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The State Bank of Pakistan (SBP) said on Monday that the policy mix appears adequate to address the macroeconomic imbalances and push the economy towards stability as Pakistan's economy moved progressively along the adjustment path during the first quarter (July-Sep) of this fiscal year (FY20).

The State Bank has also predicted that Pakistan is likely to miss the real GDP growth target of 4 percent for this fiscal year (FY20) mainly due to subdued performance of agricultural and manufacturing sectors.

According to SBP report "The State of Pakistan's Economy" for first quarter (July-Sep) of FY20, following the modest GDP growth of 3.3 percent last year, the government set a 4.0 percent growth target for FY20. This recovery was premised on a better performance by the agriculture and industrial sectors. However, based on the sluggish start during the first quarter, it appears that achieving the annual targets for agriculture and industry may prove to be challenging.

The SBP said that export growth and foreign exchange reserves, documentation of economy for required revenue and higher food inflation are still major challenges to the country's economy. "Keeping these challenges in view, it is vital that the government continues to address the underlying structural vulnerabilities and put the economy on a balanced and sustainable growth trajectory," the report said.

Furthermore, there is a need to build on gains on the ease of doing business front, which requires not just the capacity development in key public institutions, but also a continuous dialogue with relevant stakeholders to ensure smooth implementation, it added,

According to report, in terms of policies, a number of developments were important. The macroeconomic stabilization process picked up momentum with the initiation of the IMF's Extended Fund Facility (EFF) program and the SBP continued to keep the monetary policy consistent with the medium-term inflation target, whereas, consolidation efforts were visible on the fiscal front.

Furthermore, a market-based exchange rate system was implemented, to which the interbank foreign exchange market adjusted relatively well. Notably, the government avoided deficit monetization, including rollover of SBP debt and actively pursued documentation efforts.

While the success of documentation measures hinges upon the policy consistency and would manifest in revenue mobilization over the medium term, the payoff from ongoing stabilization efforts has become visible in the form of declining twin deficits. The current account deficit in Q1-FY20 fell to less than half of last year's level, primarily on the back of significant import compression.

Owing to low unit prices, exports growth remained low. However, in volumetric terms exports witnessed a noticeable growth. On the fiscal front, the overall deficit remained lower as compared to the same period of last year, and the primary balance recorded a surplus for the first time in 7 quarters. This improvement was made possible through both revenue enhancing and expenditure control measures. Importantly, development expenditures witnessed a sharp growth of 30.5 percent during the quarter, the report mentioned.

"However, despite these stability gains, the overall confidence among businesses and consumers remained weak, as they struggled to preserve their purchasing powers and dealt with operational constraints stemming from the adjustment process," the SBP said and added that while large businesses especially export-oriented and import-competing industries remained bullish on fundamentals and they refrained from taking a long-term view.

In case of GDP, the report noted that the revised estimates for the kharif season suggest that the production of important crops is likely to fall short of target for FY20. The large-scale manufacturing sector witnessed a decline of 5.9 percent in Q1-FY20 on YoY basis. This contraction was broad-based, as construction-allied industries, petroleum and automobile industries continued on downward path.

In contrast, previous corrections in the exchange rate helped the export-oriented industries, as reflected in the relatively better performance of textiles and leather. On balance, however, achieving the real GDP growth target of 4 percent appears unlikely, the SBP said.

The report further highlighted that the average headline CPI inflation reached 11.5 percent in Q1-FY20, extending the steep upward trend persistent since the beginning of FY19. Not only this level was double the inflation observed in the same quarter last year, it was also the highest level of quarterly inflation since Q4-FY12. This outcome was attributed to the lagged pass-through of the exchange rate depreciation towards the end of FY19; rationalization of energy tariffs; and revenue-led fiscal measures taken in the budget 2019-20, which included the imposition of federal excise duty on a number of consumer items, and the ending of the zero-rating regime for export-oriented sectors and of the reduced GST regime on sugar.

On the external front, the balance of payments continued to improve during Q1-FY20. Beside significant improvement in trade deficit, and with the receipt of the first EFF tranche from the IMF and increase in foreign portfolio investment, the current account gap was plugged by the available financial flows. These inflows also helped the SBP to increase its foreign exchange reserves by US$ 656.2 million and reduce its net forward liabilities by US$ 1.3 billion during the quarter.

From the policy perspective, it is important to continue with the adjustment process despite weakening economic activity, as well as the visible stability gains in terms of the falling twin deficits, the report said and added "the policy continuation is warranted given the lingering vulnerabilities in the economy and the chronic nature of the structural weaknesses".

Three aspects are important. First, most of the improvement in the current account has come from a reduction in the country's import bill; exports have yet to contribute significantly, as healthy quantum gains are not supported by price trends.

Furthermore, while the drawdown in foreign exchange reserves has been reversed, the overall reserves position remains below the comfort level (in terms of import coverage).

Second, the announced documentation-related measures must be implemented in order to bring the needed diversification in the revenue base. This is important to rebalance the country's fiscal revenue structure, which is currently over-reliant on very few sectors.

Third, managing food prices has lately become challenging. Supply-management issues, such as weak governance in commodity procurement agencies, hoarding practices and regional trade bottlenecks, may potentially perpetuate food inflation going forward.

Within the budgetary borrowings, a clear shift was observed, with the government borrowing heavily from commercial banks to retire its SBP debt. This was unlike last year, when the government had borrowed heavily from the SBP to retire its commercial bank debt.

With regards to private sector credit, a general slowdown in the manufacturing and commercial activities resulted in significantly lower credit appetite of businesses. This, coupled with higher interest rates, led firms in a number of sectors to deleverage, whereas fresh applications for working capital finance also decreased notably. In cumulative terms, private businesses retired Rs 85.4 billion loans, compared to an offtake of Rs 99.0 billion during Q1-FY19.

The pace of external debt accumulation in Q1-FY20 was relatively slower compared to Q1-FY19 in the wake of revaluation gains due to depreciation of other currencies against the US dollar and higher debt repayments.

Copyright Business Recorder, 2020

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