Can we celebrate Eid before the fasting month of Ramadan? Or is it a possibility for the Christians to celebrate Easter without eggs? Certainly not! Similarly, we should not expect economic recovery when consumption and incomes are declining.
The current economic recovery is a mirage created by huge foreign loans obtained by the government. We have a consumer base, where wealth has significantly eroded, burdened with debt, with a pervasive high risk of unemployment/decline in income.
As far as economic recovery or economic growth is concerned, it is always associated with higher demand. Three most common consumer demand drivers are wealth, income and credit. It is true that first the macro-economic indicators improve and then its impact is visible at the micro level. However, as soon as the macro-economic indicators improve, the decline at the micro level stop and a status quo is maintained. Another point worth noting in sustainable recovery is that the economic planners should not get carried away with improvements in one or the other indicators for a short time and consider that as permanent sign of revival.
The wealth of most households has eroded during past two years due to extremely high inflation from a peak of 24 per cent in 2008-09 to an average of 12 per cent in the first four months of this fiscal. In February, however, the inflation started rising and is currently ranging at around 18 per cent. Moreover, the increase in unemployment has also reduced the wealth of millions of families.
As household wealth increases consumers proportionately spend more and save less. When wealth decreases households save a greater portion of their income and spend less. While this is rational for the individual, spending less by the aggregate population negatively impacts economic growth and thus recovery. This in fact happens in societies where the population has access to adequate food but in societies like Pakistan the poor remain undernourished despite spending all their income.
Income based demand is one of the most stable forms of demand as it does not come at the expense of future demand as in the case of borrowing to finance consumption or unsustainable government transfers. The current state of consumer demand/spending is weakened through lower availability of income for spending due to protracted high rates and amounts of unemployment and underemployment, and a heavy debt burden.
The severity of cost cutting methods through layoffs and the protracted period of high unemployment inhibit recovery, as is happening in our economy. The slight increase in productivity in some sectors has been neutralised by decline in consumption in other sectors. For instance the automobile production has increased but the steel demand has declined by 40 per cent in fist six months of this fiscal compared with the consumption during the corresponding period last year. The consumption of cement, bricks, pipes, cable and many other industries connected with construction sector have declined appreciably.
The government has come up with the Benazir Income Support Program to provide some relief to the poor particularly those who lost jobs in recent years. Though the portion of population covered under this scheme is still very low between those who benefited households' financial conditions are regularly deteriorating. They are heavily burdened by debt and use almost all the amount they receive through the BISP to pay off debt instead of consumption.
The banks are facing the dilemma of dealing with huge portfolios of non-performing loans. The central bank has facilitated them with very high policy rate at a time when the public sector is the largest borrower. The commercial banks prefer loaning to the government at the policy rate of the central bank instead of risking their money on private sector. They fear that the private sector would not be able to earn enough to service the high mark-up loans.
The private sector has either defaulted on its past loans or those that survived due to exceptional efficiency are retiring loans. The banks have in the meantime invented ways to increase their non-interest income through mostly hidden service charges. They are minting money from the depositors.
About a decade back the non-interest income of the banks was less than 10 per cent of their interest earnings. Now it constitutes almost 40-50 per cent of their total income. When the private sector defaults its means loss of many jobs depending upon the company they were operating. When the private sector retires loan it is a bad omen for the economy. It indicates that the entrepreneurs are not investing and are squeezing business. In both cases the net result is job loss and decline in production.
Though not as stable as income driven demand, access to credit increases current spending (at the expense of future spending). Access to consumer credit has declined precipitously. Banks continue to decrease lending particularly the consumer loans and credit to small and medium enterprises.
On the consumer front, heavy debt burden in the context of the severity and protracted periods of unemployment, continue to depress consumption levels as consumers use a greater portion of existing income to pay off debt. They are in cyclic debt. What they earn today is spent on paying off past debt and they borrow more to fulfil their current needs. We are still without a clear road map for the future.
Our planners show exuberance if the inflation declines in any given month or week. They feel pride when foreign exchange reserves increase on borrowed money. It is another matter that the debt servicing because of these loans has become unsustainable. During the first six months of this fiscal year the debt servicing of local and foreign loans amounted to Rs292 billion that is almost half of the total revenue collected during this period. The defence spending amounted to Rs165 billion (partly because of war on terror).
During the first seven months of the present regime the economy declined sharply eroding the foreign exchange reserves, rupee stability and the self sustainability of economy. The inflation reached new heights, debt burden increased tremendously with the first instalment of $4 billion from the International Monetary Fund (IMF) in the last November 2008 while the trade deficit reached unmanageable level. The reason for economic deterioration given at that time was high commodity rates particularly those of crude oil and food items in the global markets.
After initial help from the IMF the rupee stabilised for a while. At the same time the commodity rates started declining. The crude oil rate dropped from a peak of $140 to as low as $40 a barrel. The stability period did not last long though the foreign exchange reserves continued to increase on the strength of foreign flows both from the creditors and remittances from Pakistani workers. The rupee started declining again, the exports remained stagnant but the trade deficit was reduced due to lower commodity and crude oil rates. The industrial production stopped declining but did not pick up enough to make an impact on the economy. The inflation declined for almost 13 straight months before rising again. It never came down to comfortable zone or even in single digit. The economic fundamentals though slightly improved remained very weak and not enough to warrant any meaningful recovery.