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Sunday, 19 May 2013 10:36 am
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Profit Editorials
Economics of oil
Despite fundamental growth problems in the global economy, geopolitical tensions in the Persian Gulf seem set to trigger yet another round of nervous hikes in international oil prices. So far, oil above 100 is definitely overbid, especially since markets have not yet priced in any unintended, or intended, consequences of war clouds gathering over Iran. Yet with Tehran throwing an unexpected ace as its first visible move – blockading the Straits of Hormus for ‘regular military exercises’ – oil is likely to break its uncertain, range-bound trading pattern to the upside. That is bad news for emerging markets, and bad news for Pakistan considering its present low-growth dilemma. In case of further escalation, it is difficult to foresee a not-so-sobering outcome. One, expensive oil seriously threatens to derail fragile recoveries in America and the euro-zone, both beset by debilitating hangovers from the ’08 recession. Two, it will make retaining struggling emerging economies’ growth trajectories that much more difficult, slowing down Asia. Three, it will burn America-friendly oil barons in Riyadh, long the stabilising force in international oil. They have always been wary of the consequences of too-expensive-oil, and how demand slowdown in the west can compromise its own vaults. But with a $130 billion social spending package to stall a building spring in the oil-rich eastern provinces, it’s support price has risen to the $90-100 range, forcing it to stand with “intolerable” Iran and Venezuela at the opec conclave. Four, the worst blow will be dealt to economies mired in stagflation, already suffering low-growth and high-inflation, like we are. Granted, no economy is immune to international shocks, especially oil price gyrations. But considering how oil movement causes input price correction across the board, commodity price alone can seriously derail our economy. The prime reason is that our economy is continuously near break-down point, unable to withstand exogenous shocks, which is simply poor planning. These developments should prompt some manner of proactive posturing in Islamabad.
Dr Sheikh and the tax net
While the finance minister’s revelation of netting 700,000 tax evaders during the ongoing fiscal is appreciated, we will need to see visible, on ground improvement to overcome our mistrust of just such boasts. Back at budget time, and slightly earlier during our pre-budget seminar in Lahore, similar statements by Dr Sheikh led us to believe that this might really be Pakistan’s year of growth, that ambitious budget targets reflect proactive posturing by the government, that the finance ministry will turn a new leaf by finally checking unnecessary leakages and stimulating tax receipts to ease the centre’s fiscal space. Yet there has been little to back tall claims, save the odd statement by the odd official, followed by the odd news-item the following day. The economy remains as it was, hemorrhaging billions annually due to official inefficiency with both tax and exports earnings unimpressive, not nearly enough to grow eight per cent of GDP in the medium term to absorb the furious 3.5 per cent growth in the labour force. Dr Sheikh also noted the undeniable centrality of the private sector with regard to putting the economy back on track. Yet his tenure at the finance ministry has not met with success on promised privatisation of sick public sector entities running the government into ruinous debt. If what has been is any indication of what will be, then Dr Sheikh should expect few serious minded people to take his latest claims seriously. However, if the future is to be any different from the past, we will have to do exactly what Dr Sheikh has noted. There can be no other way. The government’s earning capacity needs serious upgradation, and for that a paradigm shift is needed in both tax receipts and trade earning. Failing that, we will remain aid dependant, forever jammed far below the production possibility frontier.
