LSM decline – a wake-up call for policymakers
Country needs stable exchange and interest rates, meaningful documentation
PHOTO: FILE
KARACHI:
Large-scale manufacturing (LSM) is still not growing. In first five months (Jul-Nov 2019) of the current fiscal year, LSM output showed a year-on-year decline of 5.93%.
In the last fiscal year (Jul-Jun 2018-19), production of large industries had dropped 3.37% year-on-year. What went wrong and where and what can be done to reverse the situation?
When Pakistan Tehreek-e-Insaf (PTI) came to power in August 2018, it had inherited a strong 6.38% increase in LSM output in the just-ended FY18. Subsequent decline of 3% plus in the very next fiscal year and about 6% further decline in five months of the current fiscal year mean government policies are not industry-friendly.
Maintaining an upward trend in any sector depends on consistency of policies and a favourable environment for the overall economy.
In the overall economy, a declining trend was witnessed in gross domestic product (GDP) growth from 5.5% in FY18 to 3.3% in FY19 and now the International Monetary Fund (IMF) has projected an even lower growth – just 2.4% – for FY20.
So, well, the industrial sector is not growing because overall environment for the economy is not growth-friendly. When the economy grows slower, it means demand is lower. And, when demand is down, how on earth industries can produce more – they are bound to produce less. But this is just one, and partial, explanation for the decline in LSM.
Another explanation, also partial, is that industries were growing during the tenure of Pakistan Muslim League-Nawaz (PML-N) government because policies were industry-friendly and domestic demand was high.
An artificially maintained exchange rate and low interest rate were helping both the industries and consumers alike. It is a separate story though that the external sector was in a very bad shape.
When PTI took over, its policymakers spent all energy on fixing external-sector issues – and quite naively.
Remember the initial reluctance this government showed in deciding whether or not to go to the IMF? Remember how Prime Minister Imran Khan was taken by surprise when during the initial days of Asad Umar in the Ministry of Finance the State Bank of Pakistan began devaluing the rupee massively?
It took PM Imran and the entire PTI government some time to realise that if they want to fix external-sector issues, they must go to the IMF. It took them some time to digest the fact that during pre-consultation with the IMF, an overvalued currency always has to be devalued to seek an economic stabilisation programme.
Then Dr Abdul Hafeez Shaikh was appointed PM adviser on finance, replacing Umar, and Dr Reza Baqir was appointed SBP governor. The IMF lending began but with it started a painful phase of depreciation of the rupee and continuation of the already tight monetary policy.
In FY19, the rupee depreciated 31.7% as it slumped to 160.05 to the US dollar by June 2019 from 121.50 in June 2018. At the same time, banks’ weighted average lending rate jumped from 7.5% to 12.5%.
It is no wonder that the LSM output declined in FY19. The rupee’s depreciation made imported raw material dearer for the industries and a huge 5% increase in interest rate within a year jacked up cost of finance for the industries.
This happened at a time when the rupee fall pushed up the overall inflation and higher interest rate also meant higher cost of consumer finance for the public.
So, the rupee depreciation-higher interest rate nexus was responsible for the decline in LSM in FY19 and it is still this nexus that is not allowing reversal of the trend.
The government has targeted 1.3% LSM growth in the current fiscal year. How will this target be achieved when the five-month trend shows 6% decline is a big question?
What makes the achievement of this target all the more difficult is that though the rupee slide has stopped and the currency has rather gained in the current fiscal year, some of the value lost in the last fiscal year, its lagged impact on inflation is still quite visible. And, banks’ weighted average interest rate continues to rise.
Latest SBP data reveals that the weighted average lending rate of banks crossed the 14% mark in November 2019.
Documentation
Apart from exchange and interest rates, inflationary pressures and subdued domestic demand, what else has contributed to the declining trend in LSM output is the misconceived documentation drive of the PTI government.
This documentation drive, combined with a crackdown on businessmen linked to the opposition parties, appears to have forced industrialists to adopt a wait-and-see policy for their business expansion or sales promotion plans.
Going forward, the country needs stability in the exchange and interest rates and a documentation drive, more meaningful with least collateral damage. Otherwise, achieving the LSM growth target of 1.3% for the current fiscal year will become next to impossible.
