SBP's Annual Report

State Bank's annual report released on 10th December, 2014 contains, as usual, an objective assessment of the economy for FY14 along with the prospects for the current year. The report states that, "following several years of low economic growth and poorly-implemented structural reforms, FY14 was a better year for the economy". Most notable developments during the year were formalisation of IMF's EFF in September, 2013, tangible improvement in country's FX reserves, unprecedented appreciation of the PKR in early March, reduction in fiscal deficit, lower than expected inflation, improvement in private sector credit and relatively-contained current account deficit. On the other hand, although government took several initiatives in the energy sector, results remained short of expectations. PSEs continued to be a fiscal burden, "as little in the way of internal restructuring was possible in power-related PSEs, Pak Railways, PIA and Pak Steel". As for the actual behaviour of various macroeconomic indicators, real GDP during FY14 grew by 4.1 percent compared to 3.7 percent in the previous year and the target of 4.4 percent. Energy sector continued to burden the economy though FY14 witnessed fewer days when the demand-supply gap exceeded 4,000 MW compared to the previous year. Inadequate planning and development of the energy infrastructure and lack of reforms in Gencos and Discos continue to impede Pakistan's economy. More binding bottleneck in the energy sector was not generation but distribution. In the natural gas sector, growing public campaign by industrial, commercial and CNG associations to supply them gas was a clear indication "that the shortage of gas has regressed to publicly lobbying policymakers". There was a significant improvement in the fiscal deficit in FY14 as the deficit at 5.5 percent of GDP was even lower than the target of 6.5 percent. However, bulk of the improvement was attributed to factors, which were one-off in nature. FY14 was also the first time in two years that Pakistan's outstanding external debt did not fall and dollar 4.6 billion increase in outstanding debt was clearly explained by the start of the IMF programme. CPI inflation during the year was 8.6 percent, significantly lower than 11-12 percent initially projected by the SBP. This decline was primarily due to softening of global oil price, smaller than expected increase in electricity and gas tariffs etc. "As part of the stabilisation programme to reduce the twin deficits (fiscal and external), the easing monetary policy stance, that started in mid-2011, was changed in September, 2013". Current account deficit at 1.2 percent of GDP during FY14 was somewhat higher than 1.1 percent compared to the previous year and target for 2013-14. While exports remained stagnant, home remittances continued to grow strongly. The grant of US $1.5 billion in February-March, 2014, Eurobond and 3G/4G auction proceeds in April and the divesture of UBL shares in June pushed up SBP's FX reserves at a rapid pace. As for the outlook of Pakistan's economy, it was tainted by floods in early FY15 but the damage appears to be less severe than the previous years'. According to the SBP projections, while GDP was estimated to be lower than the target, fiscal deficit and current account deficits were expected to be higher than the government projections. Another key development was the political uncertainty created by public protests. This uncertainty has delayed investment plans and interface of business with the federal government has become difficult. The IMF programme too was becoming a source of concern, as the Fund has deferred its tranche due to a delay in the 4th Review. SBP's initial range for inflation was 7.5-8.5 percent for FY15 but a further cut in power subsidies and the realisation of GIDC do pose upside risks. Of greater concern to the SBP was about commercial banks' continued interest in holding on to PIBs and avoiding of corporate lending. Finally, there was the issue of structural reforms in the PSEs. There was reluctance on the part of management and the staff to change their self-serving behaviour and move ahead with the restructuring of loss-making PSEs. To say that the assessment of the economy by the SBP in its annual report is quite candid and comprehensive, in our view, is stating the obvious. Looking at the quarterly reports in the recent past, there was growing apprehension in certain circles that the State Bank's analysis was somewhat influenced, if not dictated, by Islamabad. However, such a perception has largely been dispelled by the release of the present report. Another characteristic of the report was that it has highlighted the weaknesses and risks to the economy in a very politic tone, without making a high pitch or much fuss about various issues. Anyhow, as already known, FY14 was definitely a better year for the economy in terms of growth, fiscal deficit, inflation rate, FX reserves, exchange rate etc but the State Bank has not minced words in highlighting that most of these gains were either one-off or not too significant to make a difference on major indicators of the economy. For instance, GDP growth was somewhat higher than last year but the extent of increase in growth was too small to increase the per capita income in a meaningful manner and improve the quality of life for an ordinary person. Similarly, there was improvement in private sector credit but, given the appetite of banks for PIBs, lending to the corporate sector and overall investment was still constrained. Of course, there is no need to say that if one-off foreign inflows like bilateral grant of dollar 1.5 billion from a friendly country had not materialised, fiscal and external deficits of the country would have been much larger, resulting in higher inflation, lower availability of credit to the private sector, depleted level of FX reserves held by the SBP and depreciation of the exchange rate of the rupee. State Bank has also said, rather indirectly and without being blunt, that Pakistan needs to remain in the good books of the IMF for stabilisation of the economy and sustain the gains of FY14. However, continued assistance from the Fund would be contingent on certain actions to be taken by the government of Pakistan. For the current year, State Bank has indicated the need for restructuring of PSEs, reprofiling of domestic debt and resolving of the political crisis for the businesses and the economy to grow. Of course, the analysis of the State bank focusing on the fragile nature of certain indicators and the transitory or one-off factors responsible for certain gains during FY14 is somewhat at odds with the assertions of the Finance Minister who generally claims to place the economy on an upward trajectory. The real picture as painted by the SBP would certainly help in giving a balanced view of the economy to the policy makers as well as the general public. The report this time also includes special sections on automobiles, gas allocation and coal as the potential game changer. Hopefully, this addition would also be useful for policy formulation by the government. Some of the observations in the report would be both revealing and interesting to an ordinary reader. For instance, it has been stated that the growth rate of the economy as indicated by various documents was not very reliable as large part of more vibrant economic activities were not reflected in the official data. This supports the view "that Pakistan's informal economy was more the engine of economic growth, compared to established businesses captured by official data". Such a statement by the SBP makes the official growth statistics suspect and could be a proof that national income estimates were underestimated and the poverty level in Pakistan may be lower than generally believed. The remarks that binding bottleneck in the energy sector was distribution and not generation would show various governments in bad light since most of them had been concentrating all their energies on generation. This indicates the need to change priorities and focus more on the collection of authentic statistics. However, the SBP seems to be deriving sweeping conclusions on the gas allocation policy in the special section where it has quantified the likely benefits of allocating gas from fertilizer to power sector and strongly recommended to give high priority to the power sector, which was the backbone of the economy. In our view, there are a lot of factors to be considered in the allocation of gas and prescription of policy should not be that straight-forward or simplistic. Also, the SBP needs to take a more serious view of the disconnect between the PIB and T-bill rates and its impact on the behaviour of banks. Last but not the least, the State Bank should realise that the late release of Annual Report, generally in the month of December, is a reason for the loss of its importance and utility to a great extent. SBP, therefore, needs to make efforts to make the report available, preferably in the first quarter of the next year to enable the readers to make the best possible use of this document.