The Annual Report released by the State Bank of Pakistan on 29th October contains a good exposition of Pakistan's economy during 2006-07, pinpoints latest economic challenges confronting the country and offers advice to overcome weaknesses in a number of key areas.
It is also educative in the sense that it has discussed policy trade-offs at appropriate places and given the reasons for preferring certain strategies in the larger interest of the economy. As for the achievements during 2006-07, the State Bank seems to be highly pleased with the rate of growth in the country. At 7.0 percent, the real GDP growth was one of the fastest in Asia during FY07, surpassed only by China and India.
A very healthy aspect of the growth of the economy was that this was the third consecutive year in which growth was supported by acceleration in real investment. According to the Report, "sound macro-economic policies have successfully transformed the initial consumption-led growth impetus of a few years back to a greater role for sustainable investment-led growth.
With the investment to GDP ratio at a record 23 percent, complemented with a surge in domestic private investment and record FDI flows, the economy looks well-poised to continue on a high growth trajectory in coming years".
The State Bank also appears to support the contention of the government that the current spell of high, sustained growth is having a desirable impact on alleviating poverty in the country.
However, as opposed to the government, it has not relied on some kind of household survey to prove its point but merely stated that the country witnessed a marked reduction in poverty level during FY79-FY83 when the growth rates were quite high and the relationship between growth and poverty level could also be similar this time.
Gains were not only confined to growth and investment but were also recorded in other areas of the economy. "More specifically, and in proportion to GDP, national savings rose, the external debt burden declined, and total revenue increased while the budget deficit stayed at last year's level of 4.3 percent of GDP".
The State Bank stresses in no uncertain terms that key macroeconomic challenges remain to be fully addressed yet. "The current account deficit widened further in FY07, the tax to GDP ratio is still very low, and inflation remained stubbornly high, showing only a sluggish decline in FY07". If the economy is to continue growing at rates above historical norms, policies and measures have to be implemented to stabilise emerging macroeconomic imbalances.
Justifying continued tight monetary policy, the Report states that such a stance addresses inflationary expectations and prevents the seepage of pressures from rising food prices into the broader economy.
Although monetary policy was effective in containing demand-pull inflationary pressures, the impact of monetary tightening was muted by the unanticipated strength of food inflation, an expansionary fiscal policy and the need for concessional financing for strategic sectors of the economy.
The growing current account deficit, led primarily by a sharp slowdown in export growth, poses another great risk to the economy. In the immediate response to the sluggish growth in exports, the State Bank increased the subsidy for export lending in July, 2006 but concessional lending is no answer to this challenge.
Greater benefits in this area are likely to emerge from policies aiming to reduce the cost of doing business, removing bureaucratic hurdles, reducing the cost of energy and water, and lowering inflation in the economy, rather than short-term palliatives.
Subsidies, in particular, were unsustainable given the shrinking fiscal space available to the government. The State Bank also seems to be concerned about a higher burden of debt servicing in the coming years as repayments of the rescheduled non-ODA Paris Club debt stock will resume from FY08, and the maturities of the Eurobond issued in FY04 and Sukuk issued in FY05 will become due in FY09 and FY10 respectively, besides interest payments on various Eurobonds issued recently.
As for the fiscal policy, the State Bank has recommended restricting public investment to high priority sectors, encouraging public-private partnerships in the provision of infrastructure and expanding the tax base. "In the latter context, a large part of agriculture and the services sector, which account for over two-thirds of GDP, is largely out of the direct tax net. This is not sustainable".
The State Bank has also ventured to guesstimate the direction of major economic aggregates for 2007-08, recognising, of course, that the projections are based on limited data availability. The growth during FY08 was expected to be strong and broad-based, with contributions coming mainly from agriculture and the services sectors.
Aggressive monetary tightening would help contain demand pressures in the economy, with monetary growth forecast to remain close to indicative target of 13.7 percent. Domestic inflation was also expected to be close to the annual target of 6.5 percent.
However, high food commodity prices and rising international energy prices which may force the government to increase domestic oil prices are major risks to the inflation outlook. Current account deficit may be larger than FY07 in absolute terms but is expected to fall as a share of GDP.
