Pakistan's currency real effective exchange rate depreciated by 34 percent since January 2007, partly tied to large and persistent structural macroeconomic imbalances. According to World Bank's Global Economic Prospects 2011, available on the WB website here on Friday, since January 2007 regional currencies have remained broadly stable, trading within a plus/minus 10 percent band-with the exceptions of Afghanistan and Pakistan.
Over the same period, Afghanistan's currency appreciated by 17 percent, supported by massive foreign aid inflows. In contrast, Pakistan's currency real effective exchange rate depreciated by 34 percent since January 2007, partly tied to large and persistent structural macroeconomic imbalances.
In Pakistan, floods led to an estimated 20 percent reduction in cotton harvest and sharp fall-off in cotton exports and textiles (with the latter representing two-thirds of total merchandise exports). The pace of growth of regional merchandise import volumes slowed markedly compared with other regions, and could reflect a recent moderation in the pace of growth of remittances inflows-a key driver of regional private consumption.
It said that in Pakistan, however, a standstill on policy implementation, severe disruption tied to massive flooding and continued security problems constrained economic activity. The report said that the macroeconomic policy in South Asia is accommodative, given the strength of regional economic activity and relative to other regions (where growth has generally not gained as strong of a footing). While policy interest-rates have been raised (beginning in mid-March 2010 in India, and, more recently, in Bangladesh and Pakistan), monetary policy normalisation is incomplete, and real interest rates remain negative. Moreover, despite some modest progress toward fiscal consolidation in 2010, South Asia had the largest fiscal deficit among developing countries with the region-wide deficit estimated at 8.2 percent in 2010. At the country-level, fiscal deficits as a share of GDP range significantly. For instance, Bangladesh's overall general government deficit is more manageable (estimated at 2.5 percent in FY2010/11) compared with the Maldives' deficit of 22.4 percent, and those in India (9.6 percent), Sri Lanka (8 percent), Pakistan (6.3 percent), and Bhutan (6.1 percent).
It stated that the temporary price shocks had also been a factor, such as the disruption of flooding in Pakistan and some liberalisation of fuel price subsidies in India. More recently, inflationary pressures had been partly offset by falling local food prices, due to improved harvests following good 2010 monsoon, particularly in Afghanistan and India.
The remittances were a main source of foreign exchange for the region, and were an important driver of regional domestic demand. Official remittances inflows represent a significant share of GDP in Nepal (23 percent), Bangladesh (12 percent), Sri Lanka (9 percent), Pakistan (6 percent) and India (4 percent).
Remittances inflows to South Asia increased by an estimated 10.3 percent (in US-dollar value terms) in 2010, more than double the 4.5 percent growth rate in 2009-but well below the 19 percent average annual rate recorded between 1999 and 2009. However, because local currencies appreciated against the US dollar, remittances inflows in real local currency terms were estimated to have contracted in India (down 8.6 percent), Bangladesh (3.4 percent), Nepal (3.1 percent), Sri Lanka (1.7 percent) and Pakistan (0.5 percent). This compares with vibrant growth in real local currency-terms in the past, which over the previous five years (2004-2009) expanded by an average 17.6 percent (median growth rate across the five countries).
South Asia is projected to continue to post robust growth of 7.7 percent and 8.1 percent over the forecast horizon in FY2011/12 and FY2012-13, respectively-albeit a deceleration from the 8.7 percent growth recorded in FY2010/11. The projected slowdown in growth partly reflects expected further tightening of fiscal and monetary policies, which are aimed at reducing inflationary pressures, bringing fiscal deficits down to sustainable levels, creating fiscal space, and avoiding the build-up of large external imbalances. India is targeting progressive reductions in the central government's fiscal deficit to 3 percent of GDP by end-FY2013-14 from 6.7 percent in FY2009-10, which will be supported by proceeds from divestment and reforms to fuel-subsidy programs. The Maldives, Pakistan and Sri Lanka are also pursuing fiscal deficit-reduction programs as part of their IMF stand-by agreements, the report added.
Other factors contributed to the region's large deficits, including in the case of India, for example, elevated countercyclical spending that has yet to be fully unwound. Recent efforts at budget consolidation have been missed in Pakistan, because of flood-related and security expenditures; and in the Maldives and Nepal, due to political stalemates that have undermined progress on budget agreements, it said.
The report added that the regional fixed investment is projected to strengthen over the forecast period to an average of 13.2 percent from 10.2 percent in 2010-11, supported by reconstruction activity in flood-ravaged Pakistan and to a lesser extent by continued strong investment growth tied to ongoing post-war reconstruction in Sri Lanka. Further, investment growth will be underpinned by an expected continued firming of net private capital inflows to the region, buoyed by strong growth fundamentals, particularly in India.