KARACHI (December 30 2008): The country's ailing economy is witnessing improvement and has started to ease from the crisis since November, that had circumscribed it during the early months of the current fiscal year. However, despite some improvement, the country needs effective policies and implementation of reforms in the fiscal year FY09 to regain the macroeconomic stability and meet economic challenges, says the (SBP) First Quarterly Report (July-September) FY09, released on Monday.
The report said that healthy economic signs emerged after the government addressed the most immediate risks to the country's falling economy through entering the macroeconomic stabilisation programme to support medium-term reforms under the aegis of IMF.
It said that among the biggest challenges for the government would be to ensure the passthrough of the decline in international commodity prices to consumers. In this background, while recent downward adjustments in the administered prices of key fuels is appreciable, transport fares and goods transportation charges were "either not adjusted downwards or saw small changes", it added.
However, notwithstanding the relative positives, there is no room for complacency, the Report asserted. "While many of the country's macroeconomic indicators may no longer be worsening, the imbalances are nonetheless still quite large," it said, and added that resolving them will require disciplined efforts over an extended timeframe.
"This challenge is all the greater because of the difficult international economic environment, which has restricted the country's ability to tap international capital markets and carries risks for other external receipts like exports, remittances, FDI, etc," it said.
The central bank has estimated that the country is likely to miss the GDP growth, inflation, and export targets, while foreign direct investment would be lower than recent years. However, on a positive note, both fiscal and current account deficits are estimated to improve in FY09, the SBP said. As per report, real GDP growth is likely to be significantly lower, around at 3.5-4.5 percent, than the annual target of 5.5 percent and inflation will breach its target of 11 percent to 20 percent by the end of FY09 with a wide margin of 9 percent.
While fiscal and current account deficits are expected to be under control and would be close to the targets, fiscal deficit is likely to stand at 4.3-4.8 percent of GDP against the target of 4.7, and current account deficit would be 6.2-6.8 percent against the target of 7.2 percent by the end of current fiscal year.
The SBP has estimated that imports and exports have been revised downward, with a more pronounced effect on imports. At the same time, in the event of shortfall of external financing, the burden of financing fiscal deficit will disproportionately fall on the domestic commercial banks, since the government has committed not to borrow incrementally from the central bank.
In addition, FDI inflows may be substantially lower than in recent years, in which case, pressures on forex reserves could remain strong. Both possible developments indicate continuing risk on interest rates and exchange rate, and thus the need for continued vigilance by policymakers. The Report maintained that global recession and risk averse behaviour of investor would likely severely impact international trade and level of foreign exchange inflows in the economy.
"SBP estimates for both imports and exports have been revised downwards, with a more pronounced effect on imports," it said, and added that at the same time, in the event of shortfall of external financing, the burden of financing fiscal deficit will disproportionately fall on domestic commercial banks, since the government has committed not to borrow incrementally from the central bank.
It said the disbursement of the first tranche of $3.0 billion by end-November 2008 under the program meant that any immediate risk of default on external obligations receded, with a substantial improvement in foreign exchange reserve adequacy indicators. Also, export growth has strengthened and import growth moderated somewhat. "This lent strength to the rupee, reducing the impact of an important generator of inflationary pressures," it added.
The Report said the gain on the external account was helped by a sharp decline in international commodity prices that is expected to substantially lower the country's import bill, offering the possibility of a decline in the country's very large current account deficit, and lower inflation. This supply side improvement has been reinforced by the reasonably good performance of crops during kharif FY09 cropping season, it said.
There is also substantial progress on containing fiscal imbalances, with the government moving bravely to reduce subsidies, contain growth in other spending and increase revenues, the report said. It added that the result has been an encouraging improvement in some fiscal indicators, including a sharp fall in the fiscal deficit from 1.5 percent of GDP during first quarter of FY08 to 1 percent of GDP in Q1-FY09.
"This figure appears consistent with the annual target embedded in the macroeconomic stabilisation program framework," it said. According to SBP's Report, agricultural growth in the current fiscal year could be significantly better than in FY08, notwithstanding a sharp fall in sugarcane harvest.
"This expectation is based on a record rice harvest of 6.5 million tons, a small improvement in cotton production during Kharif FY09, supported by the possibility of a record wheat harvest," it said, and added that initial information also raises the possibility of a very good showing by minor crops and reasonable growth in the livestock sub-sectors.
However, large scale manufacturing (LSM) continued to decline during the first quarter due to energy shortages, deterioration in domestic law & order situation, impact of pass through of international oil prices, sharp depreciation in rupee parity and most importantly, weak external demand on the back of global recession and slowdown in domestic demand.
LSM registered a negative growth of 6.2 percent in Q1-FY09 against a reasonable growth of 7.3 percent in Q1-FY08. This decline in LSM production is broad-based, as seven sub-sectors (having 72.4 percent weight) out of fifteen registered a decline, while three (having 15.3 percent weight) registered a growth of less than one percent, it said.
Referring to services sector, the report said that the sector exhibited resilience to fluctuations in economic activity in recent years. "This is also evident in continued growth in FDI in the services sector, despite slowdown in overall economic activities in the country," it added.
The Report said that the State Bank undertook aggressive monetary tightening during FY09, further increasing the policy rate by 300 bps in two rounds. On cumulative basis, this means a 550 bps increase during the last 18 months. It said in terms of monetary aggregates, the YoY growth in M2 decelerated steeply to 10.7 percent by end-November 2008 - the lowest growth seen during the last seven years. Indeed, an extraordinarily strong contraction in net foreign assets (NFA) of the banking system more than offset a sharp rise in budgetary borrowings from the central bank and continued strong demand for credit both from public sector enterprise and private sector, it added.
Referring to fiscal developments, the Report said that the Q1-FY09 fiscal performance improved consequent to the policy shift, with the overall fiscal deficit estimated to have dropped to 1 percent of annual GDP. "This is consistent with the annual fiscal deficit target set under the IMF stabilisation program. The reduction in fiscal deficit in Q1-FY09 was brought about mainly by a drastic cut in development expenditures," it added.
The Report said Pakistan's external account remained under stress through July-November FY09, as acceleration in the growth of the current account deficit, and sharply reduced financial & capital account inflows drew the country's foreign currency reserves to perilously low levels.
Not surprisingly, the rupee also weakened substantially in the period, depreciating by as much as 17.5 percent against the US dollar by end-October 2008, before recovering, somewhat, after Pakistan gained IMF support for a macroeconomic stabilisation program.
The Report said that during July-November period of FY09, strong growth in imports, mainly due to higher import prices, outpaced the otherwise substantial improvement in export growth causing the trade deficit for the period to widen by $1.4 billion compared to the same period last year. However, the combined impact of lower commodity prices and easing of domestic demand pressure are likely to reduce the trade deficit going forward, it added.