Evaluating the Performance of 100 Days of PML-N

Article appeared in October PIQUE Magazine
http://pique.pk/economy/07-Oct-2013/evaluating-the-performance-of-100-days-of-pml-n

Despite massive obstacles, government seems headed in the right direction

Economic revival was the top priority of PML-N government when they took power after May 11 elections. However, they had given an impression that they have already done their homework, were just waiting to take control of power and would fix the troubling economy sooner than later. But soon the government realized its limitations.

To be fair, the government inherited an economy in a shambles. Inflation is on the rise; circular debt has reached Rs. 950 billion, budget deficit is at its peak. There wasn’t any fiscal cliff for the government, money printing, T-Bills auctions, external debt, government borrowing from schedule banks and other public loans have already been taken to their limit to finance budget deficit. Too many un-targeted subsidies, including Rs. 1.4 trillion subsidies to energy sector, huge energy shortfall, gigantic public debt with more pinching payments of debt servicing, low growth of GDP, and fall in foreign exchange reserves, the government inherited a plethora of bad indicators.

IT is difficult to explicitly spell out the performance of any government in the first 100 days because most of the indicators have minimum of 3-6 months lag effect. However, we can examine the policy actions taken by the government and their possible impact on the overall economy.

Budget document, which was the first outcome of the current government, was expected to give some relief to the middle class, lower middle class and the poor. However, it has apparently pushed them towards more misery by imposing one extra percent GST on them and not subsidizing wheat flour and other necessities, which increases the price of goods in their basket. Moreover, increase in utility, petrol and CNG prices by 12 percent has already damaged the expectations formed by the people from the current government. Most of the subsidies were reduced or removed in the Budget. However, Rs. 503 billion were sanctioned for the payment of circular debt. Other negative points which have affected the expectations of the current government are : 5 percent extra witholding-tax  imposed on cellphone users, exchange rate is depreciating (8.4 percent), and overall inflation is going up (more than 3.2 percent), which pressurizes the financial market thus result in increase in interest rate by 50 basis points.

In the rest of the article, we will try to explore the possibilities of curbing the above mentioned increase in taxes and prices, depreciation in exchange rate and reduction in subsidies.

As far as overall inflation is concerned, it increased due to three reasons during 100 days of PML-N government: (1) Ramzan effect (2) persistence in inflation and (3) lagging effect of previous policies taken by the last government. Artificial control of prices is not a good idea at any time.  Finance Minister Ishaq Dar wanted to intervene in the market and activate district-level price control committees for fixing, monitoring and enforcing controls on prices of essential items. But it would not have worked.  Therefore, it would be illogical to blame current government for increase in inflation in its first 100 days.

Exchange rate is the second most talked variable after inflation in the society. No doubt the depreciation in exchange rate was too much after the current government took charge. Though, real effective exchange rate is still overvalued by 5-6 percent, therefore one should not be surprised if it depreciates more in the next few weeks. Although we cannot rule out IMF conditions but most of the times these rumors. Exchange rate cannot be controlled unless: (i) we remove the differences between our inflation and world inflation (currently our inflation is more than world inflation) (ii) our current account balance becomes surplus or becomes zero and (iii) we attract foreign direct investment and foreign portfolio investment, which is possible by removing the barriers and constraints to investment such as terrorism and energy shortages.

Foreign exchange we earn from foreign investment will then be used to artificially control the exchange rate, as we used to do in 2006-07 and 2007-08. Therefore I will not blame the current government for depreciation in exchange rate.

Petrol prices are adjusted according to change in international oil prices or if there is a change in exchange rate. Since June 2013, the overall trend shows increase in oil prices, which is the main reasons for increase in petrol prices. Moreover, exchange rate in the last 100 days depreciated as well and thus, in Rupee terms, domestic petrol prices have also increased. Therefore I would not blame the current government on increase in petrol prices.

Other than above mentioned problems, the public complains that government has not done sufficient work to eradicate problem of State Owned Enterprises, which costs us Rs. 500 billion a year. The amount can be used to finance the circular debt but due to its presence, the government needs to borrow required amount from either State Bank of Pakistan or schedule banks, which pressurizes inflation and crowd out investment.

However, recently announced privatization policy by the government to sell 26 percent of PIA shares may reduce some loss of PIA but they are committed not to lay off any employee. It would be interesting to see that how 26 percent PIA privatization would help mitigate the problem of Rs.500 billion loss. Moreover, Railways is also among the loss making, SOEs which is in revamping stage. It seems government does not either want Railways to be privatized or it will make it profitable and then sell it. In concise manner SOEs are hurting Rs. 1.37 billion daily, which is a lot and if we calculate it on 100 days then we have already lost Rs. 137 billion on these SOEs if the ultimate loss remained at Rs. 500 billion.

