State Bank of Pakistan Second Quarterly Report: An overview

Written By: Jamil Nasir

Several economic indicators have halted their downward slide. External account has improved due to contraction in the current account deficit. Exports have gained momentum and witnessed a 23.5 per cent growth during July-Feb 2011. The non-farm incomes have gone up. Foreign remittances have registered a record growth. Large scale manufacturing (LSM) posted a positive growth despite weak textile performance and frequent power outages. This is what has been observed by the State Bank of Pakistan (SBP) in its second quarterly report for the year 2010-11, released last week.

According to the report, recent economic data shows mild signs of economic recovery and if things run smoothly, the growth trajectory could ease off in later stages of current fiscal year. But, it is not as easy as it sounds.

In spite of a few signs of revival, the overall economic scenario does not appear auspicious, to say the least.

The GDP growth is projected at the dismal rate of 2-3 per cent. Further, sustainability of recovery depends on several ‘ifs and buts’ like: (a) Nature is kind and crops for rabi season meet their targets, (b) IMF funds are released as per schedule, and (c) the price of oil does not shoot in the global market etc. The report further reveals an upsurge in the orders for Pakistani goods due to economic revival in developed countries, increase in foreign remittances, and better agricultural prices having fuelled aggregate demand that in turn has stimulated economic recovery.

LSM production has registered a positive growth since December 2010. This improvement is mainly attributable to the automobile and sugar industry. Improvement in sugar is mainly due to better recovery rate on account of high moisture content and during Oct-Nov 2011, banks disbursed Rs12.4 billion for the purchase of automobiles compared with Rs3.2 billion during the corresponding period of the previous year.

But the appetite for vehicles is a double-edged sword as it will spur demand for oil as well; hence escalate the furnace oil import bill. The debt-driven surge in consumer spending is reminiscent of the trend that prevailed during the time of the previous regime. Consumer spending constituted a major component of the aggregate demand. It resulted in the heating up of the economy and rise in the import bill. In short, sustained growth is unattainable merely by expanding the consumption component of aggregate demand. It is investment and government spending (for development projects) that can stimulate economic recovery and growth on a continuous basis. Otherwise, the swell in demand would be of no use to the economy.

The report projects inflation at 14.5-15.5 per cent against the annual target of 9.5 per cent. Theoretical and empirical literature that has explored the relationship between growth and inflation demonstrates that there is little evidence of moderate inflation being detrimental to growth. Officially, inflation in Pakistan has remained within moderate limits. But factual position may not be the same. According to the SBP report, popular perception regarding inflation tends to focus on administered prices like petrol prices, power tariffs, and wheat support prices etc., whereas fiscal slippages and excessive borrowing by the government from the central bank are main determinants of price expectations. Financing the budget deficit by borrowing from the SBP through seignior age has become one of the chief reasons for spiralling prices. It is, therefore, very important to limit government borrowing from the central bank to contain the inflationary trends.

High inflationary trends could prevail in the remaining period of the current fiscal year. By the end of the year, inflation is likely to exceed the projections of the SBP due to two main reasons: firstly, the government will slash the subsidies on petrol, diesel and gas etc. in a bid to set the prices right. Slashing away of the subsidies currently being doled out across-the-board (as subsidies are not targeted) will have an inflationary impact. Secondly, the government will have to take effective measures to enhance its revenue to qualify for the funds from IMF. The fiscal deficit is likely to further widen. The report anticipates that the fiscal deficit could exceed the target of 5.3 per cent of the GDP for the financial year 2011.

Despite some signs of improvement in a few economic variables, it is an undeniable fact that Pakistan’s economy is in dire straits. We are on the economic crossroads. The law and order situation, terrorism, power outages and political instability are the contributory factors towards the economic downturn. It is exceedingly difficult to put the economy on the right track unless fundamental structural changes are introduced. Our economy is afflicted with perennial ailments such as supply-side constraints and large fiscal gaps.

Even if it is assumed that the impact of the financial crisis is waning in the developed countries (which may not necessarily be the true picture) and we have demand for our goods, the question is whether we are in a position to produce exportable surplus and eke out our share from escalated demand. The answer is in the negative because we are faced with serious supply-side constraints. In the past the manufacturing sector flourished as export promotion incentives like refunds, rebates, subsidies and R&D were liberally used.

But in today’s changed scenario, our industries have to compete with the world and the leadership cannot protect them from cutthroat foreign competition. Pakistan’s exports have not increased due to supply-side restraints. At the macro level, shortage of energy, low productivity and non-upgradation of machinery (especially in textile) are some of the major bottlenecks. In order to overcome the supply-side impediments, a holistic strategy is required that must contain up-gradation, diversification, and productivity etc. as its main ingredients.

In addition to supply-side limitations, large fiscal deficits have plagued the economy. To fill the gap between domestic revenue and needs, we have relied excessively on foreign assistance. Besides the problem of mounting foreign debt etc., foreign aid has remained spasmodic both in terms of time and quantum. It is generally procyclical. So dependence on foreign aid is not a permanent and viable solution. Without higher tax revenue mobilisation, the issue of large fiscal imbalances cannot be tackled. If we fail to revamp the entire taxation structure, we will always be facing macroeconomic vulnerabilities of an acute nature. Pakistan’s current taxation system is affected by serious hitches such as low tax base, high tax evasion, sharp horizontal inequities and wide-ranging exemptions, creating economic distortions, and above all weak enforcement. A corruption-resistant taxation structure with robust taxation machinery is direly needed to rein in rampant tax pilferage and reduce yawning tax gap.

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