SBP’s Third Quarterly Report FY-2007-08

State of the economy: a realistic assessment
The government has indicated its intention of broadening the tax base, and rein-in expenditure for macro-economic stability and has also indicated that it intends to diversify its financial base and reduce its dependence on central bank borrowings
By Aftab Ahmad Khan

The recently released Third Quarterly Report of the State Bank of Pakistan (SBP) for the fiscal year 2007-08 presents on analytic, objective assessment of performance of the economy during July-March FY-08 and highlights the challenges confronting it. It recommends appropriate policies and measures for ensuring socially necessary growth in an inhospitable international milieu.

According to the report, the economy is currently reflecting increasing signs of stress. An adverse combination of domestic and international factors is resulting in deterioration in principal macro-economic indicators. Growth in real gross domestic product (GDP) in the current fiscal year is expected to be in the range of 5.5 to 6 per cent as against the original target of 7.2 per cent and 7.0 per cent in FY-07. Annual inflation rate as measured by consumer price index (CPI) is projected at 11.0 to 12.0 per cent as compared with the target of 6.5 per cent. Fiscal deficit is forecast in the range of -6.5 to -7.0 per cent of GDP, significantly higher than the target of 4.0 per cent. The current account deficit of the balance of payments in likely to be at an all time high of –7.3 to -7.8 per cent of GDP. The year to date (YTD) depreciation of the Pak Rupee by the first week of May 2008 was at an uncomfortable level of 7.3 per cent. The country’s foreign exchange reserves fell to $11.5 billion by 22 May, 2008.

Despite considerable deterioration in key economic indicators, the report is quite hopeful about the resilience of the economy on account of structural reforms and liberalisation over the last fifteen years. It is confident that macro-economic stability can be regained through further reforms and corrective policy measures.

The report quite correctly points out that the showdown in the growth of the economy in FY-08 is due to lackluster performance of the commodity producing sectors. There is significant decline in important major agricultural crops in FY-08 relative to the previous year. Wheat production in FY-08 may turnout to be substantially below target.

Real value addition in rice, cotton and sugarcane in FY-08 is now estimated at Rs192.2 billion as compared with Rs193.9 billion last year billion showing a negative growth of -0.9 per cent.

The report has quite appropriately recommended that since commodity prices are going to remain strong, government should frame policies to raise farmers’ ability to enhance productivity substantially in the years ahead. Key areas which require policy intervention are the transmission of price gains, risk mitigation (group insurance, storage facilities), large investment in agri-sector infra structure and value addition claims (through processing).

The report has warned that water shortage seen in rabi in FY-08 is likely to persist in FY-09. Water availability during the second phase of kharif FY-09 (June 10-September 30) would largely depend on monsoon rains in the catchment areas as well as the conducive high temperatures in the glacial belt. At present, water shortage for t he full kharif season has been estimated at 3.77 per cent relative to normal requirement for the season.

It is heartening to note that Pakistan is to build multipurpose dams, irrigation canals and drinking water supplies across Potohar Plateau near Islamabad with US$ 75 million loan provided by the Asian Development Bank (ADB).

Agricultural credit disbursement continued apace with impressive progress. The total agri credit disbursements amounting to Rs157.6 billion were achieved during July – April FY-08 – an increase of 34.9 per cent YoY. A part of this increase was attributable to rising prices of fertilisers and pesticides.

In the important field of large scale manufacturing, there was a disappointing growth of 4.8 per cent during July – March FY-08 as compared with 9.0 per cent in the same period last year. The poor performance of this important sector is attributable to energy crisis, high international commodity prices and political unrest through most of the year.

Unlike agriculture and large scale manufacturing, the services sector in the first nine months of FY-08 achieved its annual targeted growth. The main contributors to the commendable growth performance of this sector are wholesale and retail trade, transport, storage, and communications as well as public administration and defence.

Inflationary pressures in the economy during the fist nine months of the current fiscal year remained disturbingly strong. A number of factors are responsible for this menacing increase in prices. There are, (1) sustained increase in global commodity demand, (2) supply constraints, and (3) higher investments on account of a weak dollar and falling interest rates.

