Dr Saeed Ahmed

Pakistan has a history of sacrificing economic growth for short-term macroeconomic stabilization. At its core, structural weaknesses of the economy do not allow high growth rates to be sustained via demand generation. The two Achilles’ heels of Pakistan’s macroeconomic management – the low tax-to-GDP ratio and foreign exchange deficit – have time and again challenged the budding growth momentums, forcing the economy to recede only after a few strides. Therefore, over the past three decades, Pakistan’s economy grew at a rate which was not only below its potential, but also below the growth rates experienced by most developing countries. The last eight years had been particularly testing; in addition to macroeconomic issues, the country saw unprecedented heights of security concerns that were extremely discouraging for investments. In addition, the country experienced a full-blown energy crisis that not only stifled manufacturing activity but also caused huge productivity losses. Global economic trends were not helpful either; external demand remained lackluster as our major export markets struggled in recovering from the aftermath of the 2009 crisis.

The underperformance of Pakistan’s economy during FY09-13 was quite glaring (Table 1): real GDP grew anemically, with much compromised performances from manufacturing and exports. Macroeconomic imbalances widened as higher fiscal spending, remittances influx and a vibrant informal economy continued to strengthen domestic demand. Inflation stayed in double-digits through most of the period and the FX position remained vulnerable.

However, at the closing of fiscal year 2013, things started to turn better. A smooth political transition occurred in June 2013, and the new government spelled out its clear policy for the settlement of energy issues; side by side, it also initiated talks with the IMF for a new programme, with a clear tilt towards structural reforms. The fiscal position was consolidated via cutbacks in subsidies and other non-development expenditures, and improvement in revenue generation. Fortunately, global commodity prices began to soften from mid-2014, which helped bring down CPI inflation as well as the country’s import bill.

This favourable mix of macroeconomic discipline and low commodity prices entered its third year in FY16. By the end of the year, CPI inflation had reached a multi-decade low level, and the country’s foreign exchange reserves increased to an all-time high. With a significant narrowing down of macroeconomic imbalances, the government has shifted its focus towards achieving high growth. For the next year (FY17), the government has set the growth target at 5.7 percent.

Stepping back to the growth question, is this enough? This growth looks reasonable compared to the 4.6 percent growth that other emerging markets and developing economies are expected to achieve next year. However, we should view this as a step towards achieving an even higher growth rate in the medium-term, which is compatible with the demographic transition the country is going through. Specifically, we need a consistent growth rate of over 7 percent to be able to engage the 1.7 million youth entering the labour force every year; otherwise unemployment in the country will increase. Importantly, unlike the past, we need to achieve this high growth rate without putting too much burden on the government. The real push to economic growth must come from the private sector.

By suggesting this, we are not downplaying the role of government; it is going to stay important, but it should only be limited to maintenance of macroeconomic stability; facilitating markets with informed policy and competent regulation; implementation of good governance; provision of law and order; enforcement of contracts; quick and fair dispensation of justice; provision of basic social services; provision of safety nets for the poor and vulnerable; and regulation of markets. However, it is the private sector that has to invest more in order to break out from the past and achieve a high and sustainable growth that is built on the pillars of entrepreneurship and innovation.

This concept is not new. In fact, the idea behind the privatisation and liberalization programs of early 1990s was to expand the role of private sector in enhancing the economy’s growth rate. The last 10 years have witnessed considerable deregulation, liberalization and privatization in the financial sector. As a result, private sector banks now control over 80 percent of banking sector assets, and have emerged as the dominant source of external funding for private sector businesses. Despite this, the overall contribution of the banking industry in Pakistan’s economic growth has remained limited, as seen from the country’s lowest credit-to-GDP ratio among emerging markets. Both demand and supply side issues are at play; for instance, while heavy budgetary borrowings by the government has kept liquidity tight with banks, many firms have been reluctant to invest keeping in view excess capacities and high borrowing costs. The state of financial inclusion is quite weak in the country due to low level of financial literacy and weak bank-corporate nexus. Therefore, the private sector in Pakistan has not been able to play its due role in capital formation, the way it did in other Asian economies (Figure 1).

To promote private sector investment, the ideal funding arrangement would be domestic equity and corporate bond markets providing fixed investment funding to large corporates and multinationals, with the banking sector providing financial support to agriculture production and marketing, dairy, livestock, fisheries, SMEs, storage and processing facilities, housing, etc. However, this shift will take some time to happen. In the meantime, the large private corporate sector must come forward and take charge of capital formation in the country, either by using resources of the banking industry, or drawing down its own funds. This is the only way to limit the role of the resource-constrained government in enhancing the economy’s growth rate; the private sector is that sustainable engine of inclusive growth in Pakistan, which has the potential of generating employment, contributing public revenue and providing affordable goods and services, without compromising on macroeconomic stability.