Railways collapse
A Rs25 billion subsidy and still Railways’ annual loss adds up to Rs45 billion. Everything about the current state of the enterprise – wrecked locomotives, appalling monitoring and oversight, unacceptable safety conditions, non-existent checks and balances, inexcusable handling of engines – reeks of corruption and mismanagement of the highest order. Regrettably, recommendations of the National Assembly Standing Committee on Railways, largely citing fire-fighting measures to forestall immediate collapse, will only amount to the proverbial band-aiding bullet wounds. Railways, like most public sector enterprises, is in a state of utter collapse because it has been allowed to decay. And while we have endlessly explained numerous reasons for its fall, its best to concentrate time and energy into identifying avenues for improvement. A homogeneous system is needed that covers all such organisations. One, they can no longer be used to dump political appointees. This practice has led to collapse of practically all government institutions. Two, it cannot have a management not answerable to market forces. Three, employees cannot be compensated according to an arrangement from a bygone era. Four, they cannot sit on extremely large tracts of prized real estate used for non-productive enterprises. At the risk of repetition, till the holding company argument, proposed on numerous occasions by our panel of experts, is implemented, there can be no avoiding total collapse of all sick PSEs, railways perhaps the first to fall on its own weight. There must be immediate and credible steps towards strategic privatisation, which cannot materialise till a management turnaround is engineered. We must have infusion of private sector dynamics, aimed chiefly at stitching together a suitable product for sale – checking leakages, addressing over-staffing, minimising losses, etc. One an even more important note, Railways in such disarray is not just an embarrassment for the government, it has the makings of a colossal calamity. The people’s suffering being one thing, it can seriously compromise the army’s tactical deployment should push come to shove, and we are already in a very strained security situation.
Rupee sounds alarm bells
Financial markets anticipating a rupee fall to 92 against the dollar by Jun ’12 does not bode well for the economy as a whole, especially our export structure is no way strong enough to leverage the weakness for revenue gains. It is an apt description of our current financial situation – deficits bloating out of control, investors fleeing, revenue inflow not nearly good enough and high unemployment combining with low growth and high inflation to deepen the current bout with stagflation. If these projections fail to shake our able fiscal and monetary managers, then the middle and lower income groups can just forget about subsistence and survival getting any easier until, at least, a change of administration in Islamabad. There are a couple of interesting features about the rupee losing value so aggressively. The Pakistani currency has largely lost against the dollar when the reserve currency is itself under immense downward pressure. Its recent gains have owed more to safe-haven trading as investors sought refuge from the euro’s dramatic unwinding. For the rupee-dollar exchange to have sunk to its lowest in the present environment speaks of inherent weaknesses in the local economy. Yet this phenomenon is not singular to Pakistan. After years of trumpeting India’s BRIC rise, Mumbai’s Dalal Street seems beset by many similar problems, including an aggressive investor outflow and a frightening pace of rupee depreciation, threatening collapse of New Delhi’s investment economy model. It seems Southeast Asia must also reinvent itself, just like much of the world has done in the aftermath of the monstrous collapse of ’08. Fortunately, Pakistan was spared much of the collateral damage, being poorly linked with the international economy. Yet unfortunately, we created pitfalls of our own, ensuring we didn’t remain unscathed when all else were suffering. There is still time to recollect, and the rupee warning is perhaps the last before collapse becomes inevitable.
Back to the deficits
If November’s 10 per cent year-on-year decline in exports and 19 per cent surge in imports fail to sound alarm bells in the finance ministry, the middle and lower income groups should brace for a particularly hazardous run-up to the elections. That the trade gap widened by 55.5 per cent in the previous month despite a healthy rise in remittances underscores the perilous fiscal state the government is about to send itself head first into. Normally, we’d take the usual argument at face value, that unusually amplified imports owe to increased raw material demand for manufacturing sector expansion in the wake of monetary expansion by the central bank. But as we have often questioned in this space, as has our panel of experts, it is difficult to expect current monetary easing to stimulate expansion when industry is operating well below capacity. Unless existing capacity is amicably utilised, there can be no question of expansion. Plus, the interest rate regime has turned into a double-edged sword. What advantages a declining borrowing rate can deliver the private sector with the government so heavily present in the borrowing market is questionable. Furthermore, it turns out that our fears regarding international commodity prices falling, thus removing the exogenous support our exports got last fiscal, were all too real. Unfortunately, for some reason such concerns were not appreciated within the finance ministry, hence the deficit quagmire Islamabad has sleepwalked into. It is not just exports, the government’s position is compromised on most issues concerning its fiscal breathing space. Promised tax reforms are nowhere to be seen and provincial powers granted by the 18th amendment have so far been wasted. PSEs continue to unnecessarily bleed the government of billions every year, with few chances of addressing the problem. And the export base is still unimpressive, far from adequately tapping our comparative advantages. Judging by the trend, it seems the finance ministry should prepare for another round of embarrassment come budget time, when actual achievement is compared to projected targets.
