This raises a number of questions: Why has the buoyancy been so short-lived? The next question is whether the process of decline will continue in the subsequent months or there will be some recovery? There is need also to understand how the performance of the industrial sector will affect the overall economy in 2018-19.
The beginning of the process of the slowdown started during the tenure of the caretaker Government and even earlier when a major effect was made to control the size of the fiscal deficit. There was a big cutback in development spending. Consequently, the expenditure on the development account in the last quarter of 2017-18 was 40 percent lower than the level of spending in the corresponding quarter of 2016-17.
The new government of the PTI has continued with the process of cutting back on the level of development spending. The Revised Budget for 2018-19, presented in September 2018, contains a big reduction in the size of the PSDP by 28 percent in relation to the original Budget presented for 2018-19 just prior to its exit by the PML (N) Government. The data on Fiscal Operations reveals that in the first quarter of 2018-19, the actual development expenditure was 46 percent lower than the level in the first quarter of 2017-18.
The two industries which have been affected adversely, are those who providing construction inputs. The first industry is cement, which has shown a growth rate of only 2 percent in the initial four months of 2018-19. This is in sharp contrast to the growth rate in the first four months of 2017-18 of over 13 percent. Similarly, the iron and steel industry has shown a growth rate of only 2 percent compared to a growth rate as high as 31 percent last year.
There have been other major developments since December 2017. By October 2018 the Rupee had been cumulatively devalued by 26 percent. This was expected to provide a boost to the export by various industries, especially textiles. Unfortunately, there has been zero growth in the production of both cotton yarn and cotton cloth in the first four months of 2018-19. In fact, the export of cotton yarn has fallen by 20 percent in quantity terms. The problem is that these two industries have the largest combined weight of 20 percent in the QIM. Therefore, their failure to grow is a major factor in the slowdown of industrial production. Among other factors, the shortage in gas supplies and the relatively high tariff charged from textile units in Punjab has contributed to the stagnation of output. Fortunately, this discriminatory treatment has been brought to an end recently.
The large devaluation has also affected negatively those industries which rely primarily on imported inputs due to the resulting increase in domestic prices. This is best illustrated in the case of vegetable ghee, tea, pharmaceuticals and automobiles. Vegetable ghee is produced from imported palm oil. The industry has exhibited a growth rate of only 4 percent as compared to 12 percent last year. Similarly, the tea industry, which is essentially engaged in packing imported tea, has shown no growth. The biggest fall of 6 percent is observed in the case of pharmaceuticals.
However, import-substituting industries ought to have shown a positive response to the rise in the prices of competing imported products. Here again, the impact has been muted. The chemical, fertilizer, paper and paperboard and rubber products industries have demonstrated low growth rates ranging from below 1 percent to 4 percent. The only industry which has taken full advantage of rising import prices, is the engineering goods industry with a double-digit increase in production of 14 percent. The output of refrigerators has gone up by 16 percent and of air conditioners by as much as 151 percent. This augurs well for increasing technological sophistication of Pakistani industry.
Some special factors have been in operation in particular industries. The petroleum refining industry saw a significant decline of over 6 percent primarily because of less off-take by 21 percent of furnace oil, due to its substitution as a fuel input by LNG and coal in power generation. On the positive side, despite a big jump in the rate of excise duty the cigarette industry has shown a robust growth rate of 9 percent.
The important issue relates to short-run prospects of growth of the large-scale manufacturing sector during the remaining period of 2018-19. This sector is usually the leading sector in the process of achieving a higher growth rate of the GDP. Therefore, the growth of the sector will play a critical role not only directly but also indirectly in influencing the growth in major sectors like wholesale and retail trade, transport and banking.
The basic problem is that the process of adjustment of the economy to especially lower fiscal and current account deficits will continue, implying the likelihood of further cuts in development spending and hikes in indirect taxes on industry. Also, a state of diminishing returns has probably been reached with respect to depreciation of the rupee in terms of the impact on exports. Rising interest rates will further restrict aggregate demand.
The most commonly quoted projection of the GDP growth rate in 2018-19 is 4.5 percent or so. For the growth rate of the large-scale manufacturing sector to go up from negative 1 percent to at least 4.5 percent for the year as a whole will require an average growth rate monthly of over 6 percent in the last eight months of 2018-19. Of course, this is highly unlikely.
The consequences of the low growth in industrial production are manifold. First, the process of employment creation will be adversely affected, especially for relatively skilled workers. Second, the growth in tax revenues will be correspondingly reduced. Already, in the first quarter of 2018-19 the growth rate of FBR revenues is down to 8 percent when the targeted rate for the year is 14 percent. Almost two-thirds of tax revenues are collected from large industrial units and importers of manufactured goods.
The loss of buoyancy of the industrial sector is the first indicator of how the policy measures undertaken for stabilization of the economy will impact on the rate of economic growth. Unfortunately, we may see more negative developments in coming months.
(The writer is Professor Emeritus at BNU and former Commerce, Planning and Finance Minister)