Inflation outlook disheartening

The State Bank of Pakistan (SBP) has said that Pakistan’s economy will continue to grow at a steady pace, facing a number of domestic and external challenges in the current fiscal year 2010-11.
The State Bank of Pakistan published its report for the second quarter of FY11 on Friday.

The report found the revenue targets set under the tax reforms for the prevalent financial years are ambitious, warning that the planned official inflows from the IMF and other international financial institutions could be affected in case the government fails to implement the fiscal austerity measures effectively. “With fiscal pressures and below-target external funding, domestic financing pressures may increase; this will either crowd out the private sector further or result in unwelcome borrowing from SBP, which in turn may reverse some of the positive steps taken to date to address the country’s macroeconomic problems,” it said. The SBP has stuck to its earlier projection of Gross Domestic Product growth of 2-3pc for the current fiscal year (FY11), accounting for the catastrophic floods in Aug 2010. However, looking at inflation, the report said, “Although projections for FY11 have eased marginally to 14.5-15.5pc but it seems that inflationary expectations are becoming engrained”.

Despite expected decent growth in the agriculture sector, the SBP report highlighted three key risks in the present domestic and global economic environment. Firstly, it noted that Pakistan’s talks with the IMF have been difficult primarily because of socio-political resistance to paying taxes. Hence, it is not surprising that the programme is suspended, and even some of the recent tax measures may be viewed as second-best, being one-off in nature.

Secondly, due to the risk-averse behaviour of commercial banks it is expected that banks would channel increasing volumes of credit to the government, crowding out the private sector further because of a high fiscal deficit and blockages in external sector. Thirdly, if political uncertainty remains and spreads further in the Middle East/ North Africa (MENA) region, oil prices could increase even more sharply than the recent past. Although this will hurt the global economy quite severely, the impact on Pakistan could be disproportionately larger.

Finally, the uncertain investment horizon and an adverse law & order situation – related to the fight against extremism – will also strongly influence this outlook.

The report stated, “Looking ahead, perhaps measures like the withdrawal of exemptions from GST signal a more inclusive and aggressive intent for the FY12 Budget – recent FBR efforts to identify wealthy non-payers is a good sign in this regard”.

“Although we do not have formal data for the period Jan-Mar 2011, a preliminary assessment suggests that the external sector will remain comfortable, the report said adding that we remain cautiously optimistic about progress on the fiscal side, as shown by the recent fiscal measures to reduce the gap by Rs210 billion this fiscal year. On the banking side, the increase in textile lending may slow down as international cotton prices fall from their recent peak, and seasonal demand for credit eases.

“Despite the staggering humanitarian cost of the August 2010 floods, there is a possible upside for the agriculture sector. Other than better-than-expected wheat production this year, we are also optimistic about cotton, sugarcane and rice in FY12, it said.

In fact, recent weather conditions may help – the unexpectedly large snowfall this winter will help our kharif crops when the snow melts, while cotton could get a boost with the shift to BT cotton. Although targets for the next crop have not been firmed up yet, there is a view that the target for FY12 could be as high as 17.0 million bales, against FY11’s target of 14.5 million bales and actual output of 11.7 million bales. The possible upside to GDP in FY12 – if this were to happen – could be significant, it added.

The government appears to be working with key stakeholders (Pakistan’s political leadership) to implement policies, which may not get the necessary support from their financial and political constituencies. However, we remain optimistic that multi-partisan efforts will resolve this stubborn economic impediment. We hope that despite these fiscal challenges, the government continues to meet its commitment (to SBP) to stay below its end-September 2010 level of borrowing from the central bank, it opined.

“There are only three avenues that Pakistan can take to meet deficit targets – exceptional steps to increase fiscal revenues; reforming loss-making PSEs; and eliminating end-user subsidies. On the revenues side, although RGST has become the focal point, addressing revenue leakages and glaring exemptions (eg agriculture and ineffective taxation of properties) needs serious attention,” it suggested.

The report disclosed that the external sector is comfortable. During Jul-Feb FY11, Pakistan’s current account deficit was only $98.0 million, against $3,027 million in the corresponding period in FY10.

Strong dollar-denominated export growth of 20.3 percent (on the back of high prices of textiles), sluggish manufacturing and consumer demand (reflected in the 12.7 percent growth in imports), and strong remittances (up 18 percent over FY10); are primarily responsible for the improvement.

“Having said this, net foreign inflows in the financial account have declined sharply, as the stalled IMF programme has stopped inflows from other IFIs and bilateral donors. Nevertheless, the improvement in the current account has pushed Pakistan’s foreign reserves to record highs, while the Pak rupee remains stable,” it said.