Timely aid from Beijing
China has often proved an all-weather friend, especially when business with the traditional patron has turned cold-ish. So never mind the expected stiffness in US aid flows. Part of the disappointment will be offset by increased friendlier inflows, and hopefully, another sizeable part by proactive posturing on part of Islamabad. Two an extent, hints of both trends are found in the Bhasha-Diamer dam example. With the world bank still non-committal, adding to our disappointment with donors, Beijing’s $4 billion assistance has come at a crucial time for Pakistan. And that the discontent has pushed Islamabad to diversify its funding base, approaching the Saudi Fund for Development and Japan Bank of International Cooperation, can rightly be seen as a long-term positive for Pakistan. Anything that forces the government machinery out of its inertia is welcome, even if it causes a hiccup or two in the process. Funding and other bottlenecks only underscore the importance of the project. In addition to relieving the power sector’s unbearable burden, it will bring compound benefits. These include helping save foreign exchange, supplementing irrigation supplies, mitigating downstream flood damage and above all, it enhancing Tarbela’s potential life by 35 years. At a higher government level, the project also demonstrates the virtues of prudent planning and intelligent application of foreign aid. For years our political and financial machineries have diverted aid funds to non-development heads, eroding the people’s trust to no small extent. Projects like the dam will not only aid the real economy in the long run, they will also provide crucial fiscal expansion in the immediate term. Projects that provide employment, stimulate consumerism and engineer the second round multiplier will go a long way in countering persistent stagflation. We will follow these developments closely, and press for wider application when the narrative starts taking definitive shape.
Fruits of central borrowing
The remarkable 87 per cent plunge in bank advances to the private sector (during first five months of the ongoing fiscal) is exactly what should happen when the centre refuses to address its ridiculous addiction to cheap money. Expect the projected 4.2 per cent GDP growth target, unimpressive to begin with, to be compromised. Expect also increased unemployment to pressure an already depressed market. It’s the strangest of ironies. Despite being strangely decoupled from the lingering international downturn, we have achieved low savings, insignificant investment and high unemployment completely on our own. Still there are no signs of the government’s borrowing stopping anytime soon, making a joke of central bank autonomy and letting a precious opportunity to stimulate local and lure foreign investment go begging. The banking sector’s position is no less passive. Just when they should have postured towards unprecedented efficiency, so their examples could lend weight to the PSE-privatisation argument, they have let risk-aversion have the better of them, at least for the time being. Instead of tending to the worrying NPL count, they probably figure the government’s dependence on borrowing could not have come at a better time for the private financial elite. From their point of view, lending to a hungry government obviously makes a lot more sense than betraying more fault-lines in their collective risk-management credentials. Yet their deliberate disconnect from the real economy bodes ill not just for eventual growth, but also for their own future. Sooner or later, they will have to return to real lending. And sooner rather than later, private sector investment will have to be facilitated if any manner of growth is to be attained. But should we continue directionless, Islamabad will play host to a very different variety of politicians after the next poll.
