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Economic Outlook, July-December 2017

July 6, 2017

@asadcmka
Asad Rizvi 

After the release of 3rd quarter FY-17 SBP report, a lot has been said and written about the economy, but I still believe that market is not addressing and is not concentrating on the basic economic problems.

The truth is that overall our economy has a developed large size “Black Hole” due to unaddressed issues and therefore it is faced with many challenges because of underlying weaknesses.

As we are heading for elections, in number terms with present government’s stance I do believe that economy will perform well and is unlikely to stumble in FY-18.

It is simply because money will be dumped and in any debt ridden economy when cash is injected either by borrowed means or otherwise, the economy is bound to do well, as added liquidity pushes growth higher.

However, despite CPEC in place, with its continued policy of current growth pattern economic surge will not be sustainable in medium to long term due to severe income constrain.

Meanwhile, over the years (decade) despite depreciation of Rupee, sharp cut in KIBOR rate, subsidies given to business community in shape of cash, rebate, tax and other incentives our market has never responded positively.

Furthermore, in the absence of much needed policy support, outdated methods, equipment’s and strategies, high cost of doing business and lack of burning wish to excel, the economy cannot perform at its maximum to attain desired level of growth, it then ultimately have negative impact on economy.

If we compare between types of relief given to the business community in recent years and the hardship faced by them (incentive & constrains). I would say business entrepreneurs are blessed with goodies, which is why they have become complacent and are often too demanding when they under-perform. The reason is obvious, as government provides them comfort at the cost of tax payer’s money and their demands are comfortably met.

Here are few good examples. Banks are minting cash in billions by investing in risk free government securities at the expense of economy and not contributing towards much need growth at same proportion. Despite sharp cut in Discount Rate in 2016 Commercial Banks earned profit of Rs 190 billion against Rs 199 billion in 2015.

Despite easing of Major Currencies against US Dollars, the car makers are fleecing the nation by not adjusting the prices accordingly.

Petroleum prices are down by nearly 30 pct from the highs, but transportation cost is not adjusted at same proportion.

On July 12, 2012, wheat price was USD 9.12 per bushel, which crashed to hit USD 3.81 per bushel on Sept 15 2014 and is now currently trading around USD 5.6 per bushel. But in Pakistan wheat support price has been raised from Rs 1100 per to Rs 1500 per 40 Kilograms, while in 5-years, Rupee against USD has weakened by nearly 11+3 = 14 pct. Similarly Sugar, Rice and Corn prices are down by around 35 to 45 pct.

Unfortunately benefits of the fall of basic food commodity prices in the international market have never been passed to the end user nor did it help in increase in tax collection.

Meanwhile, during this period (2007-2017) rental properties and real estate prices surged by nearly 5-8 times, but revenue collection on transactions is a mere joke that helps tax evaders to manipulate the economic system enabling them to park their funds in properties.

Difficult economic condition at home was created to reduce public expenditure on IMF’s demand that helped to bring down fiscal deficit to a desired level resulting tougher social condition.

If we look at the entire perspective of issues of last 3 or 4 decades the economy has always succeeded in dodging the structural reforms. While, in recent decades government spending and (ratio of Bank Advances to Private Sector) suggest that austerity measure was/is the biggest culprit hindering real growth/stimulation.

Therefore, unless the crux of economic problem is addressed and corrected the economy will continue to haunt the economic managers.

SBP Monetary Policy Stance

After all the hard work in last 3 to 4 years, SBP lost its firm grip on the market as it could not read the market trend correctly. Since last year and a half Central Bank’s Monetary Policy Statement suggest that it has been over cautious about inflationary threat, which was never there, as oil comfortably averaged below USD 55 per barrel. Targeting 6 pct inflation rate was an “Exaggerated Estimate”, which was never a possibility. This is why CPI for FY 17 ended at 4.16 pct, which is well within my target of 4.25 pct.

Since SBP was targeting 6 pct inflation rate in FY 17, it did not slash its Policy Rate, which should have been lowered by 100-150 basis point. Lowering of interest rate would have paved way for MOF to slash PIB coupon rate at same proportion.

Such action would have provided room to reduce government’s cost of borrowings by nearly Rs 250-300 Billion that would have helped in attaining its Revenue collection target.