Heavy debt burden is one of the biggest problems current government is facing, with depreciation in exchange rate and increase in overall inflation. Moreover, increase in the net domestic assets will further increase pressure on the government if non-performing loans will increase. Thus, government, and especially State Bank of Pakistan, need to seriously follow non-performing loans, which needs to stay as low as possible. Otherwise, increase in net domestic assets will results in increase in inflation without having any impact on real sector.

Terrorism and energy crisis are among the major constraints of investment in Pakistan. Both the problems need to be addressed for economic revival. The government has been successful in mitigating energy shortages and came to an agreement in All Parties Conference to tackle terrorism although the negotiations with terrorists have not yet been started. Nevertheless, problem of energy shortage has lessened but not completely fixed. Strong energy policy by the government ensures continuous electricity supply for the next 10-13 years. If both the obstacles are removed by the government in the next two to three years, it would be an astounding work for Pakistan for next many years. 

Different projects have been signed with Chinese and Turkish investors and government, and private as well, are investing a lot in the infrastructure projects but investment in soft infrastructure is also needed. Soft infrastructure implies reforms process, which is essential for removal of barriers and constraints prohibiting investors from investing in Pakistan. For Example, inefficiency in customs, custom formalities needs to be removed. Clearance of consignments is among the major problems due to weaknesses in custom administration and cumbersome regulatory processes. Excessive procedural requirements and too much reliance on the custom inspectors, who have extra discretionary powers, create more complex situations including corrupt practices. Regulations either related to tax, health, labor laws or environment need to be transparent. Moreover, environment of lesser regulations are required to give free business environment with lesser anomalies.

The speech by Prime Minister Nawaz Sharif on Sept. 21 was very interesting. He announced six projects for youth including Micro Interest Free Loans Scheme, Small Business Loans Scheme, Youth Training Scheme, Youth Skill Development Scheme, Fee Assistance Scheme and PM’s Scheme for Laptops Provision. Although they have allocated Rs. 20 billion for the six major projects, which is not too much, but I am hoping that they will increase the amount by next year. Moreover, to keep transparency in these small projects, strict monitoring and evaluation of these programs is needed. Apart from the first five initiatives, I have my own reservations on the laptop scheme. It is more of a political gimmick than a youth development policy. Instead of distributing laptops to the individuals, they should setup IT/computer labs in schools so that more than one user can take benefit from it.

The chances of economic revival are very bleak in the first year of the government in the presence of high fiscal deficit as well as circular debt, debt servicing, Rs. 636 billion loans from schedule banks and rise in inflation etc. However, based on reputation and then the policies were adopted by the government, the stock market is giving us positive sign. It has gone up by 3,000 points since the government has taken control. Thus as far as economic revival is concerned and it seems that government is going in the right direction.

Exports Promotion through Branding

The article appeared in the Money Matters on December 16, 2013

In the last three decades, successive governments have emphasised the importance of export promotion.  But, the country’ export performance still remains dismal. Although Pakistan’s exports have increased from 10.5 percent in 1980 to 16.8 percent in 1990 and currently stand at 21.3 percent, the share of manufacturing exports and the terms of trade have declined in the last ten years.

The Ministry of Planning and Development is in process of developing Vision 2025 and the Five-Year Plan. Similar to its previous plans, more emphasis is being placed on increasing exports through value addition, which can take place through industrial development.

To achieve the aforesaid goal various strategies including technical upgradation; improvement in business environment; restructuring of industries; internalisation of innovation; tariff escalation and tariff rationalisation; export-oriented industrial policies; research and development; human resource development and enhancement of workers’ skills and the establishment of industrial clusters, estates and zones are being discussed by the economic policymakers. However, all these strategies have been discussed and partially implemented before but the issue of branding has not been taken into consideration as yet.

A brand name is the name of a distinctive product or service, which people can associate themselves with. It is an idea or image of a specific product or service that consumers can connect with, by identifying the name, logo, slogan, or design of the company who owns the idea or image.    In today’s age of globalisation and e-commerce, foreign buyers can ask for any product or service by looking at the brand name.

Building a brand name is none other than building trust with one’s employees, customers and stakeholders. In terms of marketing, a brand name represents the value of a company. The assumption that only big companies have better brands is incorrect. Strong brands help consumers know what to expect, regardless of the company size. In addition, a brand name helps develop a unique product or service that develops customer loyalty overtime. For instance, even though Cola is a brown, sweetened beverage, a loyal Coca Cola customer will always prefer Coca Cola over other brands.

Similarly, a significant component of branding is how much a certain brand is valued or its reputation in the market. Unique selling proposition is another factor that makes a product or service different from and better than that of competitors. Reputable brands deliver their message clearly; maintain their product or service credibility; form emotional connections with their prospective consumers; motivate buyers and solidify customer loyalty.

