A melting economy

Throughout the SBP report, governance is the key theme, whether fiscal affairs or management of public sector.

I knew the situation was bad but I didn’t realise how bad it really was until I read the State Bank’s annual report.

For instance, from every conversation I have with businessmen, I know that business confidence is low, very low and has been falling since, at least, four years now. The continuously rising portfolio of non-performing loans amongst banks tells us this.

But the report has this little observation: “Pakistan’s investment rate was only 13.4 per cent in FY11, which is the lowest since FY74”. For context, please recall that 1974 was the year immediately following the last of the big nationalisations, so if there was ever a bad time to be investing, it was then. Today, we have hit that floor one more time, which means business confidence has plummeted to a level so low as to be comparable to a period when assets were subjected to forced seizure.

Fuelling this plummeting confidence is poor governance. The State Bank makes that quite clear time and again. When talking about the relative restraint, the government was able to show in its expenditures during FY11 as compared to the previous year for instance, the report quickly qualifies the praise. Much of the reduction in expenditures — from 20.5 per cent of the GDP in FY10 to 18.9 in FY11 — came at the expense of development expenditures, which will “dampen fixed investment” and “lower future growth prospects”. Also “federal subsidies were three times higher than envisaged in the budget” leading to “resource misallocation”. And finally, “Pakistan Railways, PIA and Pakistan Steel are classical examples of the heavy cost of poor governance to the economy.”

The bleeding public sector enterprises are not the only examples of the ‘heavy cost of poor governance’ that the economy has had to bear. The power sector provides further examples for the authors of the report. Here is a sampling of some phrases used in the chapter on the power sector: “PSO’s ability to honour L/C payments was jeopardised” and “accumulating interest payments eroded profitability across the board” and “peak load management has increased tremendously during recent years, from 2,645 MW in FY07 to a level of 6,151 MW recorded in FY11”.

Just a small and arbitrarily selected sample from the chapter tells us the following: that a sovereign default of its domestic obligations has already happened for the Government of Pakistan and that default nearly extended to international obligations during FY11 in the form of L/C’s for oil imports; that ‘penal interest charges’ are eating up a growing share of power sector revenues, to add to the leakages and inefficiencies that already plague the system, giving us losses of around 20 per cent in the total transmission and distribution of electricity; that the gap between total supply and demand for electricity more than tripled since this government came to power — we already had a serious power crisis on our hands in 2007 when the peak deficit stood at 2,645 MW. But in FY11 that peak deficit crossed 6,000 MW.

To manage this growing deficit, the government commissioned new power generation capacity of 1,600 MW, which came online in FY11. However, continued fuel shortages, with gas shortfalls for the power sector at almost 30 per cent of requirement and furnace oil imports severely curtailed in April 2011 due to liquidity crises at PSO, showed that the “policy response to supply side issues were not well-conceived and a large part of newly installed capacity remained idle”.

Meanwhile, capacity utilisation at the publicly-owned generation companies known as Gencos fell to 23 per cent in May 2011. Think about that for a moment. While new generation capacity was being commissioned, existing generation capacity was producing only a fifth of what it was capable of. The reason for this was the circular debt, for which the government made an extraordinary payment of Rs120 billion in May 2011, money that was picked up from banks at approximately 12 per cent interest. But by end June the circular debt was back, “estimated to have reached Rs251 billion”. Of this amount, Rs106 billion were owed by public sector enterprises, and the remainder by private consumers. Add those numbers up and you’ll find out that the root of the circular debt problem is an inability to make people and entities pay their electricity bills.

What on earth was the government doing commissioning idle capacity at the time of such a deep crisis, while doing little to nothing to address the underlying issues of losses and inefficiencies that are the bedrock of the country’s power crisis?

Throughout the report, governance remains the key theme, whether in fiscal affairs or management of the public sector assets of the country. The deplorable state of governance is something the current rulers must answer for and, the best and most appropriate forum where this accountability must be held is a general election. Nobody but the direct stakeholders concerned in the mismanagement of public goods can be asked to hold the government to account for its failure to put in place a credible effort to help resolve the country’s governance weaknesses. The report indeed paints a troubling and deplorable picture of the state of Pakistan’s economy and the stewardship it has received over the past four years. But it’s important to not compound this failure with folly and become emotional about the required course of action going forward.

Confidence in our economy will only return as a rule-based order begins to take shape in our country. The most important ingredient in creating such a ‘rule-based order’ is to sanctify the principle that there is only one path to power and that path goes through the ballot box. Once this principle truly strikes roots, the self-correcting mechanisms of democracy and its injunction upon the rulers to earn their right to rule directly from those who are most effected by these governance failures, is the only hope we have of restoring any confidence, whether business or individual, in our economy, indeed even in our country.

Published in The Express Tribune, December 22^nd, 2011.