Fund's assessment of the economy

Concluding the ninth and final review under the Poverty Reduction and Growth Facility (PRGF), the IMF team, after a thorough consultation with Pakistan's economic managers in Islamabad, issued a statement on 9th September, 2004 that contained its assessment of the economy.
As expected, the Fund appeared to be quite upbeat and noted confidently that "Pakistan's economic performance and prospects are now more favourable than at any time in at least the past decade."
The restoration of fiscal discipline, a cautious monetary policy, trade liberalisation, privatisation and other structural reforms in the financial and tax areas have created a sound basis for a lasting recovery. Led by a strong domestic and external demand, the growth during 2004-05 was expected at around 6.5 percent.
The Fund mission also supported Islamabad's fiscal policy stance for further reduction in public debt burden and a substantial increase in social and development spending to reduce poverty.
Overall, most of the structural reforms were found on track, and the macro-economic outlook favourable.
While praising Pakistan's economic progress, the IMF mission, nonetheless, noted the risks posed by not passing high international oil prices on to the consumers and stated rather emphatically that the rising trend of inflation was a matter of concern.
The IMF, it may be noted, is required to assess periodically the economy of a member country against certain prescribed benchmarks quite closely when that country enters into an agreement to avail of certain facility from the Fund.
Since Pakistan is currently availing of PRGF with a disbursement totalling $1.52 billion in instalments to battle poverty and spur economic growth, a critical review of the economy at different intervals sums up the progress on reform process and underlines the emerging weaknesses in various areas.
The latest appraisal of the economy by the Fund staff, in our view, is largely realistic. During the period of the programme, Pakistan has successfully taken a host of tough reform measures in close consultation with the IMF and other IFIs and the country has now progressed to a stage where it hopes to achieve a sustainable growth rate of 6 percent and above.
This has been duly acknowledged by the Fund staff in its statement. Not only this, the IMF mission is also appreciative of fiscal thrust of the country which is geared to alleviate poverty and reduce debt burden so that Pakistan does not again fall into a vicious debt trap.
By far the best achievement is in the external sector. Pakistan which was nearly insolvent a few years back could now boast a sharp turnaround in current account balance and accumulation of foreign exchange reserves equivalent nearly to 11 months of imports.
On the issue of inflation, the IMF mission, in our view, has also alerted the country in time. This was needed in order to induce the policy makers to undertake appropriate policy measures to avoid the threat of instability in prices that is looming large on the horizon.
The concern obviously has been expressed due to the recent surge in inflationary pressures in the economy. The Consumer Price Index (CPI), after remaining quite stable for a consecutive five years ending 2002-03, rose by 4.57 percent during 2003-04 as against the original target of 3.9 percent.
The year 2004-05 has also started with a disturbing trend. The CPI in July, 2004 was 1.38 percent higher than in June and 9.33 percent higher than a year earlier.
Price trends during the subsequent period suggest that the inflation target of 5.0 percent for 2004-05 may be exceeded by a considerable margin. Last month, the Asian Development Bank had also pointed out such a possibility.
Another worrying aspect is that rising food and oil prices, which could severely impact the average households, are the main causes for sharp increase in inflation. With the onset of Ramazan which is only a month away, the prices of food items may rise sharply, making it difficult for the common man to make both ends meet.
Monetary policy, amply supported by a prudent fiscal policy, could be deployed to ease the pressure on prices. During the last three years, liquidity in the economy has outstripped the growth in availabilities by a wide margin and presumably there is still a lot of monetary overhang in the economy with the potential to exacerbate the price pressures.
Fortunately, however, there were certain factors which kept the price pressures in check until recently. Monetary expansion originated basically from private sector credit growth which is always less inflationary. It financed private sector investment and served to enhance the utilisation capacity in many industries.
A vast amount of liquidity at the disposal of banks was mostly channelled into the productive sectors of the economy due to low lending rates. Monetary policy has now to be realigned with the change in environment.
The emerging inflationary pressures have to be contained within manageable limits largely through various monetary policy instruments. At the recent treasury bills auctions, the State Bank has pushed up yields and it may be required to tighten monetary policy further in the coming months while ensuring that the recovery process now underway is not unduly disrupted.
At the same time, the central bank would need to keep our exports competitive by making proper adjustment in exchange rate which would be crucially influenced by the rate of inflation and interest rates.
The government could also lean upon banks' resources if its fiscal policy is too expansionary. It is clear that the State Bank has a very complex task at hand to simultaneously meet so many objectives and any lapse on its part could be quite costly for the economy.
We are sure that the State Bank would be looking very closely at the latest developments and examining its options.
However, the Fund mission seems to be overly worried about the risks of not increasing the domestic oil prices in line with the international prices in the last few months.
Obviously, it is concerned with the budgetary impact such a policy entails. In our view, what the government has done in this connection was a preferred course of action.
Upward revision in domestic oil prices would have worsened the inflationary situation, retarded the growth process thereby curtailing employment opportunities, and made the lives of ordinary people more unbearable.
The likely adverse budgetary impact of the present government policy, according to most estimates, could be between Rs 5-10 billion which could easily be recouped by widening and deepening the tax net and reforming certain tax measures.
The CBR, encouraged by the tax receipts during the first two months of the current fiscal, is already thinking about an upward revision in the target of tax revenues by about Rs 10 billion which would help keep the estimated overall budgetary deficit unchanged.
The real problem, contrary to the Fund's view, may be an increase of about one billion dollars in import bill due to the rise in international oil prices which may force the authorities to draw down foreign exchange reserves or undertake measures like heavy depreciation of the rupee.