For FY-18 SBP is once again targeting 6 pct inflation, which in my view is on the higher side. Even with 5-7 pct depreciation of Rupee I do not see inflation beyond 5 pct. In next 2-quarters I do not see inflation surging sharply for two reasons. Oil prices in (July-December) will comfortably average around or below USD 52 per barrel. And secondly with the help of food support price at current levels, healthy monsoon season and good weather condition, crop condition will remain stable for next six months.

Therefore, in all probability, I do not see inflation surpassing my January 2017 Outlook target of 4.80 pct and is likely to stay within 4.5 pct to 4.80 pct band (July-December).

Further to attain 6 pct growth and Rs 4 Trillion Tax Target SBP will have to act and take pro active measures. It is required to make sure that promised funding of Rs 1-Trillion each to Private Sector and Agriculture is timely injected.

Price Stability

Price stability is one of the key mandates of SBP that should allow economic growth. To optimize, policy should be formulated in such a manner that it must help to predict the future prices/trend.

In last FY with inflation constantly staying around 4 pct or slightly above whereas SBP was targeting CPI @ 6 pct , it makes no sense or was/is this intentional to keep Policy Rate higher. Or if SBP disagrees with my argument then how does it define price stability to defend wide gap between inflation number and Policy Rate and what is the objective behind this strategy ? It is this juxtaposition, which is confusing.

There is another huge discrepancy, which has never been discussed. Since last couple of years SBP 6 month outright forward rate averages around 125 paisa, which means based on swap points, exchange rate and funding cost in USD, Rupee’s average Cost is well below 4 pct. (Formula-Swap Points X 365 / Ex Rate / # of days + Libor = 6 month interest rate), whereas SBP Policy Rate is currently 5.75 pct. Therefore, based on SBP 3-month or 6-month swap points, Policy Rate should be around 4 pct for 6-month. Or otherwise 6-month Swap Points should be around 225 paisa instead of 125 Paisa (current). This puts a question mark on SBP’s inflation and price stability policy.

Therefore, even with 4 pct Policy Rate, Rupee will remain attractive because of interest rate differential advantage. As potentially there is room for another 25 basis point US interest rate hike, but I do not expect it to happen in remaining two quarters of 2017. Neither do I see European Interest Rate Hike beyond 25 basis point.

Further, in another recent move according to SBP Master Circular – OMO, as part of its monetary policy implementation under revised interest rate corridor framework, it says SBP will keep money market O/N Repo rate close to its “Target Rate” (5.75%). To me this is clearly a hint that SBP will opt for softer rate stance, which is globally practiced to reduce cost of borrowing. Hence, by 150 basis point cut means annual deficit financing can be reduced by nearly Rs 300 billion.

Rupee/US Dollar

FM Dar’s statement on Rupee depreciation will give more clarity to the inter-bank market, as market remained nervous and choppy since yesterday.

It is worth noting that 73 pct depreciation of PKR against USD in last 10-years has never helped Pakistani exports to make big strides in the international market. I would once again reiterate my earlier call that minor adjustment is OK, but since Pakistan is not a manufacturing or industrial country, Rupee depreciation will not help large surge in exports.

We have to make a quick shift in our strategy. Our Wheat, Sugar and Rice are too expensive because after providing support price subsidy to growers our commodity becomes too costly to sell in international market and then we are not competitive. Cotton our main source of exports in past continues to look gloomy, as we have to move beyond to meet local demand by revising tax slab.

To gain maximum in terms of trade volume, Pakistan is required to make a change in its approach by contacting high income countries. Textile industry should be allowed to operate at the fullest, as high energy cost is a discouraging factor. Cost of doing business is too high, which needs to be arrested so that the industry is run in full capacity. The industry is still faced with refund problem that needs to be sorted out, as under investment is another troubling factor.

While, remittances would remain a major source of income to fund current account, but minor dip is a possibility as softer oil prices may add pressure and FY end (June 2018) could still see a minor drop in remittances by nearly 3 pct.

Based on above facts, my view on Rupee remains unchanged, as projected earlier in January 2017 outlook. I do not see any reason for downward adjustment of Rupee, which should not move beyond 2 pct (plus/minus). There is no change in my Fiscal Deficit target of 4 pct.

Meanwhile, drop in PSX from my earlier given target of 53.000 to 42.000 is intact, but then it should hold. I will not be surprised to see another spell of fall if banking sector stocks fails to hold its breath.

(Disclaimer applies in my post, which means that the perspective is my personal view. I have made every effort to ensure accuracy of information provided. However, accuracy cannot be guaranteed. This article is strictly for information and not intended for Trade or Business Transaction).

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