Consumptions Parameter

Pakistans average consumption to GDP ratio of 84% over the last six years is indicative of the continued relevance of those words of wisdom. What this means is that, on average, we have consumed 84% of our income. A high consumption to GDP ratio might be justifiable when per capita income is low. Third world countries with low per capita incomes typically suffer from this problem. In the middle to lower classes, incomes are so low that nothing can be saved. A high consumption to GDP ratio is the inevitable by-product. But, then, as a country expands and its per capita income rises, the consumption to GDP ratio should fall. More specifically, as GDP per capita increases, marginal propensity to consume should fall. Marginal propensity to consume measures the proportion of incremental GDP that is spent on additional consumption. Marginal propensity to consume = Change in consumption Change in GDP In Pakistan, the post 9/11 years (2002-2005) have seen the economy rebounding and GNP per capita has risen steadily from US$ 500 in FY01 to US$736 at the end of FY05. True to script, marginal propensity to consume in FY02 fell to 74% from 84% a year earlier. And for three fiscal 3

years, it stayed at 74%. Because GDP was rising, even a constant marginal propensity to consume resulted in a rising savings rate. FY05- a Year of Getting and Spending This happy equilibrium, however, reversed sharply last year. Marginal propensity to consume rose from 74% to 121%, as the savings rate fell to a five year low of 15.1%. What does a marginal propensity to consume of 121% mean? For example, GDP between FY04 and FY05 increased by PKR 1015 billion. Consumption increased by PKR 1233 billion, more than the rise in GDP. This translates into a marginal propensity to consume of 121%. Bottom-line; in a period of record high growth of 8.4%, the nation as a whole consumed more than it earned, it dis-saved. A very generic interpretation of this is that the benefit of the GDP growth was exhausted completely within the year and no benefit is carried forward to future years. Such a high marginal propensity to consume is extremely worrying. It is indicative of a spendthrift culture, a make hay while the sun shines kind of attitude. Instead of boosting savings, and in turn, investments, much of the nation decided to simply cash in on the economic revival. GDP is rising, but so is our consumption. Evidence is all around us; new cars, housing projects, mobile phones, fancy restaurants and consumer durables in general have taken centre stage in many of our lives. Granted, this is the age of consumerism globally and we are no contrarians in that regard. However, comparisons only hold relevance and meaning when circumstances are similar. For a country only skin-deep into economic revival, it is surely extravagant to spend so much, so soon. Our historical addiction to pleasure living, which took a turn for the worse in FY05, seems to be continuing into FY06 as well. Case in point, a friend of mine wanted to book a Daihatsu Cuore recently. On calling up a car dealer, he was informed that due to an unmanageable back-log, booking for the car was closed. Forget about the wait-time, you just could not book the car at all! A few weeks later, another dealer informed him that booking had re-opened, but delivery would be in December, a wait of 10 months. The on premium, if immediate delivery was desired, amounted to PKR 100,000. Thats more than 20% of the value of the car. Yet people actually pay the premium, it is not such a huge deal anymore. Even more problematic is the fact that much of the new consumption is being imported from abroad. Pakistans economy has already overheated; the sudden remittance injected liquidity boom had resulted in too much money chasing too few goods. The proper way of dealing with the liquidity would have been to direct those funds to profitable investment expenditure that would increase the productive capacity of the economy. To some extent, that did happen. Balancing, Modernizing, and Restructuring (BMR) in key industries like textiles and construction did take place. But much of the new-found liquidity was deployed in consumption and speculative activities, such as stock and real estate investments. This resulted in, and re-enforced, inflationary pressures in the economy. And when inflation reached untenable double-digits, policy makers were left with few options but to deregulate imports. Voilait should come as no surprise that the trade deficit is soaring. And the frustrating part of importing consumption from abroad is that it adds nothing to GDP; there is no possibility of consumption-led growth.

Private consumption reached to its largest share of GDP in the last decade at 76.8 percent and accounted for 217 percent of real GDP growth and total consumption with 85.8 percent stake in size of GDP accounted for 244 percent of GDP (mp) growth. Most alarming part of the composition of aggregate demand is coming from fixed investment. Its contribution to economic growth has become fractionally negative and it is third year in a row when investment is negatively contributing towards economic growth. The improvement in the current account balance was unable to translate into positive

contribution of net exports. The obvious reason being imports are driven by quantum impact whereas; exports are driven by price factor. Elimination of price effect in real GDP growth reinforced a huge negative contribution of the net export sector emanating mainly from exports. The investment rate was rising since 2004-05, and reached its peak of 22.5 percent of GDP in 2006- 07, however, amidst extraordinary headwinds, the investment to GDP ratio declined since then persistently to 13.4 percent of GDP in 201011. Domestic demand remained strength of Pakistans growth experience and this year too, domestic demand on the back of higher agriculture prices driven buoyant private consumption remained the hallmark of the modest growth this year. National savings have shown their inadequacy for financing even the lower level of investment in the country. The national savings rate has nosedived to 13.0 percent of GDP in 2010-11 compared to 13.1 percent of GDP last year.

Investment and Savings Investment is a key means for reviving economic growth to its historical levels. The total investment has declined from 22.5 percent of GDP in 2006-07 to 13.4 percent of GDP in 201011. Fixed investment has decreased to 18.1 percent of GDP from 20.4 percent last year. Gross fixed capital formation in real terms has contracted for third year in a row by 0.4 percent compared to a contraction of 57 percent last year. Even in nominal terms gross fixed capital formation increased by only 4.4 percent against decrease of 3.4 percent last year. Private sector investment on average contracted by 6 percent per annum in real terms and recorded third contraction in a row. It contracted by 3.1 percent in nominal terms during 2010-11 as against contraction of 6.1 percent last year. Public sector investment is crucial for catalyzing economic development and it has created spillovereffects for private sector investment through massive increase in development spending particularly on infrastructure in the past [See Table-1.6]. However, squeeze on development expenditures made it to decelerate at a brisk pace. It decelerated from 5.6 percent of GDP in 2006-07 to just 3.3 percent in 2010-11.

The contribution of national savings to the domestic investment is indirectly the mirror image of foreign savings required to meet investment demand. The requirement for foreign savings needed to finance the saving-investment gap simply reflects the current account deficit in the balance of payments. The marked improvement in the current account deficit is a reflection of narrowing savings-investment gap. If we disaggregate private and public savingsinvestment gaps, both gaps have improved to contribute in current account improvement [See Fig- 1.5]. There are two ways of improving savinginvestment gap; one is through increasing savings or through decreasing investment. Both in the public and private sectors saving-investment gaps, it is the fall in investment that has contributed to narrowing gap rather than increase in savings. Pakistan needs to gear up both savings and investment to enhance employment generating ability of the economy as well as more resource availability for investment. National Savings at 13.8 percent of GDP in 2010-11 is reflecting one of the lowest savings in peer economies. Domestic savings has also declined substantially from 18.1 percent of GDP in 2001-01 to 9.5 percent of GDP in 2010-11. This is the lowest ever domestic savings level in almost two decades.

The government remained major dis-saver while private sector savings are not adequate.