Budget deficit likely to widen further to 4.2 percent

 Oct 17 - 23, 2005

The devastation brought about by a major earthquake measuring 7.6 on Richter Scale is by far the worst disaster in the country's history both in terms of human casualties and loss of physical assets.

Incidentally, the worst hit regions were the relatively less populous zones of northern areas, Kashmir and NWFP, also having relatively smaller share in GDP.

While the rescue and relief efforts have been quick to respond, the quake devastation could continue in shape of more human casualties due to food shortage, breakout of diseases, weather vagaries, etc.

There is a risk of underestimation of the economic costs of the devastation. The most visible costs shall be higher fiscal expenditure in shape of compensation payments, relief & rehabilitation costs, infrastructure costs and loss in fiscal revenues.

However, the net fiscal costs shall be lowered to the extent covered from donations, aid, etc. The major economic sectors of northern areas - tourism, dry fruit and handicrafts - shall be most severely hit. The near term capital market impact of the earthquake devastation shall be limited as no major damages to industrial installation have been reported, though services sectors like banking and telecom shall face some costs due to loss of human and physical capital.

Insurance sector would face higher claims expense while expectations of pick up in reconstruction activity shall drive interest in cements.

"We believe government would re-allocate bulk of its Public Sector Development Fund (PSDP) in infrastructural development as the entire communication system (road network) has been destroyed," said Muzzammil Aslam, economist at KASB Equities. The government had allocated Rs 306 billion for PSDP in the budget announced in Jun-05. "With this we expect budget deficit to widen further to 4.2 percent against 3.8 percent forecast by the government while announcing the federal budget in June," he said.

"We expect revenue collection from northern areas to decline down significantly as government might announce tax breaks for the affected areas," he added. Since the major residential areas and road network in Muzaffarabad, Balakot and Mansehra are completely destroyed; there is a need for major re-construction in these areas.

"We believe a sizable chunk from Rs 306 billion PSDP would now be diverted to reconstruction of these areas. Overall, this will have a positive impact on cement in terms of higher demand," Aslam said.

However, the cement demand for reconstruction of the affected areas would start picking up pace at least after 3-4 months. But in the very short term, this may halt construction activities in major cities and manufacturing activities at cement plants located nearby the affected areas (Bestway, Fauji, Fecto, Askari and Dewan Hattar Cement) owing to shift of labor force. Analysts believed this bears fruit for all cement manufacturers equally (depending on production capacity) owing to a fair distribution of domestic demand among all cement manufacturers under the cartel arrangement where Lucky and DGKC are likely to get a bigger slice from the pie.

The earthquake is likely to have a positive impact on consumer marketing companies. The complete destruction of food supplies and cattle in affected areas will increase immediate demand for packed products (to be given as aid) in these areas. "It is a national loss as thousands of people have died and an equal number of human bodies remain under the tons of rubble," said Tariq Hussain Khan, research analyst at Atlas Investment Bank.

It was an unlucky morning when large areas in Islamabad, NWFP, Pakistani Kashmir and northern zones were adversely struck by the earthquake.

Rescue operations have begun to provide relief to needy people in devastated areas. Several foreign expert teams have joined hands with local rescuers and more rescue teams from abroad are expected to arrive soon.

In initial response, leaders around the world sent their condolences and extended support with financial assistance. The government has also announced Rs 5 billion for relief efforts. It is premature to estimate an initiate loss on account of the earthquake.

"We have no data to anticipate how this devastation may slow down economic growth. However, banking and cement sectors may show grater activity due to reconstruction of destroyed homes and other government properties," Hussain said.

Tanvir Abid, head of research at Live Securities said that in the aftermath of the earthquake, substantial foreign exchange inflows are expected from abroad in the form of aid receipts, casting a strengthening effect on the rupee.

In the short-run, the government may also refrain from further tightening the monetary stance (despite prospects of mounting inflation) in order to thwart a potential slowdown in the economic growth momentum.

The stock market fundamentals remain unaltered in the aftereffects of the quake, which could be gauged from the first session on depression and the index gained over 350 points. With sector and company specific fundamentals intact in the fuel and energy, cement, banking and textile sector, the overall activity in the market is expected to mobilize fresh investment from institutions and some foreign fund managers.

"We need more help," Prime Minister Shaukat Aziz said in a interview to foreign news agency. The country needs more financial aid, tents, blankets, medicines and construction equipment, he said.

The death toll is expected to rise as the army and relief workers reach remote villages and more bodies are pulled from the rubble of flattened cities like Muzaffarabad, the capital of Pakistan-controlled Kashmir, and Balakot, the main centers closest to the earthquake, he said.

US Secretary of State Condoleezza Rice visited Islamabad to demonstrate solidarity for Pakistan's earthquake victims, meeting with Musharraf for about 30 minutes at a military airport in Islamabad where the wounded were being treated and supplies were being unloaded from aircraft. "The American people are moved and saddened by what has happened,'' Rice said alongside Musharraf. ``We stand behind the people of Pakistan."

The United Nations appealed for $272 million to fund relief work. About 4 million have been rendered homeless, according to latest official estimates.

"The rescue and rehabilitation is a challenge of unseen proportions," Aziz said. The Kashmir town of Muzaffarabad and Balakot in NWFP are the most affected, he said. Damage will run into hundreds of millions of dollars, he said. Initial estimates on the cost may be available next week. The region affected by the earthquake contained mostly Small and Medium Enterprises (SMEs) and minor agricultural commodities (fruits, dry fruit and timber). Most of the entities of the region have not suffered any significant damages. The region is a major labour supplier throughout Pakistan as well as abroad. "The net direct contribution of the region is not significant enough for us to down-grade our growth expectations for FY06. However, the indirect impact of the damage is hard to compute at the moment. Thus there can be a dent in the growth depending on the net outcome. However, we deem that the GDP growth will still hover around the 6% mark in FY06,'' said Khaldoon Bin Latif, economist at AKD Securities.

One of the points discussed in the Armitia Sen's Nobel Prize winning paper 'Food entitlements' was that when a sub-economic unit is struck by a natural disaster and if the market is not restored quickly enough, its impact trickles to dependent economic units i.e. neighboring villages. Thus the economic impact of the disaster trickles to other regions, until and unless the markets are quickly restored. This means that the GoP after the initial rescue operation needs to restore these markets as quickly as possible as opposed to creating rehabilitation camps (refugee camps) to avoid misallocation of resources that create a more detrimental spiral impact from the natural disaster to their co-dependent markets.

"We have seen economies recently hit by hurricanes and tsunami have suffered shocks in the short run, however, these countries have not deviated significantly from their medium-term growth trend," Khaldoon said. "We expect similar economic recuperation in Pakistan."

None of the affected economies opted to respond to the shock with accommodative monetary stimulus as a result we do not expect SBP to loosen monetary policy either. The SBP to allow higher liquidity in the system in the short term and the cutoff yields will be maintained at their current levels in the 1HFY05. There is also a possibility that the government might offer concessionary loans to the victims of the natural disaster.