The capital and financial account balance significantly during H1-FY10 due to a modest increase in foreign portfolio investment, SDR allocation and SBA flows from IMF, despite a fall in foreign direct investment. According to State Bank of Pakistan's (SBP) Monetary Policy Statement, despite the shortfall in foreign flows, a significant reduction in the external current account deficit to $2 billion during H1-FY10 led to an overall surplus of $1.4 billion in the balance of payments.
A broad-based decline in imports, supported by strong workers' remittances, explained the considerable contraction in the external current account deficit. Notably, this improvement was despite the delay in foreign reimbursements and shortfall in grants from Friends of Democratic Pakistan (FoDP).
The decline in imports mainly reflects the moderation in aggregate demand and the benefits of relatively lower international commodity prices. The decline in exports, on the other hand, had been restrained by a gradual global economic recovery, availability of exportable surplus due to better cotton crop, and higher international prices of some exportable commodities. This helped in limiting the trade balance to $5.7 billion during H1-FY10, the SBP said. While global output growth and rising trade volumes would help Pakistan's economy, rise in commodity prices could have a negative impact, it said. The rises in energy as well as metal prices were significant and any acceleration in them could potentially result in a more than anticipated increase in the import bill and domestic inflation.
"Current trade outlook, combined with projections of other components such as current transfers, leads to a projected external current account deficit of 3.4 percent of GDP for FY10 and this represents significant improvement over last year's deficit of 5.6 percent and earlier projections of close to 5 percent," the MPS said.
The capital and financial account balance also improved significantly during H1-FY10 due to a modest increase in foreign portfolio investment, SDR allocation and SBA flows from IMF, despite a fall in the foreign direct investment.
Though the higher financial inflows appeared impressive, one would need to be cautious in interpreting this improvement. Out of total financial inflows of $3.8 billion, $1.1 billion consist of IMF credit for budgetary support, part of which is required to be retired in Q4-FY10.
"Better global growth prospects complemented with improved domestic economy could help in tapping international capital markets, enabling Pakistan to diversify its external borrowing sources", the SBP said, and added that the better image of the economy was already evident in improved credit ratings and a decline in risk premium on Pakistan's sovereign bonds from 11.0 percent in June 2009 to 6.4 percent in November 2009.
According to MPS, sustained improvement in the balance of payments position would depend significantly on the timing and scale of projected foreign inflows, specially the especially the official flows pledged by the FoDP. The actual disbursements are slightly behind schedule and thus the original $2.5 billion projected disbursements for FY10, have been revised to $1.5 billion. Thus, despite improvements in the external current account, the external sector outlook seems uncertain, the central bank said.
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