Investment, crowding out and govt role
PRIVATE sector investment has been declining at an alarming rate from an annual average of 13pc of GDP for 2001-09 to less than 10pc since 2009.
Given its importance for generating employment, sustaining stable consumption and freeing valuable government sources for allocation to other troubled areas of the economy, it is important to study the sources behind its decline.
Reckless government borrowing from commercial banks could explain one side to the story. This pushes up interest rates, crowding out private sector credit uptake and consequently investment. However, decrease in the SBP’s interest rates over the last few years and continued decline in banking spreads have failed to reverse the investment trend.
Even if it is conceded that the government borrowing has stalled private sector credit growth, it is not the only reason to explain the decline in investment
Moreover, commercial banks may not find it profitable to finance private sector investment since it may be more profitable vis-à-vis the risk to finance government operations. Outstanding credit to government sector has continued to increase at a much faster rate than to private sector.
However, the underlying data studied by the authors does not exhibit any correlation between the two. The correlation between the year-on-year quarterly growth rate of credit to government and private sector is almost zero for the period since 2006.
The slowdown in the growth rate of credit to private sector is better explained by an increase in the share of non-performing loans (NPLs). Increase in the underlying risk associated with private sector credit may have decreased banks’ desire to lend to private businesses.
The share of NPLs in total loans increased from 7.3pc in 2006 to 16.7pc in 2011 according to the World Bank data. The share has since then decreased to 12.4pc in 2015 but is still significantly higher than most regional economies. Consequently, the growth rate of credit to private sector has decreased from 17pc in 2007 to an annual average of only 5pc since 2009, according to the SBP data.
However, even if it is conceded that the government borrowing has stalled private sector credit growth, it is not the only reason to explain the decline in investment. The World Bank’s Enterprise Survey 2013 (ES2013) notes that the share of bank financing in total investment financing is only 2.4pc for Pakistan — much less than 13.8pc for South Asia region. It is, therefore, improbable that factors associated with bank financing may play a major role in explaining investment trends.
Other possible explanations for the lacklustre downward trend in investment could be the underlying regulations governing the economy. But we do not find this plausible as well. There is no evidence of any major change in regulations just before or after 2009. Pakistan’s ranking (128) in Ease of Doing Business 2015 was higher than both India (142) and Bangladesh (173).
Even though Pakistan’s ranking has worsened from 77 in 2009 to 128 in 2015, there is almost no significant change in the quality of procedures. Interestingly, the sharp decline in Pakistan’s ranking came in 2012 when ‘getting electricity’ was included as an additional indicator in evaluating the rankings.
It can be argued that the quality of indicators has worsened relative to the world. However, ES2013 reports that the fraction of time spent by an average firm’s senior management in dealing with the government regulations is almost similar for both Pakistan and South Asia region (approx 4pc of time).
And, since positive investment trends in the South Asia region have continued until recently despite almost similar governance problems, why should Pakistan be an exception?
Increase in the NPLs and worsening of the Ease of Doing Business rankings are both centred on the energy crisis. In the absence of any credible commitments on future energy supplies, firms’ desire to invest is significantly hampered.
Professor Nicholas Bloom of the Stanford University has looked at the role of uncertainty in driving firms’ investment decisions. He finds that high uncertainty (i.e. energy uncertainty in our case) forces firms to delay their investment decisions. Around 45pc of all firms in the ES2013 report electricity as their ‘main obstacle.’
Furthermore, on average 25pc of the sale value is lost to power outages for all firms. On the contrary, access to finance and customs and trade regulations are reported as main obstacles by only around 6pc of the firms.
In the current environment of persistently high uncertainty about future energy supplies, it can be plausibly argued that government investment in energy infrastructure can essentially crowd-in private investment.
The debilitated state of Pakistan’s energy distribution infrastructure is a reason enough for the government to undertake public sector investment in energy infrastructure. Doing so becomes almost imperative when the issue starts feeding into future uncertainty.
Meaningful reforms in the energy sector and investment in both energy distribution and generation infrastructure are our only hope to prosperity.
Pirzada is PhD candidate in Economics at University of Bristol
Qureshi is PhD candidate in Economics at University of Warwick
Published in Dawn, Business & Finance weekly, January 18th, 2016