State Bank says government making headway towards improving its finances

Karachi: Recent fiscal figures show that the government has been making “some headway towards improving its finances. Budget deficit for first quarter of FY12 was 1.2% of GDP, compared with 1.5% during same quarter last year, says State Bank’s First Quarterly Report on the State of Economy released Saturday.

“This reduction in budget deficit was caused primarily by 29.7% growth in FBR revenues, on the back of increased tax collection efforts and higher revenues from imports. Non-tax revenues also recorded impressive growth of 50.4%. However, on the basis of seasonal trend in FBR revenues, amount collected up to end-Dec 2011, falls short of amount needed to meet annual target of Rs 1,952.3 billion. Meeting end-year revenue targets would also depend on realization of CSF and sale of 3G licences (around Rs 150.0 billion), in absence of which, it would be difficult for the government to contain fiscal deficit within its annual target, “it said.

Federal government has budgeted surplus of Rs 125.0 billion on part of provinces. However, due to 52.8% increase in their expenditures, provinces managed only Rs 11.6 billion surplus up to Q1-FY12, which was 85.7% lower than corresponding period last year. “Any short fall in contribution by the provinces would make achievement of fiscal deficit target more challenging,” Report cautioned.

The lack of external funding has put burden of financing deficit disproportionately on banking system, which has led to crowding out of private sector and is acting as a disincentive for banks to perform their role of financial intermediation.

Government borrowing from banking system up to end-Nov 2011 was Rs 736.8 billion, against Rs 336.1 billion in corresponding period last year. This includes Rs 391.0 billion borrowed from banks to retire PSE debt, which has now been transferred on to the government’s books. “Unfortunately, PSEs continue to haemorrhage as a credible restructuring plan has not been put into action. As a result circular debt issue is likely to persist,” it added.

The government’s efforts to keep its borrowing from SBP in check during initial months of FY12, helped in keeping demand driven inflationary pressures at bay, which was supplemented by easing of food prices. As a result, YoY CPI inflation declined to single digit (9.7% in December, 2011 after remaining in double digits for last two years. While increase in energy prices, recent weakening of Pak Rupee and base effect may increase inflation in coming months, end-year average inflation is likely to fall close to 12.0% as projected earlier.

While SBP has shown its willingness to relax its policy to support private sector as it did in July & October, 2011, it cannot add to stress on economy arising from weaknesses in other sectors. Most recent policy decision to keep policy rate unchanged was influenced among others, by weakness in external accounts during Q1-FY12, Report observed.

Pakistan was fortunate in FY11 that its current account ended up in a surplus and, despite drying up of FDI and other foreign investments; there was a net increase in its FX reserves. Given rigidities in trade account and vulnerability of financial account, sustaining this performance in FY12 was always going to be difficult. Nevertheless, pace at which current account deteriorated during first quarter of FY12 took many by surprise. Specifically, current account deficit for Sep 2011 alone was over US1.0 billion, it said.

In the past, Pakistan has sustained larger current account deficits without losing its foreign reserves due to healthy inflows in financial account. Unfortunately, owing to both domestic weaknesses and international financial upheaval, financial flows have almost dried up, adding to economic vulnerability. While some financial inflows are expected, a part of current account deficit is likely to be financed through reserves as was case during July-October FY12. This has important implications for monetary management and price stability.
Report noted that government is, however, optimistic that 3G telecom licence fee will be realized. In addition, due to recent developments, there is still optimism that parts of CSF, bilateral assistance from the US, and privatization proceeds of PTCL will be received. Furthermore, currency swap arrangements, which were recently formalized with central banks of Turkey & China, will also facilitate bilateral trade and investment, easing stress on the country’s reserves.

Nevertheless, SBP remains vigilant that pressure on the Rupee is not translated into market speculation, which could become self-fulfilling and striking a balance in managing a flexible exchange rate driven by economic fundamentals and by market speculation (within context of sharp currency movements in global economy) is challenging. SBP will continue to monitor forex market closely to remove any excessive volatility in Rupee.

Report said policy makers were hopeful that the country would put up better economic performance in FY12 after last year, which was difficult one for the economy, not only due to devastating floods that hit in fiscal year, but also due to lack of external financing and energy shortages. Realizing 4.2% growth target for FY12 GDP looks difficult due to a host of factors that include gas shortages, high oil prices, decline in global prices of agricultural commodities.

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