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Pakistan’s Economic & Financial Problems & Global Outlook 2015

January 2, 2015

Outlook 2015

By: ASAD RIZVI   Published on January 02, 2015

Pakistan’s economy remains in the doldrums, as it is still faced with clinical and structural challenges. Economic data (Fiscal and Monetary) clearly indicates increased suffering and social unrest due to uncertain political and economic environment caused by old-fashioned economic growth strategy. Since independence the pace of growth has averaged above 4.50 percent. But statistics suggest that Pakistan is only notch above poorest countries. It is because of high poverty rate, low literacy rate, poor infrastructure and outdated agriculture technology, lack of industrialisation, wide trade gap, poor healthcare system and low standard of living. If we take a closer look at the present economic indicators, Pakistan’s economy is dangerously imbalanced. Unfortunately, despite passing of 68 years, country’s economic dependency is solely on old methods of relying on foreign inflows and low yielding agriculture sector growth that frequently demands government assistance for increase in food support price. It is regrettable for the economy that there is a minor reliance on our partially developed industrialised manufacturing sector that does not make serious contribution in this progressive era, which is now entering fourth industrial revolution. Strong growth demands attention for firm planning and consistency in policy implementation that always remained low priority area for the decision makers for unknown reasons. In the last 15 years, Pakistan’s economy grew from USD 50 billion to USD 275 billion. During this period per capita income has surged from $490 to end up at $1370. This gain did not translate into well-being of the population causing very wide wealth gap between upper-income and middle-income to lower middle-income families. Income/asset inequality between the rich and the poor needs to be shifted from unproductive to productive areas and should be corrected through proper redistribution strategy. It is caused by many factors such as lack of education, which does not help income to rise. Healthcare, which is not affordable for majority of the population, consumes good part of their income. Housing sector, which is totally neglected, is a major cause of worry, as everyone needs a place to live. But more than half of population cannot even afford low income housing due to negligent housing policy, which is dominated by selective business entrepreneurs causing/responsible for price variance in sale and rent. To revamp obsolete policies/system and to bring changes to attain the required economic targets, emphasis should be on responsibility and reward, based on merit. Except for some exceptional cases, quota system, favouritism or arbitrary allocation should no more be encouraged, as it has constantly hindered nation’s progress. It is one of the major hurdles that have led the nation towards economic vulnerability.

