The following is the full text of Executive Summary of State Bank of Pakistan's First Quarterly Report:
REAL SECTOR Economic recovery suffered a setback in early FY11 as floods damaged about one-fourth of the country's agriculture heartland. Not only were crops and livestock destroyed by the floods, a number of agro-based industries, power plants and other manufacturing activities were also disrupted. However, an expected good performance by the services sector will provide support to GDP growth in FY11. Furthermore, a disproportionate rise in the prices of almost all agricultural produce led to a significant increase in the nominal income of the farmers, offsetting part of the negative impact of floods on domestic demand.
Agriculture Kharif crops were planted on 9.7 million hectares, but heavy rains and floods damaged standing crops on approximately 2.4 million hectares. Initial assessments indicate significant severe losses to rice, cotton, maize, pulses, vegetables and fruits. However, losses to the sugarcane crop in flood areas were partially offset by an increase in yield in non-flood regions due to rains. On the positive side, floods and extended heavy monsoon rains raised the underground water table and soil moisture level, and increased water availability in reservoirs, improving prospects for the FY11 Rabi cropping season.
Large-Scale Manufacturing: Cumulative large-scale manufacturing (LSM) production declined by 2.3 percent YoY during July-November FY11 compared with 0.5 percent growth in July-November FY10. This decline was principally driven by temporary disruptions and raw material shortages caused by unfavourable weather.
Particularly, construction activity declined partly owing to cut backs in public development expenditure, production came to a stop in the country's largest refinery due to inundation, and the textile sector had to face raw material shortages for yet another year. The damage to road networks and power infrastructure also impeded overall industrial performance. It is expected that continued strength in private aggregate domestic would support positive growth in manufacturing.
The external sector had a mixed effect on local industry. Export demand declined for cement, pharmaceutical, and electric fans, as Pakistani manufacturers lost ground in some of the export markets captured in the past two years. However, a gradual demand recovery in the US and Europe provided a boost to the leather and textile sector with the export receipts of the latter growing largely as a result of the sharp increase in prices of cotton. For textiles, higher export prices in FY11 improved profit margins in comparison of regional peers.
Services: The services sector is expected to surpass its official growth target for FY11 on the back of strong growth in social, community, and personal services led by massive relief and rehabilitation efforts undertaken in flood-affected areas. The finance and insurance and transport, storage, and communication are also likely to have substantial growth contribution, as is reflected by the performance of these sectors during Q1-FY11.
Prices: Inflationary pressures significantly strengthened in recent months as headline inflation increased to 15.5 percent in November 2010 from 10.5 percent last year. This rise is attributed to supply shortages of most of the perishable food commodities due to floods and rains; the direct impact of pass through of rising international commodity prices; indirect impact of increased fuel prices on the transportation cost; upward adjustment in electricity tariff, as well as strong external demand for some key food staples and magnetisation of the fiscal deficit.
Strong inflationary pressures are also evident from core inflation measured by 20% trimmed mean measure, which rose to 13.4 percent in November 2010 from 10.5 percent during the same period last year. Core inflation measured by non-food-non-energy (NFNE) was recorded at 9.5 percent in November 2010 compared with 10.6 percent during the corresponding month last year, showing that the current inflationary pressures are mainly stemming from food and energy components of CPI basket.
Money and banking: The SBP raised its policy rate by 50 bps in each of the three rate decisions during H1-FY11, taking it to 14 percent. At the start of the fiscal year, continued demand induced pressures on prices and macro stability prompted the central bank to begin tightening its policy stance. Soon after, the supply-shock from monsoon flooding heightened existing concerns over growth and inflation - notably food prices. While this complicated calibration of the policy stance; the monetary implications of the increasing magnetisation of the fiscal deficit - amid persistence in inflation - left the central bank with little choice but to continue tightening in the next two policy meetings.
