Pakistan''s economy continued to show macroeconomic stability in the third quarter of the current 2008-09 fiscal year (FY09), however it became clear that economic performance of the country would remain weak in current fiscal year.
According to the Third Quarterly Report of the State Bank of Pakistan on the state of the economy, earlier months developments such as high inflation, deterioration in external account and declining industrial output have made it clear that lower growth target for the FY09 would be difficult to achieve and the country''s GDP growth would be 2-3 percent.
However, the report noted with caution: "Despite the improvement in macroeconomic indicators is very encouraging, the economy is not out of the woods yet. Major macroeconomic indicators show underlying weaknesses which, if not addressed, could hamper economic recovery."
Macroeconomic stability, in third quarter, is largely attributed to the macroeconomic reforms initiated by the government and the economy benefited from a sharp decline in international commodity prices and other favourable developments. Inflation began to decline, the current account deficit narrowed substantially with a corresponding stability in the exchange rate, and fiscal discipline was maintained with the fiscal deficit being reported to be 3.1 percent of GDP for July-March FY09.
The report said that recent easing of inflationary pressures is indeed encouraging as the headline inflation - measured by consumer price index (CPI) - dropped to 17.2 percent on year-on-year (YoY) basis in April 2009 from its peak of 25.3 percent YoY in August 2008.
The report pointed out that major economic targets such as GDP growth, inflation, workers remittances and exports would not be achieved and inflation would be 20.5-21.5 percent in FY09 against the target of 11 percent.
While, the country''s goods exports would be 18.5-19.5 billion dollars against the target of 22.9 billion dollars and workers remittances 7.5 billion dollars, it added. A slowdown in economic activities as well as poor law & order situation also impacted the performance of services sector during FY09.
In contrast with stellar growth in recent years, services sector is expected to record below target growth in FY09. The report said that trade deficit recorded a break from rising trend of the past six years, declining by 15.9 percent YoY during July-April FY09.
This was principally led by a 9.8 percent YoY fall in imports that more than offset a small 3.0 percent YoY fall in exports during this period. A larger share of the improvement in trade deficit was observed during January-April FY09; due to a sharp 35.1 percent YoY fall in imports that outpaced a yet large 19.2 percent YoY fall in exports in this period, it added.
The report said that in order to support industry and particularly the export-oriented sectors, which were pressured by the impact of the global recession, the SBP introduced measures such as easing access to concessional financing schemes, and lengthening maturities.
The central bank also injected appropriate liquidity to meet banking system''s increased demands for commodity operations and settlement of circular debt. However, by April 2009, broad money (M2) growth was still quite weak, at 1.9 percent year-to-date, down sharply from 8.4 percent in the corresponding period last year, reflecting continued deceleration in domestic demand.
"As a result of this, the SBP projections suggest that deceleration in inflation will be much sharper in the next few months. This is also evident from the successive fall in the core inflation during March and April 2009," it added. It said this has encouraged the SBP to gradually shift its policy bias towards supporting growth in the economy.
Thus, as other macroeconomic indicators improved further, this allowed the central bank a 100 bps reduction in the policy rate, bringing it to 14 percent effective April 21, 2009. The report said that the record wheat and rice harvests together with the likelihood of good production in minor crops and of fodder increase expectations that growth in the crops sub-sector of agriculture will exceed the FY09 annual target.
"A reasonable performance from the livestock sector, supporting all this, will help take the overall agri-sector growth close to, or over, the annual target," it added. However, it noted with concern that growth in large scale manufacturing (LSM) has been negative for the 10th consecutive month in March 2009, the longest period in which production continued to shrink.
LSM growth dropped by 7.6 percent during July-March FY09 compared with a 5.0 percent rise in the corresponding period of FY08. This is the major drag on the prospects of improving real GDP growth, it added. In addition, the report said the international inflows under financial and capital accounts are relatively lower compared with the preceding years, causing a rise in overall external account deficit.
A fall in financial inflows is the result of combined impact of both external and domestic factors, the report said. "While, Pakistan''s ability to access international financial market is constrained, any shortfall in external inflows would add to pressures on monetary policy," the report added.
"In short, the limited gains in key macroeconomic indicators should not lead to complacency as the quality of these improvement and challenges to economy are some factors of disquiet," it pointed out. The report also stressed upon increasing exports by product and market diversification with gains in productivity. It underscored the need to implement second generation reforms to improve governance, strengthening institutions and reforming legal as well as regulatory system.