RISKS AND OPPORTUNITY: Pakistan’s economy may be celebrating calendar year end 2014 with a bang for attaining Fx Reserves target of USD 15 billion. The fact is that the economy is living on a thin line and has been walking on tightrope for years. Building of foreign exchange reserves did not happen due to economic gains, it was only possible after costly borrowings against Euro and Sukuk Bond and IMF’s conditional lending that totals to USD 6.2 billion, which does not include USD 1.05 billion IMF’s 4th and 5th tranche. In reality, there is multiple disconnect between real economy and performance. The truth is that there is severe liquidity crunch (both Foreign Exchange & Rupee), which is met forcefully through borrowings or generated by using risky monetary tools (USD 2.135 billion by attracting/offering low rate buy/sell $/rupee swap/outright that negates tight monetary policy and by using depositor money F.E 25 $1.2 billion as of October 31/2014 for oil purchase). Therefore, calculated monetary/fiscal adjustments strategy may have helped in meeting the short-term targets, but overall ratios of combined monetary statistics and banking sector data negate claims of “Economic Recovery”. With the current ongoing strategy prospect of economic revival does not look very encouraging. Anything below 6 percent GDP growth is too little to counter economic and financial odds. There is not much hope from Chinese pledge to invest USD 42 billion, unless Chinese government has made a commitment, which may not be the case. It is simply memorandum of understanding (MoU) and not foreign direct investment (FDI) commitment that requires a minimum of 10 percent investment and voting stocks to acquire shares through merger and joint venture. There could be a possibility that couple of Chinese firms may take interest to loan energy projects in Pakistan, which is a very expensive affair, as commercial loans are always very costly. But with oil prices already sharply down investments in energy sector may not be forthcoming. By taking a closer look on economic numbers, it will assist in identifying and help to understand the problem that needs to be checked and corrected. On most occasions fiscal tax targets are missed and are frequently revised downward, if short-term or emergency measures do not work. Here is an example, in another desperate move, due to collapse in oil prices fearing fall in revenue collection by nearly Rs 75-80 billion by the end of FY 2014-15, government decided to raise sales tax (GST) of oil products by 5 percent to counter impact of falling oil prices. Government is quick to tap ease of collection method by taxing at the import stage instead of making effort to impose taxes on all taxable income. The pace of debt growth and its size is very frightening (expected to get close to Rs 20 trillion by end of FY 15). High cost of debt servicing is extremely difficult to manage, as it consumes 65 percent of the revenue and is choking economic recovery, even though fiscal deficit has shown minor improvement due to reduced spending. Instead of attacking the causes circular debt (energy 67 percent and crop 33) through direct cash payment, settlement is done on regular basis by parking through sale of government securities that gives hint of inability to manage, because it end up inflating the size of debt. Constant increase in the size of sale of government securities (PIB’s, T/Bills, Sukuk Rs 4.65 trillion) to banks, which is 57 percent of the total size of commercial bank deposit, discourages banks to lend to private sector. Of the total 77 percent or Rs 6.29 trillion investments in government securities, remaining 20 percent of investments are shared by non-banks and the corporate sector. The size of investment by banks in government securities is alarming, which two and a half times more than the size of SBP reserve/liquidity requirement. Banks are required to maintain Cash Reserve Requirement (CRR) 5 percent and Statuary Liquid Requirement (SLR) 19 percent. Allowing banks to invest 57 percent in government securities against 24 percent central bank’s requirement is a move in desperation to adjust books at the cost of growth, which is considered abnormal and is an extremely risky proposition. Meanwhile, Pakistan is also required to seriously address another major issue of natural disaster, especially floods, which in recent times have become a regular feature that causes lot of hardship for all the agriculture related economy. Though it is caused by global climate changes, but the country is badly exposed natural/seismic hazard resulting frequent loss of lives and economic damages due to lack of necessary infrastructure and poor co-ordination. Hence, more attention and planning are required in consultation with government agencies and disaster risk management cell to formulate a policy and strategic planning to reduce the economic and other risk and future vulnerability. Falling oil prices should not make our economic managers complacent. This is surely a good opportunity, as it provides breathing space to the economy. To take maximum advantage of falling oil prices requires developing a strategy, planning and determination to get the best result through better management. Furthermore, it would be a prudent decision to obtain over 50 percent oil hedge for a longer duration that would enable the government for its future budgeting plans. Oil hedge at current or level below will place Pakistan economy in comfortable position, as the downside risk against upside risk is small. Lower or higher oil price, both poses risk to our economy, which needs monitoring. Though lower oil prices for longer duration has many advantages and is beneficial too, as it will lower the oil import bill; and help to stimulate economy and ease inflationary pressure. But the flip side risk is that lower oil prices for extended period of time will have lag impact on oil-dependent economies. It may force Middle Eastern oil producing countries to cut down business activity, thus cut in spending will cause deficit. Hence, drop in oil prices risks reduction in investments that will hit employment sector and flow of home remittances may be disturbed.

ECONOMIC POSITIVES However, with falling oil and other commodity prices, economic conditions are favourable. Quick and better administrative and monetary measures can improve economic conditions that should help closing fiscal year-end in a positive note. Advance purchase of oil arrangement could assist budgeting. Power sector can increase electricity production by 2000-3000 megawatts by servicing and improving conditions in its production plants, which can bring life to export sector which at present is behind the target. It is imperative for the economic managers to ensure that benefit of oil prices is filtered down to every sector of economy. Business not willing to compromise should be panellised by imposing additional tax/duty or by asking SBP to ask banks to withdraw credit facilities. Unfortunately, government missed out a big opportunity to provide comfort to every citizen, as it did not pass the benefit of falling global prices of wheat, rice, sugar and other food items to general public. Instead is acted in haste by imposing import duty on food items. It also increases the risk of smuggling. Export data of last 4-years suggest that exports remained stagnant around $24.5-$25 billion. It also confirms that Rupee weakness made minor economic contribution, whereas it gave more pain to the economy, as it caused inflation to rise, forcing Central Bank to adopt tight monetary policy that pushed the size of debt higher, making debt serving very difficult to fund. Present economic conditions suggest GDP growth could hit four percent and inflation may hover around seven percent, but keeping the fiscal deficit below five percent deficit could be difficult.

