limelight for last year’s growth was small-scale manufacturing (8.2%), construction (7%), livestock (4.1%) and general government services (9.4%). Most of these sectors have arbitrary methods of calculation and usually used as fillers to exhibit better numbers on paper.
And a few, like government services, increased primarily on the back of higher salaries; with no bearing whatsoever on efficiency. Similarly 6.2 percent growth in finance and insurance sector is attributable to government borrowing, which in turn is for meeting unproductive government current expenditure. The bottom line is that all these trends have to change for the uptick in growth trend to be meaningful and sustainable!
This article originally appeared in Business Recorder (BR) research on July 28, 2015.