Indian troubles
It seems Southeast Asia is headed for a particularly cold financial winter this time around. Pakistan’s tale of stagflation and the government’s inability to stem investor outflow is echoed in a much louder tone across the eastern border in India. Departing from solid investment profiles of its BRIC peers, India was the only country in the grouping that noted a decline in foreign direct investment in ’10. With the Indian rupee in an even more furious downfall than its Pakistani counterpart, New Delhi’s business model has just been exposed as fatally hostage to exogenous liquidity shocks, a simply unsustainable model in the present recession-ruined environment for trade-dependant economies. Surprisingly, India’s economic make-up has started betraying an unnerving dichotomy, at once boasting the world’s most inviting market, but with a centre too weak to fend off the recent vicious attack that rubbished the initiative attracting foreign investment in retail. In addition to embarrassing Manmohan Sing’s rhetoric about reforms, the move exposes insurmountable political cleavages. Deficits are mounting, foreign reserves are insufficient to provide forward cover, inflation is menacingly high and despite a tight monetary policy, the rupee is falling. To top it all, Congress has no friends in the polity. And with the middle and lower income groups subject to increasing austerity, there is little likelihood of India’s democratic credentials weakening enough to cover the ruling party’s inefficiency when comes time for people to go to the polls. It is perhaps ironic that while most of India’s troubles are home-cooked – high deficits, weak central bank position, insufficient reserves, no coordination across parties – its most damaging blow might come from far away in Europe. The euro narrative is weakening by the week, and with it stability in European economies, meaning increasingly reduced export earnings which New Delhi desperately relies on. Mr Singh’s government must initiate a serious overhaul of the entire economy, or prepare to depart and let another take the burden, or let a collapse in India bring down the whole region with it.
Debt, bubble and austerity
Rising external and internal debt puts the government in a precarious position. The problem is compounded because a) borrowed amounts are increasingly channeled towards non-development expenditure, b) the government’s own revenue generation capability – tax and export receipts – is severely compromised and c) reckless borrowing of today will have to be repaid tomorrow, putting the current account and currency strength in grave danger only to fund the government’s day to day functioning. That is not good. Wherever there is debt, especially non-productive debt, there is sure to be austerity. And increasingly, as is seen practically across the world presently, those who consume the debt are far removed those whose labour is milked to pay for it. Governments overflowing with debt quickly form an addiction for free money (it’s not very likely they will hold power when time comes to pay the debt back). And however much they borrow, much more still will have to be paid back. The ‘going’ solution, of course, is public austerity, which means increasing taxes on the few that care to pay them to fund political ineptitude. That is unsustainable. Pakistan, with its debt nearly doubling in the short time this government has held office, is now well down this particular, painful road. Soon, people’s cost of living will register unnerving advances because of the government’s stubbornness on the debt issue. Practically every day Islamabad borrows millions just for the government to function. Most of these funds are not invested. They will not engineer second round returns. Yet they will have to be repaid. Already, this wrong-headedness has undone a good year of first tight and then easy monetary policy. Sane heads need to prevail and the debt bubble deflated sooner rather than later.
Dr Sheikh’s finding
Finally, the finance minister admits that the model of the state running crucial institutions is faulty. Perhaps PIA, Railways, PSM, and practically all such giants under government control had to become sick with debt and addicted to bailouts to finally mobilise the finance ministry. That is, assuming, that the ministry has decided to mobilise. And Dr Sheikh was quick to follow the novel by the usual, noting somehow that prudent policies are beginning to translate into encouraging signs of economic recovery. Yet we remain caught in persistent stagflation, half way through the fiscal most crucial indicators are shy of targets, and public institutions seem likely to milk the government for at least the foreseeable future. Since the announcement of the budget, we have pushed the finance ministry to sort out revenue collection ahead of all essential measures if there is to be any chance of meeting ambitious targets. Yet month after month not only did we not notice any proactive posturing towards improve collection, we also saw no visible efforts to check blatant leakages. Ironically, PSEs provide the best example. They remain politicised despite the hemorrhaging black hole they have delivered to the system. Even if the finance ministry’s sincerity is to be believed at face value, it cannot duck the responsibility of impressing the urgency upon top decision-makers in Islamabad. In this, at least, it has failed, and to no small extent. Dr Sheikh must now follow his finding by at least spelling out, and in considerable detail, what is to be done of these dented institutions that were supposed to be the pride and joy of the national exchequer. Our economic and financial ills call for a serious and drastic reorientation of our fiscal outlook. The sooner Dr Sheikh can initiate appropriate reforms, the sooner we can prepare for a more realistic growth mix. He knows well what is to be done – FBR overhaul, export diversification, privatisation. He also knows how to do it. We just don’t understand why he is unable to do it.