HIGH DISCOUNT RATE POLICY AND GROWTH FACTOR Decade-old SBP’s high discount rate policy is a big cause of economic distortion and stagflation that leads towards income inequality. Surprisingly this factor has never been taken into consideration seriously, as all efforts during this period were made to arrest high rate of inflation. Throughout all these years growth was never a serious part of agenda. Comparative analysis of SBP data will provide further evidence, as data confirms that in this period commercial banks deposit portfolio rose sharply (from Rs 2.105 trillion to Rs 8.15 trillion), whereas, bank lending portfolio made a small up-move (from Rs 1.589 Trillion to Rs 4.398 trillion). This translates into drop in deposit/advance ratio from 75.5 percent to 54 percent. During same period, investment by banks in government securities surged by Rs 5.19 trillion or by 524 percent. This comparison also provides better understanding about SBP’s monetary policy stance that did not support growth. It is also true that the factor behind less effective monetary policies during all the years is the environment of fiscal dominance. Hence, both monetary and fiscal indiscipline is solely responsible for high inflation, High cost of lending rate hampered growth, it hindered new business – additional jobs were not created, fiscal deficit thinned down business activity, tax targets were not met, national savings rate kept on declining, rising debt continued its climb resulting sharp surge in deficit financing that has reached troublesome height and it is extremely difficult to manage funding due to lack of resources. Therefore, since banking system is badly clogged, as banks are keener to invest in government paper, Central Bank should make a prudent policy shift to boost lending for credit growth. State Bank of Pakistan’s tight monetary policy will result in slow growth. It needs make quick shift in its stance for effective use of its monetary tool by reducing its discount rate in line with inflation. To keep pace with the curve SBP should simultaneously take lead in helping to cut coupon rate accordingly to discourage banks to further invest in government securities that will help in paving way for private sector lending. Slash of coupon rate will ultimately slow the mounting debt burden, which is never discussed at any level due to lack of awareness about its consequences and the price that future generation will have to pay. Similarly, government’s excessive borrowing strategy (external and domestic) to plug holes and for the purpose of window dressing has proved costly and damaging factor, due to lack of fiscal/administrative measures that needs to be corrected. While, falling of oil prices could pose a new challenge, with oil prices down by nearly 50 percent and major commodity prices down between 30-50 percent, some adjustments at domestic level will help to minimises threat of inflationary pressure and also help in stabilising the rupee.

PAK RUPEE @ 100.48 As we saw US dollar’s strength lately due to US economic recovery, while Japan and Europe are still in struggling. Euro and Yen will take further beating due to Quantitative easing measure. So far against basket of major currencies US Dollar has gained 12 percent. Before assessing Pak Rupee trend for the calendar year 2015 let’s have a look at the performance of regional currencies. Apart from Thai Baht that was able to maintain its last year’s level, currencies of emerging market are gradually losing its gloss. Chinese Renminbi has weakened on back of weak growth. Russian Ruble and Turkish Lira are struggling due to weak conditions at home. Meanwhile, after Malaysian Ringgit took the lead on expectation US will hike rates losing 6.3 percent of its value, as Malaysia is also net exporter of oil. Indian Rupee too has weakened by 2 percent because of risk of flight of foreign money, slowing down of inflation saw decline in bond yield. Similarly South Korean Won and Taiwanese dollar’s worry is weakness of JPY, as Japan is competing in exports losing four percent of its value. Singapore Dollar was a big loser, as it lost 4.4 percent of its value due to slow growth and inflation. Overall, the trend for regional currencies may remain weak due to transfer of capital and stronger US dollar tone for the remaining part of the year. Whereas, Pak rupee made some interesting and surprise moves in the calendar year 2014. Against December 2013 closing of 105.32, Pak rupee made strong gains of 4.6 percent to close at 100.48. While, at the end of 2nd quarter of current fiscal year Pak Rupee lost 1.7 percent of its value against FY 13-14 close of 98.80. Rupee that initially saw volatile moves during the early part of year recovered after reaching understanding with IMF. It got further boost after successful Euro Bond and Sukuk auction. Lower fiscal deficit number helped Rupee stronger and attaining of Fx reserves target of USD 15 billion made all the difference. However, Pak Rupee may maintain current stability on back of better economic condition that should be supported by lower oil prices in the remaining two quarters of current fiscal year. But since challenges are numerous any dip from offshore support in last 2 quarters of 2015 or earlier can add pressure on rupee that may struggle to maintain its current strength. Strong US dollar and weakness of regional and emerging market currencies could be disadvantageous for rupee. All eyes will be on deteriorating trade numbers. Current account figure will be keenly watched. Adjustment of circular debt could be the spoiler for fiscal deficit data, which may push it beyond 5 percent. Two other important indicators that should be watched carefully are utilisation of Rs/USD Buy/Sell swap facility of USD 2.135 billion for building of foreign exchange reserves and withdrawal of USD 1.25 billion from FE-25 deposit for oil purchase. It will surely expose Fx reserve position. Further, if oil prices average around or below $55 in next 6 months, it could force spending cut in Middle East oil producing countries that will see job losses and also result in a fall in remittance. Hence, any adverse condition could see a drop in the value of Rupee 4-7 percent by end of calendar year 2015. Worsening economic condition in Middle East may not bode well and calendar year-end of 2015 that may add further pressure on Rupee.

