EVERY economic crisis has a typical transmission path or trajectory. The contagion starts with a disturbance in the external account caused by a large trade gap, a spike in debt repayments and/or ‘hot money’ heading for the exits. Its effects are immediately felt by the asset markets, where plunging forex reserves drag down both the local currency as well as market confidence. Usually in around six to nine months, the external shock is transmitted to the real sector of the economy, with the economic downturn forcing business closures and job losses.
In economies where the banking system is more integrated with global financial markets and open to foreign investment, such as Argentina or Turkey, banks are usually at the epicentre of the crisis early on, which exacerbates the effects of the shock. In economies like Pakistan where the banking system has, so far, been relatively insulated from foreign capital flows, banks typically face stress (depending on the severity of the crisis) towards the end of the cycle when recessionary conditions in the economy lead to mounting non-performing loans. This is all the more reason to insulate it from hot money flows, which the State Bank is encouraging.
The post-stabilisation cycle works in reverse. Complemented by an IMF programme, the defensive measures put in place by policymakers typically stabilise the external account first, followed closely by the asset markets. The real sector feels the effects of stabilisation last. Depending on the magnitude of the crisis, private investment and rehiring take at least one to two years to resume post-stabilisation, usually longer.
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In this context, it is both illuminating as well as depressing to point out that in the previous major crisis episode in Pakistan back in 2008, it took 10 years before economic growth managed to cross the rate of GDP growth recorded one year prior to the start of that crisis.
Recessionary conditions prevail as a result of both the crisis and the response.
So where are we in this crisis? The external account, which took a massive hit between July 2018 and July 2019, has shown some signs of stabilisation. However, it may be too early to declare that the corner has been turned. The crisis has morphed from an external trade shock to a debt crisis, suggesting possible persistence. It is in this context that the overall conceptual design of the Fund programme is open to valid criticism as its size and back-loaded disbursement leaves the external account’s vulnerability in place — rather than attacking it forcefully up front. The implication for an early and vigorous restoration of market confidence is sadly more than obvious.
Predictably, the shockwave from the crisis has transmitted from the external account to the real sector. The large-scale manufacturing sector’s output has been in negative territory for eight consecutive months, starting December last year through to July 2019. Sales of cars, motorcycles, trucks, buses and durables are all down massively, as are petroleum sales (especially of high speed diesel, a bell-weather for economy-wide activity). Similarly, capital goods imports as well as private sector credit demand from banks have also recorded negative or falling growth.
Unsurprisingly, exports appear to be a bright spot, however. The much-needed adjustment of the rupee, among other factors, has given a boost to exports in terms of quantity of key textiles products such as garments, knitwear, bed wear and fabrics. Nonetheless, in terms of the domestic economy, even fast-moving consumer goods have been impacted with companies reporting more hesitant consumers, lower sales, and ‘down-shifting’ from premier to lower segment brands as well as to smaller packets. Retail outlets anecdotally report a decrease in footfall of 60-70 per cent over the past two months especially, with traders in some of the country’s main wholesale markets reporting a fall in sales of around 50pc over the same period.
A recent national survey conducted by Ipsos Pakistan in August this year validates the bearish sentiments gathered anecdotally. According to the survey’s findings:
In comparison to one year ago, nine out of 10 Pakistanis are feeling less comfortable while purchasing general household items as well as major ones like cars, homes etc.;
In comparison to one year ago, eight out of 10 Pakistanis are feeling less confident about their job security and ability to save and invest in the future;
About one in three Pakistanis reported witnessing themselves or people known to them personally, who lost jobs in the last one year due to economic conditions;
Only one out of 10 Pakistanis are optimistic about their well-being in coming times.
A large part of the slowdown in the economy is a ‘natural’ outcome of the crisis and the ensuing stabilisation measures. This time around, another element is adding to the uncertainty as well as negative sentiments of some economic agents — a concerted documentation drive by the authorities. Reform of an entrenched status quo is by definition always disruptive. However, this disruption is both necessary as well as positive and policymakers should both recognise, as well as accept, the trade-off with short-run growth.
Nevertheless, the implication of the severity of the crisis coupled with the serious effort at documentation is that Pakistan’s economy is unlikely to see a quick ‘V-shaped’ recovery any time soon. Uncertainty among large segments of trade and industry prevails along with disruption to domestic supply chains and markets. This is unlikely to dissipate significantly during the duration of the IMF programme.
However, the government can mitigate the effects with a more well-thought-out roadmap to achieve a transition from stabilisation to growth (the subject of a subsequent article). Greater clarity and congruence in its reform objectives and plans will lead to more consistency in its pronouncements — which, in turn, will restore policy credibility. Finally, the perennial missing link in this government’s economic plans is strategic communication. It has to fashion a consistent and credible reform narrative — and then convincingly ‘sell’ it to investors and the markets.
The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.
Published in Dawn, October 11th, 2019