The SBP dilemma
The central bank contradicts itself. First it explains its (obvious) “dilemma” – excessive government borrowing has compromised advances to the private sector. Then it expects the incredible – the 200 percentage point cut so far this fiscal should translate into increased private off-take during the second half. In effect, cutting rate or holding steady, recent developments point towards a different sort of dilemma, where SBP autonomy is diluted by exogenous events no matter how strongly it postures to safeguard it. Strangely, monetary policy has been revolving around the current account deficit practically since the onset of the ongoing fiscal year. First, inability to generate funds fueled excessive borrowing, diluting a tight monetary regime meant to pressure inflationary trends. Borrowing remained high even as unexpected export windfall swelled reserves. Then when tightening screws did not (obviously) arrest high prices, the policy engine was reversed to stimulate growth and encourage private sector investment. Yet the government remained excessively present in the money market, feeding into a risk-averse banking structure reluctant to extend liquidity to private initiatives. The monetary policy statement fails to notice in as many words that the economic engine has stopped responding to interest rate toggling. But perhaps its most penetrating finding is the need for the government to initiate comprehensive tax reforms. Simply put, the sooner Islamabad falls on its own funds to service its running expenses, the sooner banking sector liquidity will be channeled into investment, employment generation and GDP growth. That the central bank has been unable to impress this simple economic rule upon the government obviously does not speak well of its prized autonomy. And commercial banks, too, find it only too convenient to lend to the government as opposed to private investors. Best not indulge in risk management and turn attention to mounting NPLs again. At some point the government’s addiction to borrowing will have to stop. Unfortunately it seems that will not happen till hyper-inflation and public revolt deliver a stern message.
The HBL verdict
Going by the trend, a Supreme Court verdict that doesn’t derail a contested privatisation exercise sets a precedent in itself. Yet there are a number of features in the HBL decision that need careful attention. One, it sends a strong ‘transparency’ signal to interested investors, especially the foreign variety. Two, coming when Pakistan must embark on a very ambitious privatisation drive very soon, the timing is important, and addresses concerns regarding credible risk management and political interference quite amicably. Three, it bolsters the privatisation commission, perhaps pushing for a permanent arrangement that resolves all issues related to fair-pricing prior to binding, deciding signatures. Four, and perhaps most important, it makes for the text-book successful strategic privatisation case, and impresses upon all parties concerned the benefits of relieving the centre’s fiscal burden. In fairness, due credit must also be given to HBL’s post-privatisaion team. Success is the only and ultimate vindication in such endeavours. They are at the centre of the turnaround narrative, which must now be embraced across the board. The key to economic survival in the immediate to medium term will be transparency and efficiency, without which serious investors will simply not channel funds towards Pakistan. Simply put, if the economy is to register meaningful growth and the centre’s fiscal burden controlled, we must have more such cases. We have repeatedly called for turnaround and strategic privatisation of loss-making entities in this space. Now, with the boost to the privatisation commission’s credibility, we must prepare other enterprises for similar treatment, checking unnecessary leakages and stimulating growth and healthy competition at the same time. It is now extremely important that this momentum is not lost. Our current economic and social complexities simply do not allow it.
