Economic recovery termed ''fragile''

Terming the current economic recovery as "fragile", State Bank of Pakistan has underscored the need for a vigilant monitoring of deteriorations in macroeconomic indicators, particularly the ones that posted substantial improvement at the beginning of the current financial year.
According to the State Bank of Pakistan''s Second Quarterly Report on the State of the Economy for FY10 released on Monday, a moderate but fragile recovery is under way, helped by a gradual increase in aggregate demand following improvement in many key macroeconomic indicators.
"The reversal of the earlier trend decline in inflation exemplifies the fragility of the improvements in the country''s economic environment seen so far in FY10," the report says. There is a clearly need to vigilantly monitor the relative deterioration in macroeconomic indicators, and particularly those that had seen substantial improvement in the initial months of the year, it adds.
More significantly, the original FY10 fiscal deficit target of 4.9 percent of GDP looks unachievable even after incorporating the proposed large reduction in the development spending. "It is worth noting here that the government''s ability to protect development spending has been severely cramped by the non-availability of expected external aid flows from the FoDP," the report says.
In addition, lower than planned availability of external financing also significantly increased the government''s reliance on financing from scheduled banks. This demand was compounded by higher demand for credit from public sector enterprises and for commodity operations, thereby squeezing market liquidity and crowding out the private sector.
According to SBP''s report, despite continuing energy shortages and rising production costs large-scale manufacturing (LSM) activity gathered pace during H1-FY10. The recovery in LSM has, in part, helped to compensate for the setbacks to major crops during July-February FY10, which have undermined hopes of reasonable growth in the agriculture sector during the full year.
With the "major crops" sub-sector likely to record a decline in value-addition during the year -principally due to fall in the production of rice, sugarcane and an expected decline in wheat harvest. Encouragingly, there are some indications that the former, at least, is expected to do well in FY10. The fiscal outlook appears especially challenging and existing inflexibility in current expenditures has been exacerbated in FY10 by the strong build-up in domestic and external debt, and rising military spending for anti-terrorist operations.
Moreover, spending has also been boosted by efforts to address the growing energy sector circular debt logjam, as well as the less desirable policy to ensure higher-than-market price for farmers. Although, development spending increased by 69.6 percent during H1-FY10, even this is below the levels implied in the original budgeted amount for FY10, the report said.
"The impact of these developments, together with weak revenue generation and considerable lags in the receipts of coalition support funds, contributed to a rise in the fiscal deficit, which rose to approximately 2.7 percent of GDP in H1-FY10, in contrast to 1.9 percent of GDP in H1-FY09," it added.
Unlike the fiscal accounts, external account balances show significant year-on-year improvement during the aggregate July-February FY10 period. Specifically, the current account deficit dropped from 6.8 percent of GDP in July-February FY09 to 2.2 percent of GDP in July-February FY10, as a large drop in imports overshadowed a smaller decline in exports, and remittances saw a 17.7 percent YoY rise in the same period. Consequently, the country''s foreign exchange reserves rose to US $14.8 billion by end-February 2010, from a low of US $6.8 billion in October 2008.
However, the SBP said that a monthly disaggregating for the period shows that most of this improvement was concentrated in the first quarter of the fiscal year. Thereafter, the YoY trends have steadily deteriorated, with an uptrend in imports relative to exports, and slowdown in remittances inflows.
The trends in the financial and capital accounts are also discouraging: of the US $3.7 billion surplus for July-February FY10, approximately US $2.8 billion was recorded in Q1-FY10. Moreover, practically all of the external sector financing was in the form of debt, significantly adding to the country''s vulnerability to external shocks, the report said.
According to SBP''s report growth prospects for agriculture sector remain weak in contrast to the strong growth seen last year and negative contribution by the two major crops of FY10 kharif particularly rice and sugarcane and expected decline in wheat harvest are mainly responsible for this gloomy outlook.
"Key fiscal indicators improved in Q2-FY10 over the previous quarter, bringing the cumulative fiscal deficit for H1-FY10 to 2.7 percent of annual estimated GDP and current statistics are consistent with the SBP forecast of budget deficit for the year," it added.
On the expenditure side, the government was able to contain growth in total outlays during Q2-FY10. However, given the rigidities in current expenditure on account of the need to address build-up of energy sector circular debt, security related expenditure etc, the government has little choice but to cut development spending if pledges by FoDP are not realized and lags in reimbursement of Coalition Support Fund continue.
Pakistan''s trade deficit contracted by 19.5 percent YoY during July-February FY10 as compared to a fall of 6.2 percent during the same period last year. This contraction was largely on account of a fall in the import bill which was supported by a marginal rise in exports, the report said.