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Why domestic savings still heading south?

Does highest growth in eight years and lowest inflation in decades mean that the economy is on right track? Let’s probe this hypothesis by analysing factors behind improved macros. Growth of 4.7 percent is mainly due to filling in the capacity gap than broad based economic recovery. The star performer is the manufacturing sector which provisionally grew by 6.8 percent in FY16 as compared to an average growth of 2 percent in the previous seven years. Does it mean that innovation and technological advancement in the country is on the rise? Sadly, no. The growth is fuelled primarily by fertilizer (15.9%), automobiles (23.3%), electricity generation, distribution and gas (12.2%) and construction (13.1%). In case of fertilisers, the capacity is unchanged, and demand perhaps declined a bit; but the availability of gas let the production go up. For autos, it’s the government run schemes doing the trick with little or no cascading impact on economy at large. Low oil prices have thinned the circular debt and enhanced power demand; this coupled with new projects have improved the energy sector performance. But what if oil prices head north in FY17? The construction sector performance is based on high demand and cement sector thrived in the process; and the momentum may continue in FY17. The CPEC projects will further enhance construction growth. The worrisome fact is subdued performance of textile sector (0.6% growth); that has hampered the exports growth. Exports to GDP stood at 8.8 percent in FY15 against an average of 10.8 percent in the previous five years. And exports to GDP is likely to deteriorate further in the outgoing year. This is a scary trend and ought to be reversed for the economy to sustainably grow over 5 percent. The agriculture sector, on the other hand, had one of the worst ever year as growth declined by 0.2 percent in FY16. Low commodity prices amidst adverse cotton crop had its toll on the farm economy; and the urbanised cabinet has not taken the falling livelihood of farmer too seriously. The sector provides employment to 43 percent of labour force and half of the country population is virtually dependant on farm income. In case of services sector, the main contributors in 5.7 percent growth are financial services (7.8%) and general government services (11.1%). Both are interlinked – government is mainly borrowing from commercial banks to fuel in latter’s growth. Thus, not much to cherish on services growth. The crux is that economic growth is neither broad based nor sustainable. The investment to GDP ratio marginally declined to 15.2 percent in FY16 and missed the target. Same is the case with gross fixed investment, which did not only miss the target but is also lower than last year’s level. How can the economy grow in coming years when investment is falling? Surprisingly, in low inflationary environment, domestic savings are heading south. Yes it’s the consumption that is driving growth – private consumption contributed 5.4 percent in FY16 GDP growth measured by expenditure approach; it doubled over last year’s number. This simply explains that falling commodity prices have increased the purchasing power and people are consuming more rather than saving. Domestic production is not enough to cater high consumption demand and that fuelled imports growth which contributed 1.7 percent in GDP composition against minus 0.25 percent previous year. The policymakers need to analyse this trend and come up with measures to arrest rising consumption trend and should be enticing households and firms to save. One way is to not pass on the benefit of lower oil prices to consumers; lately the populous approach has dominated. Price of diesel should be kept low to help businesses lower cost, especially for poor farmers. But the policy is bent towards lowering petrol prices more, which just fuels consumption. The other policy tool is to tighten monetary policy through higher interest rates or discourage imports by depreciating the currency, or both. However, in Dar(nomicsI times, the monetary policy eased even at the time when inflationary expectations are building; while the currency is not corrected at the time of falling exports and climbing non-oil imports. With such populous economic policy measures, no economic recovery can sustain. Yes, the fiscal deficit is tamed and performance of the FBR is unprecedented. But soon the IMF programme will be over and development spending will increase to win hearts of people prior to elections. The government may revert to note printing in the second half of FY17 to spur spending and that may fuel inflation. Eventually the monetary policy has to be tightened and currency has to be depreciated; let’s see how long the government delays the inevitable.

Ali Khizer, "Why domestic savings still heading south?," Business Recorder. 2016-06-03.
Keywords: Economics , Inflation targeting , Industrial capacity , Production management , Cotton trade , Purchasing power , Interest rates , Pakistan , CPEC , GDP , FBR