Structural weaknesses
The bloating current account, the relaxing monetary policy and the rising import bill all combine to pressure the rupee further against the dollar, stoking inflationary fears in an already stagnant economy where investment shows little signs of picking up. We’ve finally come to the point where the government’s excessive borrowing, channeled into non-productive avenues of running day-to-day business, is translating into structural weakness, embodied in this case in movement away from the rupee’s two-year 86 level against the greenback. With the Rs90 per dollar expectation by year end, we have also come to the final point where the government can still leverage the weakening local currency for export earning advantage, an exercise that will require considerable change of posture in Islamabad. Immediately, we should see incentivisation of productive enterprise. The weakening interest rate regime must be complemented by reducing the government’s size in the money market, allowing the private sector to exploit relatively cheaper money and inducing foreign investment at the same time. Until and unless the government restores investor confidence, both local and exogenous, the weakening currency will only feed into weakening growth and rising unemployment. Exports is but one essential feature in need of a very visible government push in the last half of the ongoing fiscal. The other, of course, is tax collection. So far, advances made by the 18th amendment have actually had a negative yield, at least in terms of revenue generation, the reason simply being a lackluster show of responsibility on part of relevant authorities. With deficits now mounting fast enough to hurt the economy structurally, and half the fiscal year gone with no signs of targets being met, those in charge must pull their socks up or risk being delivered a rude message at the polls.
The PSM example
The Rs6 billion bailout package for Pakistan Steel Mills violates one too many essential economic principles to warrant any appreciation – throws good money after bad, encourages moral hazard, rewards incompetence, sets bailout precedents even in this environment and only delays the inevitable. What happens when this bucket dries, and the family silver needs polishing again? How long will the government keep providing last minute lifelines to sick and hemorrhaging enterprises. Time and again, we have stressed the need to ease the government’s fiscal burden, a sizable bunch of which springs from inefficient institutions. PSM should actually lead the way in the government’s final turn-around initiative that restructures these organiastions in preparation for strategic privatisation. Short of that, there is no way this particular black hole can be plugged. Presently, the government’s cramped spending space has severely compromised bottoming out of stagflation. With monetary policy also compromised, again because of inexcusable government borrowing, inability to incorporate targeted expansionary fiscal policy has ruled out the option of stimulating infrastructural expansion and job creation at the same time. With these inefficient, sick giants in need of constant fiscal support, there is no way financial managers can engineer an uptick in investment and consumerism. Such patterns are indicative of the overall direction the finance ministry is posturing in. With exports slowing, no signs of FBR restructuring, and available resources increasingly channeled towards non-productive compulsions, there is little possibility of important statistics entering safe zones. At the end of the day, the tax paying middle and lower income groups are squeezed for government inefficiency. With elections not very far off now, the government should at least be prudent enough to prepare itself for a vote-out surprise unless a significant shift in direction takes place. Steel Mills must be made an example of, but a positive, beneficial one.
KESC problems
Something on the lines of 50,000 industrialists refusing bill payments to KESC was bound to happen sooner or later. That they’d rather deposit due amounts elsewhere to protest power shortages shows they are willing to risk immediate disconnection even if it means permanent closure for most units. Concerning as the situation is, it still provides the government with an opportunity of ensuring a smooth resolution, in addition to re-establishing its authority. First and foremost, it must establish the truth behind the charge that KESC deliberately indulges in power cutting, citing inadequate gas supply from SSGC, to warrant increased subsidy. And once the investigation is complete, it must ensure swift redressal of genuine grievances, and take punitive measures where necessary. Already, the power crisis has crippled industry, destroying its standing in regional and international markets. It is important to note that if this particular standoff is allowed to get uglier, then the government will be rightly blamed for letting crises simmer before turning its attention to fire-fighting and damage control, something it has made a habit of. If the situation worsens, markets and industrialists will not be the only suffering parties. Failure to posture proactively will further erode the government’s credibility. It is not long before these protestors go to the polls. Being in the market for ages, they are well aware of departmental tendencies towards excesses. If their hunch is right, and KESC is deliberately paralysing industry for its own benefits, those at the helm of affairs in Islamabad are likely to suffer as well. This matter is urgent, there can be no dilly-dallying.
Profit Editorials
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