The second quarterly report for FY07 released by the State Bank of Pakistan on 30th March, depicts generally a positive picture of the economy. According to the latest estimates, real GDP growth was projected to remain close to the seven percent annual target, despite some setbacks suffered by the commodity producing sub-sectors.
The forecast for a healthy growth was predicated largely on a bumper wheat crop, strong outturn in the livestock sub-sector and some improvement in the industrial performance and services sector. Fiscal deficit was also expected to be contained within the annual target of 4.2 percent of GDP, thanks largely to extraordinarily strong direct tax receipts. Money supply growth has decelerated to 7.7 percent during July-February, 2007 compared to 8.7 percent during the corresponding period of last year.
However, reserve money has increased sharply by 15.3 percent as compared to 9.6 percent last year. The current account deficit is projected to widen during FY07 as growth in imports remains higher than that of exports.
"However, as the economy continues to expand strongly, this does not pose a significant macroeconomic risk in the short term, particularly due to availability of debt on favourable terms and strong investment flows," says the quarterly report. The measured monetary tightening followed by the State Bank appears to be bearing fruit. But average inflation while declining to 7.7 percent is still above the 6.5 percent annual target.
"Thus, given that instability in key CPI components persists, and that reserve money growth is high, the current policy must be sustained. Indeed, inflation must be contained in order to bring real returns to savers significantly positive. This would encourage domestic savings to rise from current low levels, lowering the country's dependence on potentially fickle foreign investment".
While stressing the importance of improvement in investment for managing macroeconomic imbalances and ensuring sustained high growth, the SBP has once again urged upon the policy makers to address economic stress points, such as the high inflation, large current account deficit, fiscal risks (low tax-to-GDP ratio) and low saving rates. At places, the quarterly report has offered appropriate suggestions in various areas of economic policy.
For instance, fiscal authorities have been advised to diversify the tax base so that underperformance in a portion of the economy does not cause disproportionate revenue losses, besides separating one-off factors from underlying (sustainable) factors.
It is also imperative for the country to boost exports and encourage import substitution for products where Pakistan has competitive advantages. A turnaround in exports will need to be supported by measures to reduce the cost of doing business, facilitate supply chain improvements and provide a flexible labour market.
Pakistan also needs to foster the development of a long-term institutional savings industry (pensions and provident funds, mutual funds etc) to support investment particularly in infrastructure projects, increase domestic savings and improve the risk profile of commercial banks. A positive rate of return to the savers/investors is the bottom-line.
The feel good factor will only emerge with improvement in the purchasing power of domestic constituents. Dependence on external savings, ie overseas bonds/GDRs adds to our vulnerability and are not a replacement for stability arising from domestic savings.
Most of the observations contained in the quarterly report appear to be in accordance with the prevailing trends in the economy. Many analysts are also of the view that real GDP growth is likely to be around seven percent this year. The robust growth around this level for several years is of course a welcome development.
Certainly, the effect of this growth has not as yet trickled down to the grassroots level but it needs to be remembered that ordinary people could only expect to improve their prospects if the size of the pie becomes larger over time.
The remarks about monetary and fiscal policy, price situation and some other macro-economic indicators are also appropriate to the situation. A marked shift towards inflation containment and references to the likelihood of monetary tightening are particularly noticeable this time.
The State Bank has plainly asserted in its Report that measured monetary tightening in the past has resulted in decelerating the price pressures in the economy to a certain extent and such a policy would be maintained to boost real returns to savers and encourage domestic savings.
The use of the word "fickle" for potential foreign investment needs to be particularly noted by the government authorities who are so proud of attracting higher amount of foreign investment for long-term prospects of the economy. That the State Bank is also thinking about sterilisation of excess liquidity emanating from foreign currency flows is also a good news. Such a course of action could contain reserve money growth and subdue emerging price pressures in the economy.
The proposal about maintaining proper expenditure control, specially in an election year, for fiscal discipline is also very relevant.
Unfortunately, top government functionaries have lately made a habit of announcing big projects to gain political mileage. The electorate will not buy it. Their concerns are focused on food prices, jobs and law and order.
However, while going through the quarterly report one gets the impression that the State Bank is a little subdued this time about the challenges and emerging weaknesses of the economy.
It has advised the policy makers to address certain stress points but has been somewhat guarded in pinpointing the severity of the problems and generally refrained from highlighting the downside risks. Probably, the State Bank did not want to add to the headaches of the government by giving more ammunition to the opposition parties in an election year.
In this connection, mention may be made of the Asian Development Bank's Annual Outlook 2007 released on 27th March, which was much more critical about the policies and performance of the economy. Major threats identified by the ADB were the growing current account deficits and continuing high inflation. The structural problems highlighted included a dismal saving rate, low investment-to GDP ratio, narrow industrial base, lack of diversified export base and historical under-investment in human capital development.
The emerging power and gas shortages, the ending in 2008 of China-specific safeguards imposed by the US and EU against textile and clothing imports, and deterioration in security environment were also identified as problem areas. The combination of so many weaknesses and problems, which are real and by no means exaggerated, definitely poses a serious risk to the economy.
We, therefore, feel that it is imperative for the government to take stock of the situation quickly and act on a number of fronts. Firstly, it is essential to continue with the reform process initiated so painstakingly during the last few years and not to backtrack which is usually the first impulse in an adverse environment.
Secondly, the emerging challenges need to be confronted head-on by taking appropriate and adequate measures which are usually harsh. Fiscal discipline needs to be ensured for sustainable development.
A most troubling aspect pointed in the SBP Report is the delay in the release of monthly data (of about 100 items) on large scale manufacturing by the Federal Bureau of Statistics. Unavailability of LSM output figures for October 2006 to February 2007 and estimating growth merely on production trends in individual industries or on data received by SBP from various industrial associations and committees, is not a true measure of industrial performance. This has grave implications not only for macroeconomic decision-making but also tends to damage the credibility of official statistics.
And lastly, political stability is always of paramount importance for the economy to grow and gain strength. Obviously, the SBP or the ADB or any other multilateral institution would not like to offer suggestions in this regard, but the government must evolve a long-term process to ensure political stability in the country. Hopefully, the observations of both the State Bank and the ADB would be given serious attention and not forgotten in the self-congratulatory mantra of economic success stories.
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