Pakistan has been able to attain a semblance of macroeconomic stability but underlying weaknesses in some key areas still persist and complacency, therefore, must be avoided. This is the message conveyed by the State Bank of Pakistan (SBP) in its latest quarterly report (for the period January-March, 2009) on the performance of the economy.
The report notes that it had become apparent in the first few months of FY09 that the economy would remain weak and the prescribed targets for the fiscal year would be hard to achieve. Stubbornly high inflation, massive deterioration in external accounts and declining industrial output were, in particular, the main causes of concern. However, after the government focused on restoring the health of the economy and entered into a Stand-By Arrangement (SBA) with the IMF, macroeconomic stability began to emerge.
The reform effort coupled with sharp decline in international commodity prices and some other favourable developments benefited the economy in a number of ways. Inflation tended to decline, current account deficit narrowed along with stability in exchange rate and fiscal deficit was reported at 3.1 percent of GDP for July-March, 2009.
However, the State Bank stresses the point that while this improvement was very encouraging, the economy was not out of the woods yet. "Major macroeconomic indicators show underlying weaknesses which, if not addressed, could hamper economic recovery."
The State Bank now expects a lower growth rate between 2 and 3 percent during the current year or considerably lower than the target of 5.5 percent and actual growth of 5.8 percent in 2007-08. The overall agri-sector growth would be close to, or over, the annual target while services sector was expected to perform reasonably well.
However, a substantial negative growth in large scale manufacturing (LSM) would be a major drag. The decline in LSM growth was not only a reflection of weaker demand, both domestic and external, but was also caused by infrastructural bottlenecks (eg power and gas shortages), and increasing risk averseness of banks.
The State Bank seems to be very pleased with the recent easing of inflationary pressures and has attributed it to favourable international and domestic developments, as well as deceleration in domestic demand. "The latter, in particular, reflects the monetary tightening by the central bank, as well as the complementary improvement in fiscal discipline, especially post-November, 2008."
While defending the policy rate cut of only 100 basis points with effect from 21st April, 2009 in the face of faster decline in inflation rate, the State Bank has elaborated that a larger rate cut would have been possible if there were no risks attached to the current macroeconomic situation.
These risks include anticipated shortfalls in fiscal receipts, uncertain international environment and the fact that the accelerated decline in inflation was, so far, more an expectation than a fact.
The State Bank seems to be highly worried about the likely trends in fiscal position and current account deficit of the country and their impact on the economy. In the fiscal area, tax collections have already slowed, non-tax receipts are expected to weaken due to rising international oil prices and expenditures would be stretched by the ongoing war on terror.
Improvement in the fiscal picture due to a cut in development expenditures is neither sustainable nor desirable and substantial additional bank borrowings to finance the budget would increase the risk of crowding out the private sector. A rise in international oil prices would also have adverse consequences for domestic inflation as well as the external account balance.
A shortfall in external inflows would add to pressures on monetary policy. Limited gains in some macroeconomic indicators, therefore, should not lead to complacency. The only viable way to achieve sustainable improvement in fiscal accounts is to raise the tax-to-GDP ratio through increasing the tax net as cut in development expenditures would be unwise, current expenditures are largely inflexible and increase in the existing tax rates would probably increase tax evasion.
In the external sector, there is uncertainty over the pace of growth in workers' remittances and the country would have to face higher debt servicing in coming years. "These two factors reinforce the common view that sustainable improvement can be achieved only through increasing exports by product and market diversification with gains in productivity.
These are not easy tasks". Enhancement in productivity, which the State Bank terms as practical solution, cannot be achieved without providing basic education and health facilities as well as efficient physical infrastructure including credible low cost energy, transportation and postal systems. "The country can achieve all these despite huge investment requirements".
The third quarterly report for FY09 by the State Bank would appear to be a depressing reading but we feel that its contents are closer to reality. Most of the people were in fact led to believe that economic situation of the country has improved a lot in the past few months and sustainability indicators of the economy were well entrenched.
Such a belief was based mainly on improvement in foreign exchange reserves of the country and the expectation of considerable easing of price pressures in the economy. The State Bank has analysed the situation more thoroughly and realistically by pointing out likely risks and areas of vulnerabilities and advised against complacency by highlighting its apprehensions. Most of the concerns indicated by the State Bank are very well founded.
For instance, the present fiscal stance of the government is not sustainable and may be harmful in the long run. So far, fiscal authorities have managed to keep the budget deficit consistent with the annual target but slashing of development budget, unexpected high expenditures on war on terror and squeezing of petroleum development levy (PDL) due to rise in international oil prices call for a major shift in policy, particularly with a view to widen the tax net to encompass all sectors of the economy.
Similar is the situation in the external sector. Keeping in view the uncertainty about workers' remittances and higher debt servicing in future, the country has to concentrate its efforts on diversification of exports and enhancement in productivity to improve the current account. Hopefully, relevant authorities of the country would give serious consideration to the assessment and policy proposals of the State Bank. Governor SBP Syed Salim Raza as a member of Prime Minister's Economic Advisory Committee is involved closely in budget making this year.
The observations and improvements suggested in the report need to be reflected in the forthcoming budget. A spirited defence of the present monetary stance was also, in our view, very much in order. A sharp easing of monetary policy at this stage would be akin to declaration of victory before reaching the goal-post and this would have been very naive on the part of the State Bank.
Some of the ideas of the State Bank make eminent sense. However, they require a change in the mindset of the political leadership at both the federal and provincial level. We are afraid that even at this critical juncture, some important sectors of the economy would probably manage to remain under taxed due to their clout eg real estate and agriculture.
Advisor to the PM on Finance Shaukat Tarin has repeatedly advocated revenue generation from sectors who at present are not contributing in accordance with their size and capability. Will he succeed in roping them - only time will tell! In the external sector, everybody would agree that enhancement of productivity through basic education, health etc and provision of efficient infrastructure is the practical solution but to believe that "the country can achieve all these despite huge investment requirements" is really far-fetched.
The projects required to be implemented for the purpose would almost be unaffordable, given the present resource constraints, and the gestation period would be too long. Provision of low cost energy, for example, remains an elusive goal despite its importance in infrastructure development and the State Bank must be aware of the difficulties in providing this facility without any interruption and at a low cost.