The economy of Pakistan, notwithstanding an impressive growth rate during 2004-05, is beset by a number of problems which, if not attended to properly, could lead to undesirable consequences. This, in nutshell, is the latest message from the State Bank of Pakistan contained in its third quarterly report for FY05 released on 23rd May 2005. Anticipating that the growth rate would be between 7.4 percent and 7.8 percent, the highest level in the last 13 years, and under a favourable scenario could even surpass 8.0 percent, the Report notes that "this growth is expected to be shared by all major sectors of the economy".
Another redeeming feature was seen in that sustained growth over 6.0 percent in Pakistan was generally "correlated with a meaningful reduction in poverty levels". The sharp growth in the labour intensive agricultural sector was particularly welcome because it suggested employment generation, poverty reduction and improvement in the pattern and quality of growth. However, the Report, without mincing words, draws the attention of the policy makers towards the challenge of sustaining the growth momentum in the years ahead, saying very clearly that "this is no easy task, given that the country now faces significant macroeconomic challenges".
These remarks could be regarded as at variance with the government expectations of maintaining growth rate at around this level, almost without any reservations, in the coming years. Also, the State Bank has cast a doubt on government's claims of attaining a growth rate of 8.3 percent, by projecting a lower growth rate than that claimed for 2004-05.
Of more significance, however, are the concerns of the State Bank in a number of other areas. Inflationary pressures are clearly on the rise which "could lead to hardening of inflationary expectations in the economy, with serious repercussions on long-term growth". One of the major factors contributing to demand pressures and inflation was excessive growth in the private sector credit.
Lately, the SBP has tilted increasingly towards tightening monetary policy by raising discount rate and T-bill yields. "While this is not expected to subdue inflationary pressures immediately, the tightening will ensure that core inflation will gradually be contained at significantly lower levels". The central bank is at the same time of the view that it has to be careful to ensure that monetary tightening does not drive the economy into recession.
The State Bank is also worried about the growing imbalance in the external sector. During July-February, FY05, current account deficit was $1.1 billion and could be around 1.9 percent of the GDP for the whole year.
While this was manageable in the short-run due to non-debt creating capital flows and low-cost external financing, sustained large external deficits, according to the State Bank, were clearly undesirable. Another potentially serious threat was the re-emergence of rigidities in expenditures that threaten to eat the fiscal space generated through the reforms of yesteryears. The Report is critical of present tax mobilisation efforts of the government.
"While the 13.5 percent growth in CBR tax revenues during July-March FY05 is acceptable by historical standards, the receipts have clearly not kept pace with the growth of the economy, ie tax buoyancy remained low. This needs to be addressed urgently, if the government is to be able to increase development spending to sustain the long-term growth momentum of the economy".
The State Bank is not content only with critical analysis of the economy but has also made suitable recommendations at appropriate places. It has suggested that "the growth policy now needs to shift slightly, away from merely encouraging growth, to focussing more on delivery of basic services and targeted interventions to the poor".
Policies need to be introduced for greater absorption of relatively unskilled labour. The revenue structure requires to be revamped as the major burden at present falls disproportionately on large-scale manufacturing while the services sector and marketable surpluses in agriculture remain lightly taxed. Also, "there is no system in place to tax the recent mammoth gains in the equity as well as real estate markets".
There is also a need to improve the country's competitiveness, to enable exports to benefit from the opportunities offered by increasingly globalized markets. Cost of production could be reduced by lowering red tape, reducing utility charges, improving infrastructure and encouraging flexible labour markets by replacing outdated labour laws and investing in trainable labour force.
The third quarterly report, in our view, is a well written document, meant to serve the purpose of highlighting the emerging weaknesses in the economy and caution the relevant authorities about the dire need to remove the irritants which could at a later stage threaten the momentum of growth and other plans of the government like alleviation of poverty and employment generation.
The State Bank seems to have chosen the right areas of concern and offered the right kind of suggestions. This, we feel, was necessary because the top government functionaries were busy propagating the achievements of the economy but failing to acknowledge the problems with the result that expectations of the people were raised unnecessarily and probably to impossible levels.
So far as remedial measures like replacing outdated labour laws, reducing utility charges, containing inflation, and taxing agriculture surpluses and windfall gains are concerned, we have been advocating for necessary steps for the last few months and hope that the voice of the State Bank would add both weight and urgency to our advice to do the needful. Unfortunately, however, the experience in this regard is not very encouraging.
Some of the issues contained in the Report have been raised at various forums and appropriate suggestions have been offered, but the system often fails to respond. This is a sad reflection on the capacity of the government to appreciate the problems and react in time to make amends. Proper and timely response at government's own initiative is all the more necessary because now the IMF is not actively involved in managing the economy.
Somewhat surprising, however, is the thinking of the State Bank on the issue of inflation. It regards rising inflation as a source of great concern, but at the same time does not want to drive the economy into recession and hurt growth. The State Bank needs to discard this dilemma because containment of inflation should be the top priority of any central bank.
Excessive monetary expansion during the last three years has to be neutralised by stringent measures and keeping the present growth of liquidity well below the nominal GDP growth. Interest rates have increased during the last few months but are still substantially lower compared to the earlier years. The rise also does not appear to be sufficient to make a significant dent on the current rate of inflation.
Therefore, the State Bank should not be overly concerned about the demands of certain quarters to stabilise the interest rates at a low level. Such a policy has encouraged speculation in certain sectors and undermined the saving effort by giving negative real rate of return to the depositors, for, as rightly observed by the State Bank, hardening of inflationary expectations would have serious repercussions on long-term growth.
The government needs to take note of SBP's repeated concern that fertiliser units are presently operating at nearly full capacity. And, the growing supply-demand gap could only lead to price hike or higher imports which would have an adverse impact on the trade balance.
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