Growing strength or brewing disaster?

Pakistan has posted a current account surplus amounting $250 million during the first half (July-December) of the current fiscal year (2012-13) as against a deficit of $2.4 billion in the same period last year.

Some people regard this surplus as a sign of economic prudence and healthy for the economy. Since elections are around the corner, the government’s ministers, particularly members of its economic team may project this as a significant economic achievement.

A cursory look at the balance of payments’ table suggests that both exports and imports have registered negative growth of 0.3 percent and 1.6 percent respectively as against positive growth of 8.5 percent and 18.1 percent in the same period last year.

These developments have resulted in a marginal decline in trade deficit ($7.614 billion). It is the service balance that has contributed significantly to the current account surplus, of which the coalition support fund (CSF) amounting to $1.9 billion has been the major contributor.

The release of $1.9 billion under the CSF during the first half of the current fiscal year has been generous on the part of the US.

The timely release of this fund has prevented a serious debt payment crisis on the one hand, but at the same time has prevented Pakistan from seeking the IMF programme, as well as undertaking much-needed structural reforms, on the other.

In short, it appears that the US has bailed this government out for the remainder of its tenure (March 2013), and with this it has delayed much-needed economic reforms.

Is the current account surplus a sign of economic prudence? The current account balance is identically equal to the saving-investment gap. A surplus in the current account means saving exceeding investment. A surplus may not always be a sign of economic strength. It could mean that a country’s residents find it more profitable to invest abroad. If this is due to a lack of investment opportunities at home, the country may be forfeiting domestic growth.

Economists have tried to formalise the idea that countries are more likely to be net borrowers or savers at different times. A theory of balance of payments stages has it that developing countries begin by running both current account and trade deficits as they invest heavily.

Over time, the exports generated by investment generate a trade surplus, but the current account stays in deficit because of the interest due on the debt already accrued.

After a while, the country pays off enough of its debt to move to a current account surplus, and eventually becomes a net creditor to the rest of the world.

Thus, a country with surplus in current account means that the country is a net exporter of capital. Given the current state of Pakistan’s economy, is it sensible to suggest that it has become a net exporter of capital? The answer is obviously in the negative.

A surplus in current account in the case of Pakistan suggests that saving has exceeded investment and its saving rate is already low at 10.5 percent of GDP in 2011-12. With the investment rate at 12.5 percent of GDP, the lowest in the last five decades, Pakistan posted a current account deficit of two percent of GDP last year.

A surplus in current account during the current fiscal year means that investment has nosedived further, even lower than the already low saving rate.

This is a dangerous sign for the country’s medium-term growth prospects. Investment rate may reach a new low this year, perhaps lowest in the country’s history. Is there any sign of investment further declining this year?

First of all, the credit to private sector is dismally low. During July 1, 2012 till January 11, 2013, credit to the private sector amounted to Rs53 billion as against Rs191 billion in the same period last year.

Such a low disbursement of credit to the private sector indicates a lack of demand for credit by the private sector because of the deteriorating investment environment.

Second, as it is well known that the economic activities in developing countries are largely dependent on imported raw materials, capital goods, machinery and equipments and energy. Overall, imports during the first half of the fiscal year have registered a negative growth.

It is clear that the private sector is not borrowing for capital formation or for long term investment which is reflected in the decline in imports of key raw materials, machinery and equipments and overall petroleum group products. Such a development does not augur well for the current year and medium-term growth prospects.

The State Bank of Pakistan has been aggressively pursuing a loose monetary policy to promote investment. Little do they know that in developing countries, it is not the cost of capital but the availability of bank credit that matters the most.

Investment depends on an enabling environment. In the absence of uninterrupted power and gas supplies on the one hand and deteriorating law and order situation on the other, it is hard to imagine that the private sector would come forward and take advantage of the low interest rate environment.

This environment may encourage stock market activities, which have nothing to do with real economics. It may also encourage investors to hoard commodities and speculate in real estate activities.

Hence, surplus in the current account is nothing to celebrate. Current surplus is due to the sharp decline in investment, which does not augur well for Pakistan’s current and future growth prospects.

Five years of economic mismanagement have shattered the confidence of the private sector and forced businesses to relocate their industries abroad. A surplus in the current account at the cost of investment is a recipe for disaster and not a sign of strength.

The writer is principal and dean of NUST Business School, Islamabad. Email: ahkhan@nbs.edu.pk