Recent information points to an increased risk of a decline in aggregate value-addition by important major crops in FY08 relative to the previous year. It was hoped that a wheat harvest close to the annual target would offset much of the drag from the disappointing aggregate performance of the FY08 kharif harvest.
But some reports suggest that wheat production in FY08 may also turn out to be substantially below the target. If these concerns prove correct then a weak performance by major crops would drag the annual growth substantially below the annual target.
ALONGSIDE IS THE EXECUTIVE SUMMARY OF STATE BANK OF PAKISTAN'S THIRD QUARTERLY REPORT FOR 2007-08, ISSUED ON SATURDAY. REAL SECTOR AGRICULTURE: Given that commodity prices are likely to remain strong, it is imperative that policies be framed to support farmers' ability to raise productivity substantially in the years ahead.
Key areas requiring policy intervention remain the transmission of price gains (establishment of futures markets), risk mitigation (crop insurance, storage facilities), increasing investment in agri-sector infrastructure (water management, electricity, farm-to-market roads, etc) and in value-addition chains (eg through processing).
The agriculture credit disbursement continued apace with its positive trends. The total agri disbursements amounting to Rs 157.6 billion during July-April FY08 - an increase of 34.9 percent YoY. The water shortage seen in rabi FY08 are likely to continue in first phase of kha rif FY09, while improved water availability is anticipated from better monsoon rains during the second phase of kharif FY09 (June-September). Fertilisers off-take increased by 9.2 percent during July-March FY08.
LARGE SCALE MANUFACTURING Initial prospects of achieving a reasonable growth in LSM sector during FY08 were clouded by aggravating energy crisis coupled with high international commodity prices and political unrest through most of the year. As a result, the LSM sector posted a dismal growth of 4.8 percent in the first nine months of FY08 compared with 9.0 percent in the same period of FY07.
It appears that energy shortages had a broad-based impact on manufacturing activities. The impact was more pronounced on metal sub-sector which also faced a steep increase in international steel prices. Activities in textiles and chemicals (especially caustic soda) industries were also affected by frequent energy disruptions as well as rising input cost.
Although a large number of industries (10 out of 15) delivered a weak performance; for some industries this was largely an outcome of sort-term developments including poor FY08 cotton harvest (hurting textile and allied industries), political unrest through most of period (especially the economic losses in the aftermath of 27th December 2007), temporary closures of certain industrial units for maintenance and/or up-gradation (eg, polyester fiber, paper and fertiliser), as well as power shortages (eg, metal industries and manufacturers of caustic soda, among others).
SERVICES: Information for the first nine months of FY08 suggests that the services sector is poised to achieve the annual targeted growth. The main contributors to this performance are wholesale & retail trade, transport storage and communication as well as public administration and defence sub-sectors.
In addition, social & personal services seem well placed to contribute positively towards upbeat annual growth in services sector. However, growth in finance & insurance sub-sector appears to slow due to weaker profitability of the commercial banks, nonetheless remain strong in FY08.
PRICES The impact of strong global inflationary pressures on domestic inflation has also been compounded by the adjustments of administered prices of key fuels and wheat.
All price indices have moved up significantly so far in FY08 and are significantly higher than the annual averages for the preceding five years. Consumer Price Index (CPI) inflation accelerated to 17.2 percent YoY during April, 2008 contributed by both food and non-food sub-groups. In particular, CPI food inflation reached to 25.5 percent in April, 2008.
The desired impact of tight monetary stance of SBP has been neutralised by huge government borrowings. Core inflation, measured by 20 percent trimmed mean, accelerated to double digits (14.1 percent - record high level) in April 2008. Persistence of inflationary pressures is also evident from non-food non-energy (NFNE) based core inflation that increased to 10.8 percent in April 2008.
MONEY AND BANKING The conduct of monetary policy has become increasingly challenging for SBP as the fiscal year has progressed, and inflationary pressures are gaining further strength.
The inflationary pressures have gained momentum, due to a number of factors, including supply shocks and continuing strong demand. The former include a sustained increase in global commodity prices (including unprecedented hikes in food and energy prices). The demand pressures, on the other hand, were mostly reflected in a sharp rise in the fiscal deficit that was largely monazite through a record increase in government borrowings from the central bank.
The pass through of high global commodity prices to domestic inflation is significant, and has increased in recent years as (a) the economy has become more open in recent years, and (b) the government began to gradually pass-on the rise in cost of key fuel (petrol and diesel), which was earlier frozen, to the domestic consumers.
