The State Bank of Pakistan (SBP) has predicted a healthy scenario for the country''''s economy during FY06 compared to last year despite a slight retardation in the real GDP growth.
The SBP''''s First Quarterly Report of FY06 has based its prediction on the initial data of commodity-producing sectors which indicates that the performance of the economy during the fiscal would be worse than the preceding year.
"It will be a weaker economy owing to the retardation of growth in large-scale manufacturing, and the production in two of the four major kharif crops significantly below target. Much of this slowdown is not unexpected, as is reflected in the 7.0 percent real GDP growth target set in the Annual Development Plan for the year, against the 8.4 percent growth achieved in FY05."
The report says that it is probable to reach the FY06 target though it could prove a hard task. In agriculture sector, value-addition by major crops is expected to fall well below the target, but it could be compensated by an anticipated above-target performance by minor crops and livestock sub-sectors.
Similarly, while industrial growth may remain a little below target, activity is expected to remain strong due to expected recovery by LSM in succeeding quarters (as credit demand remains relatively strong), a buoyant construction sector, and improved electricity and gas distribution. Finally, growth in the services sector is also expected to turn in a strong performance.
In any event, while the contribution to FY06 growth by individual sub-sectors of the economy is likely to differ from earlier expectations, the SBP estimates suggest that real GDP growth will range between 6.0 and 6.6 percent.
The relative slowdown in economic activity, together with improvement in food supply (stemming from better minor crop harvests and the government''''s supply side interventions), is contributing to a relative weakening in domestic inflation.
CPI inflation continued a trend decline throughout the first 5 months of FY06, consequently dropping from the peak of 11.1 percent YoY in April 2005 to reach 7.9 percent by end of November 2005.
This raises hopes that the eventual annual inflation will remain close to the 8.0 percent target for FY06. Two assumptions that underlie this expectation are (1) that monetary policy will remain tight, and (2) fuel prices will not see a significant rise in the remaining months of the fiscal year.
Although monetary expansion has been contained to 3.0 percent during July-November 2006, as compared to the 5.0 percent increase seen in the corresponding period of FY05, demand for private sector credit remained strong and, most importantly despite a small dip in November 2005, core inflation persists at a relatively high 7.6 percent YoY.
This suggests that inflationary pressures may still be persisting in the economy, and the SBP, therefore, has to be particularly vigilant, given that M2 growth may accelerate in the quarters ahead (reinvigorating inflation), pressed by both high government borrowings for budgetary support and the realisation of external assistance.
The external assistance received for rehabilitation of the earthquake-affected areas is likely to be excluded from budgetary financing, and the government borrowings may remain strong during FY06, adding to reserve money growth.
The latter view is supported by expectations that the growth in government expenditures will remain strong (especially the encouraging rise in development spending), and an evident weakness in the structure of tax receipts--approximately 75 percent of the growth in tax receipts during Q1-FY06 stemmed from import-based taxes, led by a sharp rise in imports.
Thus, tax receipts may be adversely affected by any slowdown in imports in future quarters. Imports have seen an extraordinary 54 percent YoY growth during July-October 2006, substantially higher than the robust 22.8 percent rise in exports during the same period. As a result, the trade deficit has widened to $3.37 billion, pushing the current account deficit to $2.04 billion (1.6 percent of estimated GDP). This will substantially raise the pressure for corrective action.
Any adjustments are unlikely to be abrupt or add to market volatility, as Pakistan''''s external account receipts are expected to increase during FY06, and foreign currency reserves remain strong.
The economic outlook for Pakistan presents a mixed picture. On the one hand, real GDP growth is likely to remain well above the 6 percent long-term trajectory, and there is a strong expectation that CPI inflation will remain at the 8 percent level, in line with the annual target, by end-June 2006. However, potential emergence of large fiscal and external imbalances pose threats to the sustainability of these positive trends.
While inflation is falling, it needs to be reduced further even at the cost of sacrificing some growth in the short-term. This is essential, as a fall in inflation would allow for an easing of monetary policy, thereby supporting long-term growth and countering any cyclical downtrend. The elimination of emerging macroeconomic imbalances will also be essential to sustain long-term growth in the economy.
Similarly, while fiscal discipline is required, it cannot be at the expense of development expenditures, as this would lower the productive capacity of the economy, thereby contributing to even greater deficits in future. Therefore, improvements in the fiscal environment must necessarily stem from widening of the tax base.
In particular, the increasing dependence of overall revenues on just a few sectors of the economy poses serious risks to fiscal stability (as shocks to these sectors can derail the fiscal discipline) and constrains the growth of the sectors which currently carry the tax burden of the whole economy.
Recent increases in development spending bode well for the growth prospects of the economy but it is important to ensure that even within development spending there is a balance between the creation and maintenance of physical infrastructure, and raising the productivity of human capital through investment in health and education.
This is true even for the quake-affected areas, where initial focus may be greater on the recreation of housing and infrastructure. It may be pointed out that a key risk to the country''''s growth potential is the lack of a substantial cadre of managers, skilled technicians, and trainable general labour force. Shortage of skilled labour is already evident, especially in the high growth of some sectors in Pakistan, including telecommunications, IT, high value-added textiles, telecast media, finance, etc.