A number of developments could be read as emerging signs of a recession in the economy. It is quite discouraging to note that the nature of our economic challenge is transforming from an overheated economy to a slowing economy; the excess demand has turned into low demand. The situation points to a classical form of an evolving recession.
First, the sales of automobiles have witnessed a drop of 42 percent in the month of July compared to last year. The sales are down to 13,000 compared to a peak of 25,592 in October 2018 and 22,400 in July 2018. Last fiscal year, automobile sector posted the highest decline of more than 11 percent in its production. Taxation measures introduced in the budget have also contributed to reduced demand, besides the steep devaluation which has hit the prices to unbearable levels. The cement dispatches were down by 2.8 percent in July compared to the last July. The cement production witnessed a decline of 5 percent during last fiscal year. In the eight months of the calendar year, consumption of petroleum products has declined by 15 percent. There was a small increase of 3.5 percent in July in the power generation which is more consistent with a low growth scenario.
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Second, the tax collections were up by 15 percent in the first two months. The target for the first quarter is to achieve a growth of 32 percent compared to the first quarter of last year. To achieve this target, tax collections for September must show a growth rate of close to 50 percent. This is an uphill task to achieve. Two aspects of this performance should be kept in view. One, the tax growth last year was negative one percent while in the early months it was positive 2-3 percent. Thus the base was unusually low. Two, the refunds of Rs 22 billion made on 2nd September were counted as collections of the previous two months. Thus if refunds due for payment were excluded the performance would be even weaker.
The more important point to know is that the tax target has become even more challenging on the face of a slowing economy. As we noted earlier, the key revenue spinners, like automobiles and petroleum products, have suffered significant set-backs in their productions. Under the circumstances, it is unrealistic to hope that higher tax collections can be realized.
Third, the inflation data has very interesting facts to reveal. The rebasing has led to a significant fall in rates of inflation. For the months of August and July, yoy inflation under the old (2007-08) was 10.34% and 11.63 percent while the numbers have improved to 8.39 percent and 10.49 percent under the base of 2015-16. The rebasing has been extensive as it not only looked at the shifting patterns of consumption across various groups of commodities and services but also geographical distribution of consumption having impact on demand and supply. The new division of urban and rural markets and corresponding price indices have been constructed together with a national index.
This rebasing was shared with all IFIs and international bodies who have provided technical expertise in the area. It is therefore necessary to have a dispassionate look at the new numbers and reassess the inflation outlook in the country, which has been under serious debate because of a somewhat novel interpretation of such data and its use in inflation forecast.
Under the 2008 IMF programme, Pakistan was facing an unusually high inflation and decisions were required as to what inflation index should be used to set the policy rate. It was mutually agreed that the appropriate index was the core inflation. It is this rate that should logically be adopted as the target inflation because it irons out the volatility due to food and energy prices. Now, based on the new numbers, the core inflation in the last two months was 8.2 percent in July and 8.5 percent in August, with the two-month average at 8.35 percent. However, this is an average over a short period and hence a better measure would be to use a moving average of past twelve-month, which is 7.5 percent.
How can one ignore this reality while setting the monetary policy rate? The aim of monetary policy through many IMF programmes was simply to keep positive real interest rates. There has never been a demand from the Fund that the rate be set at a level that leads to almost usurious real interest rates. Against a 7.5 percent average core inflation the policy rate has been set at 13.5 percent, giving an astounding real interest rate of 6 percent. This has never happened in country’s history where there have been numerous years when real interest rate was negative. The best defense of such a high policy rate is the inflation forecast of 13 percent during 2019-20. How is it possible to base the policy rate on a forecast that needs a long period to verify, and when its chances are receding based on the first two months of the price data. The marginal inflation rates for the next ten months have to be more than 13 percent to realize the 13 percent average inflation during 2019-20.
Fourth, the budget of 2019-20 is already out by a long margin. The deficit of 7.2 percent has finally come out at 8.9 percent. With such a high base line deficit, it is unrealistic that this year’s budget deficit target of 7.2 percent would be achieved. The target under the program was primary deficit which excludes interest payments. The program target was that it would be brought down from 1.8 percent last year to 0.6 percent this year. But the final number of primary deficit is 3.5 percent, almost twice the assumed number. This would mean that an extra adjustment of 1.7 percent would be required, larger than the original effort, to achieve the 0.6 percent target. Any thought of an additional fiscal adjustment should be an unacceptable proposition given the precarious slow-down that is write large on the horizon.
This is a very disconsolate picture of the economy. All signs are of a deepening slowdown. It seems the government doesn’t share this assessment and hence it has not contemplated any action that would signal its concern. Nobody is interested in averting the fast building slowdown. We would however, very strongly urge the government to use the fiscal and monetary policies coordination board, headed by finance minister, to send an unequivocal message to the central bank that the policy rate is not only prohibitive but has been the leading cause of engendering depressing sentiments in stock market, investors and the rest of the economy. It is also the primary reason for fiscal disorder that has seen the worst fiscal performance in country’s history last year, which has resulted in historic build-up in public debt and public debt and liabilities.
(The writer is former finance secretary)
(This news/article originally appeared in Business Recorder on September 6th, 2019)