A brand name represents the quality of a product or service, which determines its price. It also makes it easier for local and foreign buyers to decide what to purchase and in what quantity. In other words, a brand name gives potential clients a better idea of what they are buying, thus making the purchasing decision easier.

Consequently, consumers are ready to pay a higher price if they see that the product quality is better than what is available in the market. Foreign buyers are also willing to buy a high quality product, which leads to more foreign exchange earnings for the country. For example, a few products that have a competitive advantage over their competitors include: Coca Cola and Pepsi Cola as compared to other Colas that may have almost the same taste; various smartphones against other ordinary phones and among them, iPhone is the most reliable and expensive brand both globally and domestically; Bareeze as compared to other similar clothing outlets and Shan Masala has its own significance as compared to other spices available in markets. 

On the other hand, when it comes to the services sector, for instance the construction sector, most of the materials used are similar in nature for building buildings, commercial centers and homes. However, if the products being used are branded then a reliable brand name has more demand in the market. Branding in the construction industry is more profitable in terms of value addition that pays more when exported to the other countries. Nevertheless, the construction services sector should have certain features such as creativity, durability and integrity, which add to its branding value.

The above discussion leads us to the conclusion that branding is critical to increase a country’s export earnings through value addition. However, producers want to protect their rights to produce and sell products, thereby making it necessary to enforce patent laws in the country.

Intellectual property rights help promote branding and invention as they protect the name, product, logo, design, image and slogan of a product. The issue of intellectual property rights has neither been discussed at length nor strictly implemented in Pakistan. This needs to be addressed on an urgent basis. Similarly, the country’s justice system should be quick and transparent to ensure that any violation of intellectual property rights would not be tolerated. In terms of law-making, clear legal ownership and copyrights should be defined as well as further licencing and conditions for franchises should be clearly laid out .

- See more at: http://magazine.thenews.com.pk/mag/arc_detail_article.asp?id=6817#sthash.TgLPjhPI.dpuf

Problems of Government Borrowing

Post is taken from http://www.economicshelp.org/blog/1504/economics/problems-of-government-borrowing-2/

problems of Government Borrowing by Tejvan Pettinger on April 15, 2011 in economics

What are the Problems of high government borrowing?

There are many theoretical problems of high levels of government borrowing. But, usually these problems don’t materialise under normal circumstances. However, as government borrowing as a % of GDP increases, the problems of government borrowing are exacerbated. With UK facing an annual budget deficit of over 11% of GDP, there are many potential problems.

Higher Debt Interest Payments. As borrowing increases, the government have to pay higher interest rate payments to those who hold bonds (lend government money). In some circumstances, higher borrowing can push up interest rates because markets are nervous about governments ability to repay. This means they have to pay even higher interest rate costs. Currently, the UK pays approximately £43bn in interest payments.

Inflationary Pressure. It is rare for government borrowing to cause inflation. But, the combination of quantitative easing and very high levels of borrowing make inflation more likely.

If markets fail to buy enough gilts to finance the deficit, the deficit can always be financed through ‘monetisation’. i.e. creating money. This creation of money creates inflation, reduces the value of exchange rate and makes foreign investors unwilling to hold UK debt. So far quantitative easing has not caused inflation because of the falling velocity of circulation. But, if the economy was close to full capacity, printing money to ‘monetize the debt’ would lead to inflation. In the case of Zimbabwe this could lead to hyperinflation.

Higher Interest rates.

To finance a budget deficit, the government need to sell bonds. If markets fear there is a chance of default, they will demand higher interest rates to give return for greater risk. Countries in the Eurozone experienced rapidly rising interest rates because of markets fears over their ability to repay. (see: bond yields on EU debt)

Higher interest rates on government bonds tends to push up other interest rates in the economy and reduces spending and investment. (This impact of higher interest rates in reducing private sector spending is known as financial crowding out)

These higher interest rates increase the cost of paying interest payments.

Crowing Out. A classical monetarist argument is that high levels of government borrowing cause ‘crowding out’. What they mean is that the government borrow from the private sector by selling bonds. Therefore, the private sector have less money to spend and invest. Therefore although government spending increases, private sector spending falls and there is no boost to the economy.

However, this is unlikely to apply in a recession because in a recession private sector saving is rising. The government are spending to offset the rise in private sector saving.

Higher taxes in the future. The government will need to reduce borrowing as a % of GDP. It means future budgets will need to increase taxes and / or limit spending. The danger is that if taxes are increased too early too quickly it could snuff out the recovery and cause a further downturn. If they don’t raise taxes markets may be alarmed at size of borrowing. There will be difficult choices for the future chancellors; it is a difficult situation to be in.