The writer is a mechanical engineer and is doing masters
Published in The Express Tribune, January 27th, 2020.
Large-scale manufacturing (LSM) is still not growing. In first five months (Jul-Nov 2019) of the current fiscal year, LSM output showed a year-on-year decline of 5.93%.
In the last fiscal year (Jul-Jun 2018-19), production of large industries had dropped 3.37% year-on-year. What went wrong and where and what can be done to reverse the situation?
When Pakistan Tehreek-e-Insaf (PTI) came to power in August 2018, it had inherited a strong 6.38% increase in LSM output in the just-ended FY18. Subsequent decline of 3% plus in the very next fiscal year and about 6% further decline in five months of the current fiscal year mean government policies are not industry-friendly.
Maintaining an upward trend in any sector depends on consistency of policies and a favourable environment for the overall economy.
In the overall economy, a declining trend was witnessed in gross domestic product (GDP) growth from 5.5% in FY18 to 3.3% in FY19 and now the International Monetary Fund (IMF) has projected an even lower growth – just 2.4% – for FY20.
So, well, the industrial sector is not growing because overall environment for the economy is not growth-friendly. When the economy grows slower, it means demand is lower. And, when demand is down, how on earth industries can produce more – they are bound to produce less. But this is just one, and partial, explanation for the decline in LSM.
Another explanation, also partial, is that industries were growing during the tenure of Pakistan Muslim League-Nawaz (PML-N) government because policies were industry-friendly and domestic demand was high.
An artificially maintained exchange rate and low interest rate were helping both the industries and consumers alike. It is a separate story though that the external sector was in a very bad shape.
When PTI took over, its policymakers spent all energy on fixing external-sector issues – and quite naively.
Remember the initial reluctance this government showed in deciding whether or not to go to the IMF? Remember how Prime Minister Imran Khan was taken by surprise when during the initial days of Asad Umar in the Ministry of Finance the State Bank of Pakistan began devaluing the rupee massively?
It took PM Imran and the entire PTI government some time to realise that if they want to fix external-sector issues, they must go to the IMF. It took them some time to digest the fact that during pre-consultation with the IMF, an overvalued currency always has to be devalued to seek an economic stabilisation programme.
Then Dr Abdul Hafeez Shaikh was appointed PM adviser on finance, replacing Umar, and Dr Reza Baqir was appointed SBP governor. The IMF lending began but with it started a painful phase of depreciation of the rupee and continuation of the already tight monetary policy.
In FY19, the rupee depreciated 31.7% as it slumped to 160.05 to the US dollar by June 2019 from 121.50 in June 2018. At the same time, banks’ weighted average lending rate jumped from 7.5% to 12.5%.
It is no wonder that the LSM output declined in FY19. The rupee’s depreciation made imported raw material dearer for the industries and a huge 5% increase in interest rate within a year jacked up cost of finance for the industries.
This happened at a time when the rupee fall pushed up the overall inflation and higher interest rate also meant higher cost of consumer finance for the public.
So, the rupee depreciation-higher interest rate nexus was responsible for the decline in LSM in FY19 and it is still this nexus that is not allowing reversal of the trend.
The government has targeted 1.3% LSM growth in the current fiscal year. How will this target be achieved when the five-month trend shows 6% decline is a big question?
What makes the achievement of this target all the more difficult is that though the rupee slide has stopped and the currency has rather gained in the current fiscal year, some of the value lost in the last fiscal year, its lagged impact on inflation is still quite visible. And, banks’ weighted average interest rate continues to rise.
Latest SBP data reveals that the weighted average lending rate of banks crossed the 14% mark in November 2019.
Documentation
Apart from exchange and interest rates, inflationary pressures and subdued domestic demand, what else has contributed to the declining trend in LSM output is the misconceived documentation drive of the PTI government.
This documentation drive, combined with a crackdown on businessmen linked to the opposition parties, appears to have forced industrialists to adopt a wait-and-see policy for their business expansion or sales promotion plans.
Going forward, the country needs stability in the exchange and interest rates and a documentation drive, more meaningful with least collateral damage. Otherwise, achieving the LSM growth target of 1.3% for the current fiscal year will become next to impossible.
The writer is a mechanical engineer and is doing masters
Published in The Express Tribune, January 27th, 2020.