ADB's Economic Update

The Economic Update of Asian Development Bank (ADB), released on 4th October and covering medium-term outlook for the economy, is largely realistic and gives a good measure of food for thought to the economic managers of the country.
While appreciating Pakistan's improved economic performance during 2004-05, it has predicted that the country will sustain high economic growth during the current fiscal but could face certain difficulties with the result that some of the projections may not materialise.
According to the Update, Pakistan's economy in FY05 achieved the highest growth in the last two decades but because of shortage of essential food items, high oil prices and strong domestic demand, inflation increased sharply.
The fiscal deficit also increased and the current account turned into deficit after three years. As for 2005-06, the economy is projected to register a lower growth rate of 6.5 percent as against the government's projection of 7 percent.
After growing at a very high rate in the last two years, the manufacturing sector is projected to settle down at a growth rate of about 11 percent while growth of the agriculture sector is estimated to decline to 3 percent as against the government's projection of 4.8 percent due mainly to greater moisture that would increase cotton crop vulnerability to pests.
However, with sound macroeconomic fundamentals, pick-up in private investment, expanding development expenditures, improved relations with India and reduction of external security concerns, prospects for the Pakistan economy look good.
Nevertheless, the Update expresses concerns about fiscal, trade and current account balances as well as inflationary tendencies in the economy during FY06. Although tax revenues are projected to grow by 17 percent due largely to double-digit increase in imports and on-going improvements in tax administration, the large increases planned in development expenditures and salaries and pensions of government servants will contribute to higher fiscal deficit during 2005-06.
Imports are projected to grow by about 18 percent because of higher prices of oil in the international market, export growth is likely to decelerate to about 15 percent due to expected slowdown of the global economy, trade deficit would widen to about $5.8 billion and the current account deficit will be in the range of 2.5-3.0 percent of GDP.
Inflation is projected to decline only marginally from 9.3 percent to 8.5 percent during 2005-06 compared with the government target of 8.0 percent due to expansionary fiscal policy, continuing high oil prices and the large monetary overhang from the previous years.
According to the ADB, "if oil prices continue to remain at the current record high level, or rise further, projections for imports, the fiscal deficit and inflation may have to be revised upward".
While economic managers of the country have generally been making tall claims about the prospects of the economy, yet the present assessment of the ADB, in our view, is based on some very realistic assumptions and cannot be easily dismissed. The emerging weaknesses in the areas pointed out by the ADB could be attributed to a number of factors.
On the external front, record increase in international oil prices is a major cause of concern not only for Pakistan but for all the oil importing developed and developing countries. Global growth forecasts have been revised downwards due to this unhealthy development and it would severely dampen the export from countries like Pakistan and adversely influence their current account balances.
The ADB has projected a trade deficit of $5.8 billion for Pakistan for FY06 but the actual data for the first two months show that it could reach the horrendous level of about $9.0 billion if appropriate measures are not taken in time to limit the growth in imports.
The level of current account deficit resulting from the widening of trade deficit would not be sustainable. On the other hand, it may also be pointed out, if imports are restrained to improve the trade balance, it would slow down the growth rate, reduce government revenues and spur inflation which is already proving painful for majority of the population.
In any case, policy makers have to weigh the pros and cons of various options very carefully. On the domestic front, cotton crop vulnerability due to excessive moisture and a decline in the growth rate of agricultural sector is a bad news.
Also, the push for reforms which essentially means harsh measures cannot be sustained indefinitely. In fact, influenced by government propaganda of improvement in the economy and its better prospects, every section of society is not only expecting but demanding some kind of relief to improve its standard of living.
While the effect of indigenous factors can be taken care of somehow, exogenous factors are entirely outside the control of the government and their impact is difficult to avoid.
All in all, we would urge the economic managers of the country to read the ADB's Update very carefully and also analyse the latest actual trends in the economy in depth with a view to taking appropriate measures in time to ensure that the gains of the past few years are not dissipated and the country continues its march towards a higher growth trajectory along with financial stability.