SBP Quarterly Report on State of Pakistan’s Economy

War on terror, lower revenue collection widen fiscal deficit GDP target unchanged at 3.5pc, current account deficit narrows, inflation bounces back

KARACHI: The State Bank of Pakistan (SBP) has raised the fiscal deficit forecast for the current financial year 2009/10 (July-June) to between 5.0 and 5.5 per cent of the gross domestic product (GDP) from the targeted 4.9 per cent in the wake of high defence spending and low revenue collection.

The SBP in its Second Quarterly Report on the State of Pakistan Economy maintained its GDP forecast for FY10 at between 2.5 and 3.5 per cent, but lowered its projection for the current account deficit to 3.2 to 3.8 per cent from the previous estimates of 3.7 to 4.7 per cent.

“The fiscal outlook appears especially challenging,” the SBP said in its Second Quarterly Report (October-December) for FY10 on the State of Pakistan’s Economy. “Existing rigidities in current expenditures have been exacerbated in FY10 by the strong build-up in domestic and external debt, and rising military spending on anti-terrorist operations.”

The growing energy sector circular debt and the government’s controversial policy of paying higher-than-market price to farmers for certain commodities also contributed to widening of the fiscal deficit, the bank said.

Analysts say that keeping the fiscal deficit target at 4.9 per cent remains one of the key conditions of the International Monetary Fund (IMF) under its $11.3 billion Standby Agreement with Pakistan.

Hamad Aslam, head of research at BMA Capital Management, however, said that the widening of fiscal deficit would have little impact on the Standby Agreement with the IMF. “In practice these numbers have been shared with IMF officials so it won’t0 be much of a problem for the governmentÖ But, the rising current expenditure on the large government machinery should be bothering the IMF.”

According to the SBP report, weak revenue generation and considerable lags in the receipts of Coalition Support Fund also contributed to the widening of fiscal deficit, which rose to 2.7pc of GDP in July-December 2009, compared with 1.9pc in the same period the previous year.

“In recent consultations with the IMF, need for cut in Public Sector Development Program and relaxation in fiscal deficit target was also recognised,” the report said. However, the central bank said that a cut in the development spending is not desirable. “The government’s ability to protect development spending has been severely cramped by non-availability of expected external aid inflows from the Friends of Democratic Pakistan.”

The central bank’s forecast for the current account deficit improved to 3.2 to 3.8 per cent from 3.7 to 4.7 per cent estimated in its first (Jul-Sep) quarterly report. Better than expected exports and robust performance of remittances helped slash the current account deficit, the bank said.

“The good news on the external sector ends here,” it said, adding that a monthly breakup for July-Feb shows most of the improvement was concentrated in the first quarter of the fiscal year. Thereafter, the year-on-year trend has steadily deteriorated with imports rising and remittances slowing down.

The report said Pakistan will achieve GDP growth of 2.5 to 3.5 per cent in the current fiscal year despite weak agricultural output on the back of industrial recovery and reasonable performance of the services sector.

A rise in demand for consumer durables, cars and cement led the growth in large-scale manufacturing sub-sector. “Nonetheless, it will be extremely challenging o sustain the growth seen in Jul-Jan 2009/10 given the prevalent energy shortages.”

The SBP said the country’s overall economic outlook remains mixed as inflationary pressures have decisively reemerged in recent months. The year-on-year inflation, which dropped to 8.9 per cent by October 2009, bounced back to the double digits of 13 per cent by Feb 2010, the bank said.

Also, sustaining current account deficit is challenging given rising import requirements and evident weakness in pace of growth in remittances, it added. “Prospects for real GDP growth are better relative to the preceding year. However, this level of growth is not adequate to generate required employment opportunities.”

About criticism of its tight monetary policy by the industry, the central bank said given the weakness in the country’s fiscal outlook and risks to external flows and rising inflation, policy options for Pakistan were limited.

The SBP said trends in financial and capital accounts were discouraging as of the $3.7 billion surplus for Jul-Feb about $2.8 billion were recorded in the first quarter. Practically, all of the external financing was in the form of debt, significantly adding to the country’s vulnerability to external shocks, it said.

The rupee also depreciated sharply between mid-December 2009 and mid-February 2010 despite continued inflows from the IMF pushed up Pakistan’s foreign exchange reserves, the bank said.



Projections of Major Macroeconomic Indicators

FY10

FY09 Annual Plan SBP

Targets Projections

growth rates in percent

GDP 2.0 3.3 2.5 - 3.5

Average CPI inflation 20.8 9.0 11.0 - 12.0

Monetary assets (M2) 9.6 - 14.5 - 15.5

billion US dollars

Workers’ remittances 7.8 7.0 8.0 - 8.5

Exports (fob-BoP data) 19.2 19.9 18.7 - 19.2

Imports (fob-BoP data) 31.7 28.7 30.5 - 31.0

percent of GDP

Fiscal deficit 5.2 4.9 5.0 - 5.5

Current account deficit 5.3 5.3 3.2 - 3.8

Note: Targets of fiscal and current account deficit to GDP ratios are based on nominal GDP in the budget document for FY10, while their projections are based on projected (higher) nominal GDP for the year.



Highlights

• Pakistan likely to sustain revival of economic growth during the current fiscal year.

• FY10 GDP growth target remains unchanged from the previous quarter.

• GDP growth not adequate to generate required employment opportunities.

• Pakistan’s overall economic outlook seen mixed.

• FY10 headline CPI inflation estimates in the range of 11 to 12 percent.

• Current account deficit narrows on better exports, robust remittances.

• FY10 fiscal deficit seen higher on extraordinary defense spending and weakness in revenue collection.

• Fiscal deficit seen in the range of 5.0 to 5.5 percent of GDP during FY10.

• Aggressive fiscal reforms seen key to achieve and retain macroeconomic stability in the mid-term.

• Growth prospects for the agriculture sector remain weak.

• Broad Money (M2) growth accelerates to 5.7 percent during July-Feb. FY10 from 2.0 percent in the same period of FY09.

• Net Foreign Assets of the banking system records a depletion of Rs46.6 billion in July-Feb