The tone of State Bank's first quarterly report for the current fiscal year released on 29th December, 2008 is substantially different from its annual report for 2007-08 issued only less than a month ago. While the prognosis of the economy in the annual report was quite depressing, the State Bank, in its quarterly report, appears to be convinced that the crisis gripping the economy in the initial months of FY09 has abated.
This has been due to the government's initiatives to address the most immediate risks to the economy and its decision to enter into a macroeconomic stabilisation programme to support medium-term reforms under the aegis of the IMF. The immediate result of the Fund programme was a vast improvement in foreign exchange reserve adequacy indicators following the disbursement of first tranche of dollars 3.0 billion. Also, exports growth strengthened and imports growth moderated.
"This lent strength to the rupee, reducing the impact of an important generator of inflationary pressures". A sharp decline in international commodity prices would offer the possibility of a decline in the country's very large current deficit, and lower inflation. The supply-side improvement has been reinforced by a reasonably good performance of Kharif crops during FY09. All these factors appear to have halted the persistent uptrend in inflationary pressures and could also help support a modest improvement in the growth outlook for FY09.
"There is also substantial progress on containing fiscal imbalances, with the government moving bravely to reduce subsidies, contain growth in other spending and increase revenues". The overall fiscal deficit has fallen sharply to 1.0 percent of GDP during the first quarter of FY09 as compared to 1.5 percent last year which is consistent with the annual target of the macroeconomic stabilisation framework.
The State Bank has, however, cautioned the authorities that there is no room for complacency. While major economic indicators may no longer be worsening, the imbalances, nonetheless, are still quite large and "resolving them will require disciplined efforts over an extended timeframe". Difficult international economic environment, which has restricted the country's ability to tap international capital markets and carries risks for other external receipts like exports, remittances and FDI, could also exacerbate the situation. Global recession and risk averse behaviour of investors might also adversely impact international trade and the level of forex inflows in the country.
Domestic commodity prices have not declined in tandem with the sharp fall in international prices. Containing and bringing down the persistent high inflation in the economy, the State Bank asserts, will not be easy. Government must tread a fine line, encouraging market driven solutions while avoiding degeneration into price setting or the provision of subsidies. A change in mind-set is also required in fiscal planning.
"Expenditure growth must be kept consistent with a realistic assessment of revenues, and appropriate adjustments made as the year progresses". Commitment of the government for zero additional budgetary borrowing from the central bank has now been incorporated into the IMF supported macroeconomic stabilisation programme. Most of the favourable factors would significantly boost prospects for regaining macroeconomic stability.
According to the State Bank, Pakistan's economy needs effective policies and their implementation in the right direction in the midst of a challenging year. While fiscal and current account deficits are estimated to improve, real GDP growth will be lower than the target. Inflation is now projected to be around 20 percent as against the initial target of only 11 percent during FY09. To ensure the pass through of decline in international commodity prices to domestic consumers would be a big challenge for the government. Certain other developments like the shortfall in external financing, severity in global recession, sharp reduction in FDI inflows and increased pressure on forex reserves could pose risks for interest rate and exchange rate management. Continuous vigilance by the policy matter is thus required to keep the economy on track.
The latest assessment of the economy contained in the State Bank's quarterly report appears to be quite objective and the timely advice given to the economic managers of the country adds to its value. There is no doubt that favourable turn of events in a short period of time has created room for optimism and the looming threat of economic meltdown and insolvency has diminished to a large extent. Although certain positive international developments have helped to arrest the deteriorating trend in some key economic indicators, yet it was the decision of the government to negotiate the Stand-By Arrangement with the Fund which seems to have played a crucial role in reversing the prospects of the economy. With hindsight, it could be easily argued that the country got huge infusion of foreign exchange resources from the IMF and its seal of approval for the government policies when it was most needed. This seems to have encouraged the investors and paved the way for a smooth transition. It does not mean, however, that the economy is now completely out of the woods but the crisis has certainly eased. From now onwards, if the policymakers could maintain the reform momentum as agreed under the stabilisation programme and international environments continue to be favourable, the country could regain macroeconomic stability, at least in the medium term. Importantly, the foreign sector could revert to a sustainable position and inflationary pressures would gradually subside which would give much needed relief to the ordinary people of the country. The advice to maintain vigilance and avoid complacency by the State Bank is very relevant, especially at a time when political government is under tremendous pressure to slow-down the reform process and loosen the purse-strings.
The journey towards economic stabilisation as envisioned by the IMF or visualised by the SBP would, however, not be easy. For instance, very bold initiatives would be needed in fiscal planning and implementation strategy to contain government expenditures and mobilise revenues to the desired levels. It is very easy to propose a change in the mind-set but the experience suggests that it is a very hard nut to crack, particularly at a time when the opposition parties are not in a co-operative mood and corruption is deep rooted in the system.
Besides, there are so many vested interests to block the benefits of falling international prices to be passed on to the domestic market and the government is usually helpless to force the issue. The State Bank has also refrained from linking prospects of the economy to the security situation for understandable reasons although close linkage between the two could assume critical importance in the situation now prevailing in the country. If the security situation within the country or on the borders deteriorates further, the possibility of which cannot be ruled out altogether, it would have highly negative consequences for the economy. Overall, however, the quarterly report is quite informative and reflects broadly a true picture of the economy.