The observations and analysis about the economy by the State Bank in its Annual Report, in our view, are fairly objective. Unlike government documents, it is devoid of propaganda element and depicts a true picture of the economy. Also, there is no confusion about the message of the Report.
The State Bank is satisfied with the growth numbers but highly concerned about the emerging weaknesses of the economy which, if left unadvised, could pose a serious challenge to the economic outlook of the country. However, it would be unfair if we did not give high marks and attach enough importance to the achievements recorded during the tenure of the present dispensation through concerted reform efforts and right mix of policies.
There is no denying the fact that the economy has registered a respectable growth rate over the last few years which has resulted in almost doubling the per capita income. The State Bank also seems to be fairly confident about the reduction in poverty level but has refrained from saying anything about the income inequalities, due probably to lack of relevant data.
There were also doubts about the sustainability of growth momentum, which have now largely been laid to rest due to a jump in the investment level in the economy. Hopefully, the gains of high growth trajectory would be passed on to the common people of the country, particularly the poor, by a shift in policy thrust by the government.
Foreign exchange reserves of the country are now at a record level, exchange rate is stable and fiscal deficit is also manageable. The country also does not need to depend on the IMF for borrowing the needed resources and accept its advice.
By any stretch of imagination, these are no mean achievements. It was not long ago that growth rate had almost stagnated and the country was on the verge of default, forcing it to go with the begging bowl before the multilateral institutions, lending agencies and others.
However, the economy seems to be delicately poised at this juncture. The challenges like huge current deficit, rising inflationary pressures and narrow tax base have to be squarely confronted to maintain the growth momentum and impart stability to the process.
The State Bank has, very rightly, de-emphasised the role of subsidised credit and suggested other ways to promote exports. The authorities and other stakeholders need to listen to this sane advice otherwise the country would have to take increasing recourse to the international debt market to bridge the gap between foreign exchange payments and receipts.
Already, Pakistan's external debt and liabilities have reached a record level of 40.1 billion dollars during FY07. This, along with an increasing dependence on sources like Sukuk and Eurobond issues, would increase the debt servicing liability and adversely affect the outcome in the external sector accounts in the coming years.
We wish the government not to indulge in unnecessary propaganda that the issuance of such bonds is some kind of success and represents the confidence of the international community in sound management of the economy.
The nation must be told that the inflow of funds from such sources is a short-term debt obtained at a high cost for balance of payments reasons and to bolster foreign exchange reserves of the country. It is sad that inflation rate is still at an alarmingly high level.
The problem would be exacerbated when the government decides to pass on the effect of rising international oil prices to the domestic market. How to insulate the common man from this ugly situation to maintain social harmony in society is a moot question.
Also, it is very easy to say that agriculture and services sectors should be brought under the tax net for the sake of equity and to mobilise higher level of revenues. We have also been suggesting such measures for a number of years but vested interests appear to be too strong to yield to the pressure of reason.
Coming specifically to the monetary policy, the State Bank could only boast mixed achievements. The spread between deposit and lending rates has come down somewhat due to continuous prodding by the State Bank, which is a healthy sign. It has also not shied away from taking appropriate monetary tightening measures at the right time.
However, the State Bank's record to keep the growth in monetary supply in check and contain inflation has not been very enviable. While money supply grew by 19.3 percent during 2006-07 as against the target of 13.5 percent, CPI rose by 7.8 percent or higher by 1.3 percentage points than the target.
The target for money growth during 2007-08 has been fixed at 13.7 percent which, even if achieved, would almost be equal to the rise in GNP in nominal terms and thus unable to absorb the monetary overhang of the past years.
The assertion by the State Bank that it has a dual mandate of maintaining price stability and economic growth is not very convincing. Its primary focus, like all other central banks, should be on price stability.
In fact, these two objectives are not mutually exclusive and monetary stability would be very helpful in sustaining the present growth rate in the long-term. Overall, we feel that the Report of the State Bank would raise the awareness level in the country, improve the quality of debate on various issues and may prompt the government to take necessary measures in certain weaker areas of the economy.