Since the current higher prices in international markets are forecast to persist well above their historical averages in the foreseeable future, it is anticipated that the resulting inflationary expectations will be more lasting. There is also evidence that the erosion in purchasing power and squeeze in profit margins due to sustained increase in food and commodity prices is contributing to second round of inflationary pressures. Without continued monetary tightening, the inflationary pressures may turn into a wage-price spiral.
At the same time, the already high fiscal deficit is not only limiting the scope for containing the pass through of global inflation through subsidies and tariff reduction, challenges for monetary policy have been compounded as the government is relying more on borrowings from the central bank which is the most inflationary source of financing. Moreover, the liquidity injections from unpredictable government borrowings have weakened the transmission of policy interest rates to retail rates. In order to meet the above challenges, SBP is maintaining a tight monetary policy stance. However, this stance needs to be supported by fiscal prudence.
The overall credit demand is also strong despite a significant slowdown in credit growth to consumers, energy shortages and operational bottlenecks in major industries. This was mainly attributed to (1) rise in working capital requirements due to higher input costs; (2) the need for bridge financing to settle price differential claims of OMCs and IPPs; as well as (3) the higher fixed investment (visible in a few sectors, eg textile, refineries and power) in the month of March 2008.
FISCAL DEVELOPMENTS: Although official statistics on public finance for July-March FY08 are not yet available, SBP forecast suggests that the budget deficit for July-March FY08 (as a percentage of the estimated FY08 GDP) is likely to be significantly higher than the full-year FY07 figure.
The growth in government revenues in Q3-FY08 is expected to recover from the low of 1.8 percent seen during H1-FY08 as: (1) FBR tax receipts, which contribute the bulk of government revenues, have increased by 31 .3 percent in Q3-FY08 compared to 6.0 percent during H1-FY08, and (2) non-tax revenues have been bolstered with the disbursement of budgetary support grants of US $281.7 million and US $300 million from USA and Saudi Arabia respectively.
Government domestic borrowing during July-March FY08 grew strongly, reflecting a strong year-on-year increase in the deficit, and little change in external financing from FY07. Thus, with net retirements of borrowings from commercial banks and only Rs 1.7 billion in privatisation proceeds (against Rs 75 billion budgeted for FY08), the government borrowings from the central bank continued to rise sharply.
Indeed, incremental government borrowings from SBP as of May 10, 2008 have reached Rs 551.0 billion, pushing the outstanding stock of treasury bills with SBP to Rs 940.6 billion. This development has significantly augmented inflationary pressures in the economy, and raised risks to macroeconomic stability.
After a sharp rise of 6.4 percent in second quarter, the growth in the domestic debt moderated to 5.5 percent in Q3-FY08. Although, government availed substantial financing from SBP in this quarter, growth in floating debt decelerated due to significant retirements by the commercial banks, resulting in a moderation in debt growth during Q3-FY08.
EXTERNAL SECTOR BALANCE OF PAYMENTS The deterioration in Pakistan's overall balance of payment accelerated during Jul-April FY08. On the one hand, the current account deficit continued to expand while on the other, financial and capital account surplus shrank. Consequently, the country's foreign exchange reserves fell to US $11.5 billion and the rupee depreciated by 13.4 percent against US dollar by 22nd May 2008.
A large part of the deterioration in current account deficit emanated November 2007 onwards on account of substantial increase in import bill. The rise in import bill, in turn, was driven by both high prices and demand factors, with former having the greater role. The rise in import bill was accompanied with rising freight charges which together overshadowed improvement in export growth and impressive increase in current transfers in the period under review.
The financial and capital account surplus declined during July-April FY08, mainly due to substantial fall in foreign portfolio investment, which resulted due to: (a) outflow from stock market, and (b) due to delay in floatation of Global Depository Receipts (GDRs) and (c) delay in issuance of euro bonds.
TRADE ACCOUNT Pakistan's merchandise trade deficit widened to a record high of US $16.8 billion during July-April FY08, which is 37.8 percent higher than the annual trade deficit target. The deficit was fuelled by a very strong surge in imports as well as below -target export growth.
While the 10.2 percent YoY export growth during the July-April FY08 was an improvement over the previous year, it was nonetheless significantly lower than the 12.4 percent growth targeted for the period. The surge in imports was caused by both higher aggregate demand and rising international commodity prices. Growth in exports on the other hand was led by non-textiles, while textile exports registered a fall in the period under review.
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