Despite healthy growth of 5.97% in FY22, Pakistan’s economy remains in turmoil and in need of an IMF bailout.
In fact, the healthy growth rate is widely regarded as one of the main reasons behind the bleak economic scenario. For the coming year, a lower growth target of 5% was announced in the budget.
Why instead of inspiring confidence in the economy, the growth rate of nearly 6% generated pessimism?
The answer to this question lies in analyzing the composition of gross domestic product (GDP) in the outgoing fiscal year.
GDP is categorized into three components: consumption, investment and net exports (difference between exports and imports of goods and services) and takes stock of the share of each component in total expenditure.
This approach is important because the medium to long-term growth of the economy depends not only on the amount of revenue generated, but also on how the revenue generated is spent.
Consumption represents the satisfaction of present needs. Universally, consumption is the largest component of GDP and includes household and government consumption expenditure.
Investment is the satisfaction of future needs by increasing the productive capacity of the economy. It includes both public and private sector investment expenditure.
Disposable income (income minus direct taxes) generated in an economy can be spent or set aside as savings for investment. There is therefore a trade-off between consumption and savings or investment expenditure. The more an economy consumes, the less income it has left to invest.
Exports represent the difference between domestic production and domestic consumption. The higher the domestic consumption, the lower the volume of goods and services available for export.
Imports are the difference between domestic demand and domestic production (minus exports). Higher domestic demand relative to domestic production results in higher import volume.
From the theoretical framework, let’s move on to the real numbers. According to the Pakistan Economic Survey, in FY22, consumer spending accounted for 96.2% of GDP, while the share of investment remained at 15.1%.
Household consumption accounted for 85.2% of total expenditure. By origin, investment expenditure of 15.1% was anchored to 11.1% national savings, including 4.5% domestic savings and 4.1% foreign savings.
The combined share of consumption and investment in GDP totals 111.3%, which is not possible because it cannot exceed 100%. The only way to make this possible is for the third component of expenditure, namely net exports, to be a negative figure, which remained at -11.4% in FY22 (exports 10.5%, imports 21.9%).
This explains why despite robust growth, the economy is in a precarious state and needs immediate inflows of capital from abroad, forcing the government to take very strict and obviously unpopular measures at the behest of the IMF.
The composition of GDP in FY22 is therefore a double whammy. First, consumption had a disproportionately high share compared to investment. At 15.1%, Pakistan’s investment-to-GDP ratio remains one of the lowest in the world, making it extremely difficult to record sustained growth.
Second, even the low level of investment was financed by a much lower level of domestic savings (4.5% of GDP).
This is not surprising since the disproportionately high share of consumption in total expenditure left little room for domestic savings.
Since total savings in an economy must equal total investment, the only way for a country to have greater investment than domestic savings is to tap into savings from abroad through debt and non-debt generating instruments.
Savings from abroad can take two forms: (a) savings of Pakistani nationals living abroad and (b) foreign savings.
In FY22, the gap between national saving and national saving, as a percentage of GDP, was 6.6 percentage points, mainly explained by the $22.9 billion remittances received from Pakistani expatriates.
The difference of four percentage points, as a percentage of GDP, between national savings and investment was explained by foreign savings.
Among foreign savings or capital inflows, foreign investment, representing a non-debt creating instrument, in the first nine months of FY22 was $1.45 billion, or 0, 38% of GDP.
During this period, the country borrowed $12.78 billion (3.34% of GDP of $383 billion) in foreign debt, which was the lion’s share of total foreign savings.
Unsurprisingly, the accumulated external debt reached $88.8 billion at the end of March 2022.
Debt service is a drag on both future consumption and investment. In FY22 (Jan-March), external debt repayments and interest payments were recorded at $8.14 billion and $1.30 billion respectively, together constituting 2.46% of GDP.
Rising consumption widened the gap between domestic demand and domestic production, which was filled by rising imports.
As export growth of 38.7% failed to keep pace with import growth of 45.7%, the trade deficit exploded, increasing the country’s external debt.
In short, consumption-based growth financed largely by foreign savings has placed the economy on a dangerous and unsustainable path.
Using an analogy, suppose that due to a sudden increase in demand, an automobile manufacturing company produces 20,000 units per year, which is even more than its maximum production capacity of, say, 19,000 units.
At first glance, this is a brilliant performance, as it has strengthened the company’s turnover. However, a detailed analysis reveals that the feast was accomplished by having staff work overtime, using the machines full throttle, outsourcing the production of 1,000 units, purchasing parts and components at higher prices. high and borrowing at a higher interest rate.
As a result, at least 50% of worn machinery must be replaced, exhausted workers must be compensated for overtime, contractors and suppliers must be paid, and debts must be honoured.
The cumulative cost of meeting these expenses is so high that the company will have to lay off at least 20% of the workforce, can only replace 25% of the worn out machinery and cannot buy more than 70% of the parts. and components needed to meet the new production target.
As a result, the following year, production will have to be reduced to a maximum of 12,000 units. Higher production did the company more harm than good.
The writer is a columnist based in Islamabad
Published in L’Express Tribune, June 20e2022.
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