Green shoots of a turnaround?
TWO and a half years into the IMF stabilisation programme, there are growing indications that economic activity is finally beginning to pick up. Among the bright spots: a reported surge in business confidence, a sharp increase in utilisation of bank credit by the private sector, including for fixed investment, strong retail sales, a continuing surge in car sales and bullish conditions in the housing market.
The private-sector investment response has been unusually slow this time around, despite the operation of a number of positives that Pakistan has not experienced for a long time, such as a huge improvement in the internal security situation and the dramatic fall in international commodity prices. Nonetheless, it appears to be finally taking shape. The underlying indicators that show signs of a revival in economic activity are as follows. Business confidence, as measured by the Overseas Investors Chamber of Commerce and Industry (OICCI), surged to +22pc in October/November 2015 - its highest level since inception of the OICCI's Business Confidence Index series in 2010. According to the OICCI, "confidence has increased across all levels (global, country, industry, city, company), with businesses indicating a high level of optimism for the next six months". (However, important segments of the business community - including, ironically, OICCI members - have expressed reservations about certain aspects of the business environment, including the taxation system and nonpayment of refunds.)
In tandem with the reported jump in confidence of the country's overall business sector, bank credit utilisation by the private sector has grown strongly in the past few months. According to SBP data, while overall loans to the corporate sector increased over 7pc year-on-year by December 2015, borrowing for fixed (capital) investment increased by nearly 26pc. Loans taken for fixed investment by small and medium enterprises have jumped by 88pc year-on-year.
This correlates with anecdotal evidence of large investments materialising in the cement, steel, consumer goods, durables and beverages sectors - above and beyond the substantial capital spending under way in power generation. Reinforcing the data on borrowing for investment by the private sector is the fact that import of capital goods (machinery) increased 14pc for the July to January period. If the borrowing data is a worthwhile proxy, then it is very likely that private- sector investment will record its first uptick after several years when reported as a per cent of GDP for the fiscal year as a whole. After recording a secular trend of decline since 2008, private investment had fallen to a low of 9.7pc of GDP in 2014-15.
The weak area in investment remains foreign direct investment. While net FDI (inflows minus outflows) has increased modestly in the current fiscal year, it has done so on the back of a much larger decline in outflows (60pc) compared to the drop in inflows (30pc). Investment from China, at $434 million for July-January, provided nearly 60pc of the total FDI so far this year.
The performance of the large-scale manufacturing sector indicates a deceleration in headline production in December. However, two sectors account for the bulk of the slowdown - sugar and cigarettes. Excluding these two, LSM recorded output growth of 4.6pc during July-December 2015. Sectors such as autos, fertiliser, pharmaceuticals, petroleum, chemicals and cement have recorded a strong increase in production, with production of cars increasing by over 32pc.
Similarly, proxy data for construction and retail sales point to bullish conditions in these sectors. On the flip side, however, remains the worrying - and dismal - performance of the export sector and of import-competing industries. Factors ranging from the weak global economic environment to over-valuation of the exchange rate are playing an important part in constraining the performance of these sectors. A confluence of positive developments helps explain the improvement in immediate economic performance as well as prospects for the medium term. These include: - Low international oil prices - Low domestic inflation - A sharp reduction in interest rates - A surge in optimism relating to the prospects for CPEC - Improved supply of industry - The recent injection of imported LNG into the country's energy grid - Improved sentiment regarding the internal security situation on the back of military operations in Fata, Balochistan and Karachi.
Many, if not most, of these factors are cyclical in nature. If international oil prices climb again, the gains can be easily reversed. So what should the government do to ensure that it provides structural legs to the recovery? First and foremost, since CPEC is providing such a large boost to investor sentiment, the government needs to ensure it leverages on the long-term opportunities afforded by this mega venture. The indications are less than encouraging at this point in time. Second, it has to ramp up its strategic communication and engagement with the country's private sector. Channels of communication are not as open as they should be - and where they are, the interaction is dominated by removal of existing constraints and not how to develop a strategic partnership for the future. This will also require the government to change its closed-door, non-transparent manner of working.
Third, a long term strategy for exports has to be prepared with full engagement of the private sector. Are there any specific ideas or export areas which CPEC will provide a quantum boost to? Fourth, it has to loosen the stranglehold on businesses imposed by its taxation and energy tariff measures over the past two years in the current budget.