KARACHI: The State Bank of Pakistan (SBP) has said that floods incurred immense losses to the economy and estimated the GDP growth in FY11 (July-June) to be in the range of two to three percent against the government target of 4.5 percent.
The central bank in its annual report FY10, released on Monday, said that the estimates for FY11 are based on the incomplete information on flood losses.
The report has been prepared prior to the Asian Development Bank and the World Bank flood assessment report in which the donor agencies said that the estimated losses incurred by the natural calamity remain around $9.7 billion, besides a loss of over 1,500 human lives and displacement of around 20 million people.
The SBP report said that the macroeconomic framework embedded in the FY11 Annual Development Programme targets have suffered a serious setback early in the year as large areas of the country were devastated by widespread rains and unprecedented floods.
“Large parts of the country’s agricultural heartland were particularly hit hard by these floods, with significant damages to standing Kharif crops (cotton, rice and sugarcane) and livestock,” the central bank said.
The economy also suffered extensive damage to infrastructure (bridges, road networks, gas/power plants, and some industrial units such as rice mills, ginning factories, etc), productivity losses from supply-disruptions, the large-scale displacement of people, etc, it added.
The report said that it is obvious that the economic priorities and targets for FY11 and all the key macroeconomic indicators would likely to record deterioration.
“Not surprisingly, demands on the public exchequer are expected to rise sharply in FY11 to finance relief and reconstruction activities in the wake of the floods,” it said.
The central bank supported the government decision to levy flood tax on affluent segments of the tax base. But it said that the needs are still likely to exceed any reasonable increase in receipts.
This raises two issues, firstly, it must be understood that while government interventions in terms of resources and policy are essential to the scale and speed of any recovery, the government has neither the capacity nor the resources to deliver on all public expectations for relief and support, it said.
“A large part of the reconstruction effort over the years will, therefore, depend substantially on the private enterprise and on the broad support of the civil society,” the annual report said.
Secondly, the expected increase in fiscal pressures in FY11 is also an opportunity to undertake fundamental changes.
“Given the scale of the resources needed for rehabilitation and relief for flood-stricken areas, there needs to be a political consensus on widening the tax base to hitherto untaxed (or under-taxed) segments of the economy, and plug leakages in the existing system. Such reforms will continue to pay dividends, over the years, even after the post-flood needs fade away,” it said.
The SBP advised the federal and provincial governments to carefully scrutinise and prioritise spending, both current and non-recurrent, in order to create room for the new immediate demands, as well as for the public investment needed to support growth in the medium-term.
“Even before the floods, there had been practically little change in the roles, responsibilities and structures in both levels of government, despite a substantial change in the resource distribution to provinces under the latest National Finance Commission (NFC) Award. This is not sustainable,” the SBP said.
The extended persistence of double-digit inflation had already been a source of concern even ahead of the floods, particularly given the risk that an uptrend in food commodity prices (eg, wheat, edible oil, sugar, corn, etc) could be compounded by any weakness in the exchange rate, the report said.
“Moreover, inflationary pressures were also expected to strengthen as a result of the recent 50 percent increase in government sector salaries and anticipated rise in the energy tariffs (as the government continued to reduce subsidies) and removal of the general sales tax exemptions to broaden the tax base,” it said.
The SBP forecast the post-floods inflation to be in the range of 13.5ñ14.5 percent in FY11, up from 9.5 percent target and earlier SBP forecast of 11ñ12 percent for the year.
Although a slight deterioration in the current account deficit was envisaged for FY11, reflecting the rising requirements for food imports (sugar, edible oil, etc), as well as increased imports to support an anticipated improvement in the economic activity.
“This outlook has deteriorated somewhat, post-floods. If fears of substantial losses in agricultural production (particularly cotton) prove correct, this could potentially lead to a higher trade deficit, offset only partially by an anticipated increase in the current transfers,” the report said.
Provisional SBP forecast indicate that the current account to GDP ratio will likely to rise between 3-4 percent during FY11. However, financing even this moderate increase in the current account deficit may prove stressful for the economy, with rising pressures on the country’s foreign exchange reserves and exchange rate.
Highlighting FY10, the central bank said that Pakistan’s economy witnessed a moderate, but fragile recovery during the last fiscal year. “Helped by a modest improvement in business and consumer confidence, relatively supportive monetary and fiscal policies and some good fortune, the real GDP growth rose to 4.1 percent against an anemic 1.2 percent in FY09.
The lower commodity prices and relatively weak demand also contributed to a deceleration in inflation, which fell to 11.7 percent from a multi-decade high of 20.8 percent, as well as to the decline in the current account deficit to only two percent of the GDP in FY10 from 5.7 percent of the GDP during the previous year.
While these developments marked an improvement from the FY09 picture, fundamental structural weaknesses in the economy remained unaddressed, the SBP said.
Some key reforms failed to gather traction such as persistent disagreements led to the deferment of a proposed expansion of the tax net through the introduction of a broad-based general sales tax; the proposed restructuring of the public sector enterprises to improve efficiency and lower the fiscal burden did not take place; and after some initial work, there was a little or no progress in either resolving the energy sector debt chain or substantially improving electricity supply.
The principal structural problem, however, was the weak fiscal performance; the fiscal deficit bounced back to 6.3 percent of the GDP in FY10, ie, 1.1 percentage points higher than in the previous year.
The initial Rs1.6 trillion tax revenue targets for FY10 had looked optimistic, incorporating a record 29.8 percent annual growth against an average growth of 14.6 percent over the preceding five years.
The eventual Rs77 billion shortfall in the total revenues was, therefore, not very surprising, given the absence of any significant measures to expand the tax base or to exploit the existing tax base more effectively, the report added.
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