GLOBAL ECONOMY Announcing end of quantitative easing in USA was the first sign of confidence in economy. With favourable economic fundamental America is easily looking most ideal place for the investors. US regulators should get credit for the hard work that is reaping good results. With China slowing down, Europe is struggling because Germany is unable to carry Eurozone burden on its shoulder and Japan back in recession, rest of the world could face tough days ahead. Unemployment rate in US is already comfortably below 6 percent. Collapses of oil prices have given further hope of optimism in market. Businesses should further pick up, which will give hope of faster recovery in developed economies. Market is targeting US rate hike at some stage, which may happen until the latter half of 2015, as 1st quarter could slow down a bit. For FED to hike rates growth should match their expectation and inflation should hit 2 percent target. With the falling oil prices developed and oil importing economies could perform better. But despite all positives, if US economy fails to perform, world economies could head for another long recessionary period. This is why in its mid-November 2014 gathering in Australia, G-20 members announced USD 2 trillion economic stimulation plans until 2018 to address patchy growth. So quantitative easing therapy is still alive and can be applied. Europe and Japan are still faced with low growth syndrome and the economies are dependent on loose monetary policy. Russia is the most recent casualty of oil price slump. Its economy is tagged with plenty of inter-connected links and investors are nervous. Russia is already faced with capital outflow problem weakening Rubble and is also faced with credit line issues. Another cause of big concern is the huge volume of refinancing in USD and Euro that matures in 2015. Hope Russia does not drag its economic partners, as low global oil price and Russian problem can potentially have spill over in other continents. China rich in cash could be last hope, as its business partner to step in to support Russia.

GOLD Gold is a US dollar-denominated commodity and scope for strong USD is bright. Yellow metal that in recent past enjoyed strength due to Eurozone uncertainty, quantitative easing, Geo political factor in Middle East and Central Bank buying failed to find aggressive buyers. View on gold is bearish, as China slowdown is at a faster pace, forecast for global economy is not very encouraging, Swiss Central Bank buying did not happen, global unrest has eased, commodity price is likely to remain soft and excessive liquidity has dried up. So there is nothing exciting for gold to give boost, Russian/Ukraine conflict is not big enough to excite buying. Hence, gold buyers have little reason to believe that the metal still enjoys safe haven status. Therefore, any up-move is considered good opportunity to sell. Upside break of $1225-30 zones will encourage for a move towards $1280 zones. Only break here risks for another $50-70 gain, which is not a favoured move. Gold is likely to fall and break of $1110-20 levels will open gates for $1080, as medium to long-term target remains test of $925-50 zones.

EURO @ 1.21 = Eurozone is once again faced with economic challenges/risk as Germany is unable to pull European cart alone. Draghi’s therapy may not work this time. Greece is boiling after its government has resigned and Syriza leader of anti-establishment party is leading in opinion polls that can bring political unrest in the region, as he is totally against European policies. Election is due on January 25 and Greece requires huge funding rollover in March and beyond. Furthermore, there is growing worry that troubled Euro-zone economy that is laden with heavy debt is again falling in oil trap. This means Europe could be heading for deflation increasing chances of quantitative easing at earliest. Therefore, combination of US economic strength and weaker condition in Euro-zone should initially add pressure on Euro, but may start bouncing back and start gaining strength on back of recovery around 3rd quarter. Euro is likely to stay below 1.2380-50 zones and only break risks for 1.27. However, fall below 1.1780 will encourage for 1.1620-50, which is the support line. A bounce back is possible from 1.15-1.16 zones. But, weekly close of support line would increase pressure on currency for a fall that could see drop towards 1.1250.

GBP @ 1.5520 = Fate of Cable will largely depend on its health, as overall condition of UK economy is on dip. Disappointing growth data caught market wrong footed that could worsen trade numbers. Hence, the question of early rate hike may not occur too soon. Economic dependency on Eurozone economy is a reality, which should force Bank of England to hold its breath. In present situation, odds do not favour pound sterling to gain much strength, unless UK economy makes a sharp U-turn. GBP should hold below 1.5880 and only break risks for 1.6080. On the downside break of 1.5250 would pave way for 1.4650. On the up 1.6250 is the resistance level.

JPY @ 119.60 = After Japan’s early election and Shinzo Abe’s win, Abenomics strategy of record purchase of assets (QE) is likely to stay. As promised by Shinzo government, taxes will remain low. Though Japan is still struggling to come out of recession, despite all odds, unemployment rate is at low of 3.5 percent. Unlike past shift in domestic market behaviour is visible, as flow of funds is not moving out of Japan. Domestic investors have more confidence in Japanese economy. Further, corporate governance reforms will translate into better capital efficiency. For Japan that imports bulk of its oil, with falling oil prices its economy will get boost and in combination with weak Yen policy, Japanese exports should pick up at a faster pace. Therefore, outlook looks good and hence, Japans economy should provide positive results in later part of the year. JPY could overcome its weakness in coming months. Break of 122.80 is required for a final round of its next up-move towards 124.80. It has strong resistance at 114.80-50 zones break will confirm further gains towards 110-12 zones. (The views presented and analyses articulated in this article are not necessarily those of the newspaper)

Copyright Business Recorder, 2015

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