By Sebastian Samuel
Financial sector: The financial sector was the second largest recipient of FDI over the period FY02-H1FY08. It received US$ 2.68 billion, which is 16 per cent of the total FDI, reasons for which are the underdeveloped insurance sector, low credit penetration and high banking spreads. If industry has to grow it has to be supported by a robust and competitive financial system.
The government should start paying attention to other sectors as well. The sectors that have a great potential to significantly add to the GDP and export proceeds are:
Automobile
The demand for automobiles in Pakistan is ever increasing and if the current local production falls short of demand the government should not resort to import of automobiles when we already have a widening trade deficit. The imports should be discouraged in the form of high import taxes, while the local industry is encouraged to grow. More foreign investment should be encouraged and attracted. The FDI received in this sector over FY02-H1FY08 has been a meager US$ 0.23 billion, which is only 1.4 per cent of the total FDI. If the supply/demand dynamics tend to drive prices up, the government should intervene and regulate until such time that the production capacity has increased. And as far as auto-finance segment is concerned it accounts for 4.73 per cent (as of Nov-07) of scheduled banks net advances. Earnings lost because of slowdown in auto-finance can be offset by additional long-term lending to this sector for capacity enhancement.
Transport
This sector has not received any significant investment yet. The government is poised to invest in ports & shipping. QICT, PICT, KICT and Gawadar port are examples of the government’s commitment to develop this sector. About 25 per cent of the export proceeds from the services sector come from transport.
Pakistan has a weak Airline industry. It constitutes of only 3 players – PIA, Airblue and Shaheen, of which PIA is in deep financial trouble. It has around 40 billion rupees of accumulated losses. The sooner it is privatised the better, while other local players are encouraged to grow.
Fertilisers
This industry takes a very important position given that about 11 per cent of the GDP comes from crops. We have recently seen significant investment and capacity enhancement in this sector. It is expected that by FY11 Pakistan will have excess production of urea, which can earn us some export proceeds. However, DAP is the fertiliser where we fall short. Only 30 per cent of the DAP consumed is produced locally. And with the international prices skyrocketing, the impact on the import bill is significant. The price of DAP has doubled in the last two months; it has increased from $450/tonne in December 2007 to $900/tonne in February 2008. The import bill for fertilisers for FY07 was $447 million; it has shot up to $579 million during the 1st half of FY08, which is a 60 per cent annualised increase.
The way forward is to encourage DAP production in Pakistan. Driven by the international drive to produce more ethanol, the demand for DAP will only rise; and so will its price. Therefore, the government should encourage local production of DAP in amounts significant enough to allow for exports as well. The exports would more than offset the import-bill paid for phosphate.
Chemicals
If the pharmaceutical and fertiliser industries have to grow, then the chemicals industry has to grow as well, and investment in it should be encouraged.
Pharmaceutical
Pakistan has a competitive advantage in producing medicines at lesser cost. Currently, the GDP contribution of this sector is negligible.
Information technology
The demand for new software and hardware is ever rising. IT firms usually are the top performers on stock exchanges around the world. Reason being, the enormous growth rates that these companies offer because of their ability to resell their products to the same customer over and over again.
Poor IT infrastructure can actually hinder industrial growth in an economy. Therefore, it is vital that Pakistan tries to attract foreign investment in this sector, not in terms of distribution licenses but in terms of building production units. The reason for this is distribution essentially means a higher import bill, while production does not.
The services sector accounts for 53 per cent of the GDP and generates 19 per cent of the total export proceeds. A plausible explanation for this phenomenon is that its primary purpose is to support the real sector, and not to generate export revenues. But when compared with other emerging economies like India, where the services sector accounts for about 60 per cent of the GDP and generates 1/3 of the total export proceeds, the 19 per cent contribution by Pakistan’s services sector seems low. The revenues from services should eventually increase with growth in transport, financial services and communication sectors.
