SBP raises fiscal deficit forecast

The State Bank of Pakistan on Monday stressed serious policy efforts to achieve sustainable high growth, as the central bank believes the government intervention cannot successfully stabilise the economy and simultaneously provide stimulus for growth.
Foreseeing a 2.5-3.5 percent GDP growth and mixed economic outlook for the current fiscal year, the SBP, in its Second Quarterly Report on the State of the Economy, said in recent consultations with the IMF, need for a cut in PSDP and relaxation in fiscal deficit target was also recognised, therefore, fiscal deficit is projected to be in the range of 5.0 - 5.5 percent of GDP during FY10.
According to the report the macroeconomic and political stability with particular emphasis on improved law and order and security situation was a must for sustainable growth. It said aggressive fiscal reforms are key to achieving and retaining macroeconomic stability in the medium term, which need to focus on the entire range of options from increasing efficiency of public expenditures, reducing size of the government, raising tax-to-GDP ratio as FY10 fiscal deficit is estimated to be higher on account of extraordinary defence related spending and weakness in revenue collection.
Seeing little doubt in the impression that the state intervention could succeed in stabilising the economy or providing stimulus for growth, the central bank suggested that the "fiscal policy must be carefully calibrated and prioritised by targeting either the provision of public goods or targeting market failures, and also create an enabling environment for provision of other services by the private sector".
"Implementation of structural reforms focused on elimination of subsidies, reduced role of government in price setting, formulation of effective regulations to ensure optimum market-based outcome, are needed to sustain growth and enhance resilience of the economy," the report said and added that these must also be complemented with the introduction of second generation reforms centered on institution building and governance, it added.
The SBP said the government interventions in market pricing can be particularly distortionary, which can not only lead to inefficient production decisions and entail very significant fiscal costs but the added political risk in market pricing can discourage private sector investments.
The report said that despite an anticipated decline in value addition by major crops, Pakistan is likely to sustain revival of economic growth during fiscal year 2009-10 because of an above-target recovery in manufacturing, strong rebound by the construction sector, reasonable performance by the services sector and strong domestic consumer demand.
The SBP estimates for growth remain unchanged from the previous quarter, with real GDP growth for the year projected to fall in the range of 2.5-3.5 percent. However, the SBP said this level of growth is not adequate to generate required employment opportunities and it should be remembered that the growth in labour force is higher than the preceding years due to induction of new people into the job market, and an encouraging increase in female participation in job market.
Encouragingly, due to a better than expected performance by the exports in recent months and robust performance of remittances earlier in the year, the current account deficit has narrowed more than projected earlier and current projections suggest that the FY10 current account deficit is likely to fall in the range of 3.2-3.8 percent of GDP, which represents a 0.5 - 1.1 percent of GDP improvement from the earlier estimates.
According to report inflation decelerated significantly during FY10 compared with the preceding year, however annual headline CPI inflation projection for FY10 also remains unchanged and would be 11-12 percent. An important risk to the inflation outlook lies in the possibility of a revival in inflationary expectations if domestic demand picks up further or the pass through of rising international commodity prices increases.
Although, the current account deficit witnessed improvement, sustaining it at low levels will be challenging given rising import requirements of the economy, and evident weakness in the pace of growth in remittances.
Tax reforms are most readily legislated during times of economic stress; this is also the period where the revenue impact of reforms is most limited. In other words, revenue measures will gain most traction only when the economy recovers somewhat, the report said. A key risk to this more positive assessment, however, lies in the possibility of a further large (US $5 - 10/barrel) increase in international oil prices.