Broad money supply (M2) expanded by 6.9 percent during July-December FY11, compared with 4.7 percent in the same period last year. Government led credit growth in the NDA of the banking system and a considerable rise in the NFA of scheduled banks provided the bulk of impetus to monetary expansion during the period under review. In addition, credit to the private sector also increased by Rs 81.8 billion during July-December FY11 - mainly reflecting increase in working capital loans on account of rise in the cost of inputs.
The deposit base of banks grew by 1.0 percent during July November FY11, compared with 0.1 percent in the same period last year - mainly due to a large inflow of remittances in November and the sharp increase in the government borrowings from the SBP. Meanwhile, asset quality metrics of the banking industry deteriorated further; gross non-performing loans (NPLs) rose by Rs 34.2 billion, to Rs 494 billion during Q1-FY11. In the money markets, primary market activity during H1-FY11 was dominated by T-bills - where the government accepted Rs 199.6 billion net of maturities. The period under review also saw two successful auctions of the Ijara Sukuk, with acceptance of Rs 89.0 billion against a target of Rs 80.0 billion. While the first two PIB auctions resulted in rejection of all bids by the government, auction results improved considerably in the last two auctions of the period under review.
Fiscal developments: The size of the fiscal deficit increased to 1.6 percent of projected annual GDP in Q1-FY11, regardless of the noticeable contraction in expenditures. The government reprioritised its spending pattern and scaled down the development expenditures to create space for the flood relief activities. However a significant part of fiscal slippage came from the revenue side, showing a fall in Q1-FY11; brought about by both a considerable fall in non-tax revenues and deceleration in tax revenues. Further, in the absence of ample alternate resources, the fragile fiscal stance forced the government to rely heavily on deficit magnetisation. All these developments suggest the need for urgent reforms in the taxation system for broadening the tax base and blocking leakages in revenue collection.
Domestic debt and liabilities: The total stock of domestic debt and liabilities posted an increase of 6.7 percent by end-November FY11 over the June FY10 stock. This increase in the domestic debt was witnessed on account of a higher fiscal deficit and limited availability of external financing. In terms of composition, the rise in total stock of domestic debt and liabilities came entirely from government's domestic debt, whereas commodity operations and PSEs debt experienced retirements during this period. Within government's domestic debt the increase in stock was led by government's huge borrowing from the central bank, while the stock of scheduled banks debt recorded only a nominal increase by end-November FY11.
External sector: Balance of payments: The current account deficit contracted by 72.3 percent during July November FY11 compared to the same period last year. This contraction was the result of significant export growth, sustained inflows of workers' remittances, and private and official grants for flood relief. The financial account surplus, on the other hand, declined sharply to US $0.5 billion from US $2.2 billion. A large part of this decline was result of a sharp fall in other investments despite the emergency loan of US $453 million for flood relief given by the IMF. The lower capital and financial account surplus resulted in the decline of the overall external account to US $0.1 billion compared to US $0.94 billion last year. Nevertheless, the overall surplus did help in shoring up country's foreign exchange reserves that reached US $16.9 billion by end November 2010. This also kept the exchange rate relatively stable which depreciated by 0.35 percent during July November FY11 compared to 2.6 percent in the same period last year.
Trade account Trade deficit widened by US $938.2 million during July November FY11 in contrast to a contraction of US $3220.3 million during the same period last year. Unlike last year, the sharp fall in imports improved trade account, the deterioration recorded during FY11 is principally due to an increase of US $2288.2 million in the import bill which outpaced the rise of US $1350 in export earnings.
The acceleration in the imports was a result of an increased import quantum of food and textile items. Apart from the higher import demand, relatively higher international commodity prices further inflated the import bill. In case of exports, the high value added sector of the textile group displayed a decent performance amid improved external demand, its receipts rising principally because of higher cotton prices. Export of primary commodities such as cotton, fruits and vegetables declined in quantitative terms; however this impact was partially offset by the rise in export prices.
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