IMF PROGRAM & ECONOMIC SLOWDOWN

SYED FAZL-E-HAIDER
Apr 20 - 26, 2009

Pakistan's entry into an International Monetary Fund (IMF) program has caused a significant economic slowdown and the government is facing a major challenge in managing a slowing economy. Experts say that the government's ill-conceived policies under IMF dictates has stagnated the growth and consequently closure of industries is drying up government revenue. India has recently slashed its base repo rate by 50 basis points to 5 percent in an attempt to counter the sharp slowdown in the Indian economy. The analysts expect that the state bank of Pakistan (SBP) will reduce the discount rate in its monetary policy statement for the final quarter of the current fiscal year. Expectations range from as low as 50 basis points to as high as 150 basis points. A big reduction in discount rate is not being expected, as inflationary pressures are still there. Reduction in discount rate by 200 basis points would be essential to provide relief to the ailing industry and trade.

Referring to the post-IMF assistance outlook, the central bank in its second quarter report said macroeconomic stabilization program is working as fiscal deficit has reduced and tight monetary policy has helped control inflation. Domestic inflationary pressures have eased over the past six months as all price indices have recorded a downward trend.

"While inflation is still very high (over 19 per cent), there is expectation that it will decelerate sharply in final (April-June) quarter," the report said, adding fiscal deficit as percentage of GDP has come down to 1.9 per cent during Jul-Dec 2008 from 3.4 per cent in same period of previous year.

Under IMF dictates, the central bank raised discount rate to 15 percent in November 2008, and kept it unchanged in its monetary-policy statement on January 31. Despite high interest rate, the core-inflation remained at a higher side clearly indicating that this policy did not yield the required results. In February, the inflation rose after declining month on month for three months after hitting a record high of 25 percent last October.

"The central bank will calibrate monetary policy to balance concerns about the slowdown in economic activity, subject to the overall objective of lowering inflation," according to the letter of intent released on IMF website.

The IMF is still emphasizing the country to keep the high interest rate unchanged until inflation falls decisively and to move forward with regard to tax reform. Analysts however believe that high interest rates are the main reason behind the fall in the country's industrial output. Poverty level would increase in the coming days as dependence on IMF would hurt economy.

The country's industrial output plunged by 5.35 percent during July-January period of current fiscal year over the corresponding period of previous year, according to the FBS.

The downfall in auto, textile, electronic, petroleum and other key sectors adversely affected the performance of large scale manufacturing (LSM), which was slumped by 8.91 percent in January. Exporters fear that situation might aggravate in the summer when the power outages become a routine. In view of the current situation, the growth target of 6.1 percent for the current fiscal appears impossible to be achieved.

Over 50 percent of the country's LSM sector comprises food, textiles and apparel and leather industries. The analysts believe that high interest rates, power outages and high cost of utilities and raw materials are the main reasons behind the fall in the industrial output. Higher interest rate is a big cause of concern for local exporters. Critics say that while other countries of the world are cutting down their discount rates to boost the economic growth, Pakistan has raised policy discount rates despite the negative growth in the industrial production.

Large-scale manufacturing (LSM) has recorded a sharp decline of 4.7 per cent during July to December period for fiscal 2009 against 5.2 per cent growth in the same period last year, according to the central bank. In its second quarter report, the central bank attributed this decline to intensified energy shortages, rise in input cost and lower domestic and external demand. Growth of services sector, which contributes biggest share of 53 per cent to GDP, slowed as wholesale and retail sub-sectors took the hit of economic slowdown, the report said. Targeted growth of services sector is 6.1 per cent in fiscal 2009 down from 8.2 per cent of previous year.

In February, IMF revised the target of gross domestic product (GDP) growth from 3.5 percent to 2.5 percent for the ongoing fiscal year. The country slashed total volume of Public Sector Development Programme (PSDP) for the current fiscal year by Rs108.9 billion to Rs 262.1 billion from Rs 371 billion due to financial constraints. The government released Rs 71 billion in the first six months (July-December) of the current financial year against Rs 132.6 billion in corresponding period of last year. The government has already excluded 120 projects from monitoring network and has revised monitoring targets from 705 projects to 580 projects for the current financial year.

The country's tax system still needs to be reformed and more sectors need to be brought into the tax net to achieve a tax-to-GDP ratio at 16 to 17 percent, which is currently at around 10 to 12 percent. The experts consider low tax base a real challenge to the government and deem it imperative to bring non-taxpayers into the net. The revenue target seems harder to be achieved, as Federal Board of Revenue (FBR) could collect only Rs75.98 billion in February, against a target of Rs87 billion. There is a shortfall of Rs11 billion, hence the FBR needs to collect around Rs150 billion each month from March to June to meet the target. Another serious issue for Islamabad is to manage the fiscal deficit in the presence of massive revenue shortfall.

The slump in the industrial sector has led to a decline in revenue collection and slowdown in exports proceeds. The country needs an average tax collection growth rate of 12 per cent each month from March to June to achieve the tax collection target of Rs1,300 billion for the current fiscal year. The revenue target seems harder to be achieved, as Federal Board of Revenue (FBR) could collect only Rs75.98 billion in February, against a target of Rs87 billion. There is a shortfall of Rs11 billion, hence the FBR needs to collect around Rs150 billion each month from March to June to meet the target. The experts consider low tax base a real challenge to the government and deem it imperative to bring non-taxpayers into the net.

Global economic recession has also taken toll on the country's economy. Textile exporters are likely to suffer a loss of Rs.4.8 billion, as foreign firms in the United States, European Union and Russia have refused to take Pakistani textile products due to global economic recession. With dampened external demand for its exports, an inflated import bill, and low investor confidence, the country needs additional assistance from the international community to restore economic stability and bring its economy back to a higher growth path.