CPI inflation (YoY) remained in double digit during the third quarter of FY-08.

The rise in CPI inflation has been contributed by both food and non food components. CPI food inflation increased significantly by 25.5 per cent during April 2008 as compared to the corresponding month last year. Within the food group only three items (wheat, vegetable ghee and fresh milk) contributed 56.1 per cent of the food inflation during April 2008.

Inflation as measured by wholesale price Index (WPI) also continued its uptrend throughout the first nine months of FY-08 and showed a growth of 25.5 per cent during April 2008 as compared with 6 per cent in April 2007.

Weekly inflation as measured by sensitive price Index (SPI) jumped from 7.7 per cent in the last week of FY-07 to 25.4 per cent in the first week of May 2008.

More than 60 per cent of the items included in the SPI basket recorded double digit YoY during April 2008 with some of the items like rice, wheat, vegetable ghee, cooking oil, pulse masoor, and tomatoes witnessing inflation of more than 50 per cent.

Growth in broad money supply (M2) decelerated during July 10 – May 2008 to 9.0 per cent as compared with 14.1 per cent during the same period in FY-07 due to contraction in the net foreign assets of the banking system; net domestic assets (NDA) of the banking system; however, expanded sharply during this period.

The YoY growth in monetary assets (M2) as on 10th May FY-08 remained at 14 per cent as against the FY-08 target of 13.7 per cent.

In the fiscal field, according to the report, the budget deficit in July-March FY-08 (as a percentage of estimated GDP of FY-08) is likely to be significantly higher than the full year FY-07 figure of 4.3 per cent.

Government domestic borrowing during July-March FY-08 grew rapidly, reflecting a strong year-on-year deficit and little change in external financing from FY-07. Incremental government borrowings from SBP as of May 10, 2008 have reached Rs551.0 billion, pushing the outstanding stock of MRTBs, with SBP to Rs940.6 billion. These developments have intensified inflationary pressures in the economy.

Realising these concerns, the government has indicated its intention of broadening the tax base, and rein-in expenditure for macro-economic stability. The government has also indicated that it intends to diversify its financial base and reduce its dependence on central bank borrowings.

There was a sharp deterioration in Pakistan’s over all external balance during July-April FY-08. Consequently, Pakistan’s foreign exchange reserves dropped to US$11.5 billion and the rupee depreciated by 13.4 per cent against the US dollar by 22 May, 2008.

Pakistan’s current account deficit expanded by 74.8 per cent during July-April FY-08 ($11,586 million) on top of a 67.9 per cent rise during last year. As a percentage of GDP current account deficit was 7.0 per cent, during July-April FY-08 against 4.6 per cent in the same period last year.

Pakistan’s merchandise trade deficit widened to an alarming figure of $16.8 billion during July-April FY-08 which is 37.8 per cent higher than the annual trade deficit target. The massive deficit stemmed from a strong increase in imports as well as below target export growth.

Overall foreign investment declined by 39.2 per cent during July-April FY-08 as compared with 47 per cent growth in the corresponding period the previous year.

Sector-wise analysis reveals that investment in telecommunications, power, petroleum refining and financial business declined, whereas cement, oil and gas exploration and trade recorded increases.

Workers remittances recorded an impressive growth of 19.5 per cent during July-April FY-08 and amounted to $5,319 million.

The report on the basis of recent developments in the economy has highlighted two important conclusions:

(1) A focus on macro-economic discipline pays dividends for the economy.

(2) The continuation of fiscal discipline and economic reforms do not necessarily represent a trade oft with economic growth.

The report quite appropriately advises the newly elected government to pursue social and economic policies aimed at fostering robust growth with equity in a milieu of macro-economic stability.

The newly elected government should implement the next phase of reforms wher e development expenditures on energy, infra-structure, education, health, khushali programmes, irrigation, water and storage and conservation can be implemented in a milieu of good governance.