Watch out for the BoP

"There are real risks of reversal in Pakistan''s external sector performance;" states SBP''s Third Quarterly Report for FY11. The central bank has picked up the ailment aptly as the fragility of the Balance of Payments (BoP) cannot be over emphasised. The current account was the saviour of the external accounts last year but itself appears vulnerable in the ongoing year.
SBP too is unsure whether the growth in remittances will remain consistent, while high oil prices may adversely impact the import bill. The weak recovery in global demand may hamper demand for real textile exports'' adding to the woes of recent decline in cotton prices that are expected to take a pinch out of export earnings in dollar terms. The story does not end there. The second leg of the BoP; the financial accounts, are also in poor shape to balance out any deterioration in current accounts. This explains the stagnation of foreign reserves (peaked in March) despite surplus in current account in past two months or so.
Yet, SBP is not taking this fragility as its main challenge arguing that the stability in financial markets to absorb external shocks and reduction in already abysmally low international flows for past two years may not change much in overall position in external sector.
However, central bank might be a little optimistic on this front; as our reserves composition is exposing its fragility - Two-thirds of the country''s reserves are either owed to IMF or belong to commercial banks. This could be a lull before the storm, as FDI flows are at a fourth of what they were a couple of years back and there are some signs of an impending capital flight.
Now any strain on current account along with IMF payments starting in later part of the new fiscal year may bring panic to the markets. Great care is advisable when dealing with this predicament. For starters, the central bank may not be able to be too dovish in its monetary policy stance, despite apparently receding inflation. Easing in the monetary policy is premised upon two facts, not highlighted in quarterly report as these are more recent developments.
Firstly, FBR meeting its revenue target to curtail the fiscal deficit (excluding circular debt payment) to 5.3 percent of GDP. Secondly, government borrowing from SBP has been below the September 2010 levels; in fact it closed the year below the FY11''s starting level.
The relatively reduced borrowing is a big achievement and will considerably ease the demand-pull inflation pressure helping to partially quell inflationary expectations. On the other hand, falling prices of food and other agri-commodity will slash the cost push factor. So inflation may ease off a bit in coming few months.
But keeping borrowings from SBP under caps will remain dependent on government''s ability to meet its revenue targets and more importantly rationalising energy sector subsidies. The malice of energy sector circular debt is by no means over and is haunting any good done to the economy. The SBP report pointed out that there are signs of strong demand in manufacturing particularly auto, fertilisers, textile and cement sectors but energy shortfall created production bottlenecks, leading to a significant slowdown in industrial growth.
SBP stressed that efficient management of existing energy resources; especially gas must prioritise allocations to industry and power generation and improve the pricing policy. Concurrently, it emphasised on building the necessary infrastructure for importing gas.
"More importantly, a better policy option going forward is to rationalise tariffs for different users of this scarce resource and improve the gas pricing structure to incentives further exploration and extraction," added the report.
As in previous reports, the central bank continued to chide government to improve fiscal management. Barring energy and commodity circular debt; SBP has overplayed its stick this time. The government should be given its due credit for achieving few milestones at eleventh hour. However, its consistency is rightly questionable. SBP rightly pointed out that the budgeted growth in revenues for FY12 will be a towering challenge since government must increase revenues by 23 percent or Rs 364 billion. It highlighted that recent tax measures show a net reduction of Rs 27 billion while tax administration measures alone are expected to raise Rs 50 billion in FY12.
The provincial cash balance may be disturbed by increases in salaries of government employees, further widening the overall deficit beyond Rs 851 billion. And achieving this 4.5 percent deficit may become even harder if the government is not able to meet its overly optimistic target of cuts in power sector subsidies. This is especially relevant given strong political opposition against higher electricity tariffs and the upcoming electioneering months.
Similarly, developing political consensus for rightsizing the public sector enterprises (PSE) and raising Rs 70 billion through privatisation proceeds will be a difficult feat in the current political scenario. While recent endeavours of the government have borne some fruits, it is imperative that the slight signs of fiscal responsibility do not vanish in a wave of populist measures as the general election draws closer.