Here, three questions need to be raised: (1) why should the private sector invest now; (2) which areas should it invest in; and (3) from where should the private sector finance its investments. We will briefly answer each of these questions below.

Why invest now?

When it comes to the reason

behind investing, three factors are important: stable returns; borrowing costs; and profitability.

(1) Macroeconomic stability is a prerequisite for investment decisions. A stable trend in key factors like inflation, exchange rate and interest rates is necessary in estimating future returns for businesses. In this context, Pakistan fits the bill perfectly, as energy shortages are being worked on: LNG imports and CPEC-related power projects are sufficient to ensure smooth energy supplies going forward;

(2) Low interest rates: SBP has cut the policy rate by 425 basis points since June 2013, and almost a similar cut has been observed in the cost of retail lending. SBP has also reduced the rates of the Long Term Financing Facility, which is presently 6 percent at the user’s level;

(3) Strong demand: Retail business in Pakistan has been thriving over the past few years thanks to the vibrant informal sector and influx of worker remittances. A key indicator of gauging this demand is the corporate sector’s profitability. Pakistani non-financial corporations (NFCs) have generated impressive returns from 2011 onward – as indicated by their return on assets (ROA) and return on common equity (ROCE) ratios. Furthermore, in terms of country comparison, Figure 2 reveals a favorable trend for Pakistan’s largest NFCs, which surpass Sri Lankan and Indian firms in terms of both ROA and ROCE.

Where to invest?

There is a wide range of investment opportunities on offer. CPEC is an obvious candidate, with construction-related projects being in high demand. Industries such as cement, steel, paints etc. will also benefit from the spillover effects. Then, of course, there are returns to be made by firms which introduce new technology and upgrades. Specifically, technological impetus in agriculture can be focused on to improve seed quality and fertilizers, conserve water, and reduce post-harvest losses through setting up state of the art warehouses and cold storage facilities. Similarly, improved processing of meat and leather products are viable investment avenues in the livestock sector. Industry, too, can benefit from technology up-gradation in its quest to become more cost competitive in the long run.

Where to finance the investment?

The borrowing capacity of the corporate sector has visibly increased of late. Factors accounting for this trend include:

* An improvement in the liquidity position of firms: The current ratio has reached the level seen in the year 2008. Similarly, the quick ratio, which takes cash and bank balances, trade debt and short-term investments into account, has also improved;

* Healthy profits: Net profit before tax grew at an average rate of 19.0 percent during 2010-14. Similarly, retained earnings and equity of the corporate sector increased by 22.1 percent and 17.4 percent respectively during the five-year period;

* Deleveraging: There has been a considerable improvement in debt to equity, with notable retirements witnessed in the cement and fertilizer sectors; and

* Changes in prudential regulations.

As a result, the total borrowing capacity of the corporate sector has increased significantly. Potential investible resources for the corporate sector are estimated at Rs. 3.7 trillion; putting this in perspective, this amount is more than double the entire Public Sector Development Program allocation (Rs. 1.675 trillion) for the fiscal year 2017. Furthermore, sector-wise distribution of private sector companies reveals that corporate entities related to oil and gas exploration, food and beverages, chemicals, pharmaceutical, and cement sectors can borrow huge sums for their businesses (Figure 3).

Besides commercial banks, capital markets have also proven to be an important source of funding for the corporate sector; listed companies have raised over Rs 1.16 trillion from the capital market via various equity and debt issues in the past decade. Moreover, the KSE-100 Index has demonstrated an average return of around 20 percent per annum during this period, and Pakistan’s stock market has consistently been ranked among the best performing markets in local currency terms in Asia over the last five years. Following integration of the country’s three stock exchanges into a unified Pakistan Stock Exchange (PSX) earlier in 2016, there is an expectation that the PSX might be reclassified as an emerging market (from its current ‘frontier market’ status) in the MSCI Emerging Markets Index.

How to strategize?

For borrowing and real activity to thrive, corporate managers will have to proactively adjust their organization’s strategies in line with the changing dynamics and future outlook of the economy. Recently, some corporations have preferred to park their liquidity in risk-free government securities. However, persisting with this approach is a likely invitation to be left behind by forward-thinking firms, which will take stock of the increasingly favorable macroeconomic environment and opt for aggressive expansion and growth – rather than adopting a defensive or risk-minimizing strategy.

To sum up, the stage is set for the private sector to utilize its investible resources and reap the due rewards. In pursuing their own self-interest, corporations can play a pivotal role in setting the foundations for more sustainable domestic investment, savings and economic growth.

(The writer is the Chief Economic Advisor of State Bank of Pakistan)