There is a serious anomaly in the structure of the services sector which has adverse fiscal implications for the economy of Pakistan and which the government should take notice of and try to rectify. The wholesale & retail sector accounts for 19 per cent of total GDP. Now, given that the contribution to GDP is made up of the margins taken by the wholesalers and retailers, one can well imagine their enormity when compared with the indirect taxes and subsidies which are only 8 per cent and 2 per cent of GDP respectively. Subsidies have been so great as to spin the fiscal budget out of control. Even if a portion of the enormous amount of money that goes into the pockets of the businessmen could be diverted as tax revenue instead, a lot of fiscal pressure can be released. The diverted amount could actually finance the subsidies, reduce budgetary borrowing, help control M2 growth and thus, control inflation.
Now having dealt significantly with the economic structure of Pakistan lets discuss the causes of economic growth during FY05 – FY07. The figure and tables below show the relationship between the GDP, advances and the discount rate. (see fig-2) and (see table-6 – 7)
It is very clear that it was the offtake in credit, triggered by discount rate cuts that caused the GDP growth we witnessed over the last few years. Rising credit is an indication of economic well-being, provided that it is able to generate future productivity as well. The problem one has witnessed in Pakistan is that though credit and GDP have risen, the allocation has not been right. Going forward, credit disbursed in the past will not be able to generate future growth.
Agriculture credit has been completely ignored; a colossal mistake on part of the government. Agriculture, as already mentioned earlier, is a primary part of the value chain of a large chunk of the manufacturing sector that drives more than half of the country’s export proceeds. One fails to see how the government was planning to sustain economic growth by adopting policies that would actually make the real sector weaker over time. Low agriculture growth and rising interest rates have contributed to the slowdown in the manufacturing sector (tables 6 & 7), making the trade deficit touch unsustainable levels. The trade and fiscal deficits have become so wide that even huge foreign inflows have not been able to adequately fund them.
The result is higher government borrowing, growing M2 and rising inflation. Had the government not ignored the real sector, our import bill could have been adequately funded by our export proceeds, and inflationary pressures could have been controlled. To make matters worse the State Bank has gone on a discount rate raising spree, which does not control inflation anyways because it is a global phenomenon driven by demand/supply mechanism and thus, uncontrollable for now. The effect is lower private sector credit, which again hurts the real sector growth and translates into lower exports and widening trade deficit, rising government borrowing to fund that deficit, rising M2 and rising inflation. As a result, now the State Bank is in a dilemma. There is not much it can do to curb inflation. The situation could only have been controlled had our real sector also grown over the last 4-5 years, and was able to provide the much needed natural hedge in the form of rising exports, which currently does not exist. But in the face of pressure the State bank has to take some action, so what it does is raise the discount rate even further, prompting a vicious cycle.
Under the current circumstances the government has only two alternatives:
(1) High inflation and lower productivity, and
(2) High inflation and high productivity.
By resorting to further monetary tightening, the State Bank opted for the first alternative, which going forward will only make matters worse. The discount rate should not have been further increased by 50bps. The State Bank should have let it be at the previous level for the time being. If possible, it should be brought back to 10 per cent while the government, in the meantime, makes a sincere effort to curb the domestic drivers of inflation, which are hoarding, smuggling, and unplanned and untimely export of crops.
To combat the international inflationary pressure, it is high time that Pakistan started moving toward producing high value-additive products, such as ethanol and DAP. Their demand is increasing internationally and hence they fetch high prices. We have firms in Pakistan that produce both. Currently, Pakistan is short on production capacity for DAP, however this can be enhanced over the medium-term. While this might mean higher import of crops, phosphate, and plant and machinery, it should not hinder Pakistan from producing them, because when exported they will fetch more than what will be paid for imports. Japan is a prominent example of an economy that imports and transforms those imports into products, which then fetch higher prices when exported. Japan’s economic prowess today, speaks volumes about the soundness of this policy.
Pakistan has enormous economic potential. It is all about taking the right decision at the right time and not being apprehensive in times of a slowdown or over-exuberant in times of an upturn. Pakistan can be slowly put on a long sustainable track of economic growth, with the help of sound economic policies.
courtesy: The News, 17/3/2008
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