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The positive factors expected to have a bigger say in Pakistan's medium-term prospects

Nov 26 - Dec 02, 2001

Pakistan's decision to support the US-led coalition and its frontline status has significantly enhanced the country's vulnerabilities to additional risks and costs. A number of factors are expected to put pressure. These include: increase in cost of imports and made in Pakistan products, manufacturing units to maintain higher inventories and disruption in exports. revenue collection to also suffer due to lower imports and influx of Afghan refugees to add further pressure on Pakistan's limited resources.

However, it is difficult to conjecture how long negative trends will continue. The more protracted crisis is expected to exacerbate the situation. Under this scenario, exports may decline significantly, foreign investment flows be low and output losses to adversely impact GDP growth rate. The World Bank has already hinted that growth in developing countries could be 1/2 or 3/4 percentage points lower than projected. Applying this to Pakistan's frontline status implies that GDP growth in current financial year could be in the range of 2.5 to 3.75 per cent. A number of factors, particularly debt related and better market access to Pakistani exports, are expected to have positive impact. However, these issues have yet to be discussed, negotiated and settled. Larger flows of hard currency are expected to allow the central bank to shift away from purchase of dollar from kerb market and help in bridging the external gap by using more conventional measures.

Pakistan's economic performance in last financial year was characterized by government's efforts to bring macroeconomic fundamentals back on-track. The fiscal deficit was contained within its targeted level, inflation was low, current account was in surplus, foreign exchange reserve accumulation was satisfactory and government borrowing from the banking system was within manageable limits. Pakistan completed its Standby Arrangement with the IMF and established credibility with the international financial institutions. However, restrained expenditures and efforts to increase revenues lowered purchasing power, the corresponding need to reduce the element of subsidy in utility bills also added to this issue.

The policy steps required to address underlying structural problems altered the incentives structure for the private sector. Although this was expected given the nature of the stabilization programme, poor agriculture growth compounded the problem since the country was unable to meet its aggregate growth target for the year. The aggregate growth rate was only 2.6 per cent for the last financial year as against a target of 5 per cent. Private sector investment was stagnant despite declining interest rates. Privatization drive also did not yield desired results.

Persisting drought conditions did not allow the agriculture sector to even show positive growth. The impact on water-intensive crops like sugarcane and rice compounded the problem. Risk diversification in the rural sector encouraged strong growth in livestock. However, this was insufficient to shore up the agriculture sector. Value added by agriculture declined by 2.5 per cent against a target of positive 2.6 per cent. The saving grace was large-scale manufacturing (LSM). With full growth of 8.4 per cent, the growth was broad based, but still spearheaded by sugar, vegetable ghee and cigarette production. Petroleum refining, leather and automobile sectors also witnessed strong performance. However, textiles which has the largest share in LSM did not performed well as compared to 1999-2000.

In the external sector, the two noteworthy outcomes were: 1) for the first time in history, Pakistan was able to post a current account surplus of US$ 331 million and 2) the rupee/dollar parity depreciated by 18.6 per cent the largest adjustment since 1981-82 when the rupee was moved to a managed float. In terms of the surplus, although the narrowing of the trade deficit helped, the swing factors were SBP's dollar purchase from kerb market and the recognition of the Saudi oil facility as an official transfer (grant). Pakistan's BOP experienced a windfall improvement for the past three years, with a surplus in 2000-2001. However, this improvement in the external gap did not ease pressure on rupee.

The adverse impact of drought conditions were also reflected in Pakistan's external sector. Additional oil imports were needed to compensate for reduced hydel power generation. Nevertheless, despite an unprecedented oil import bill of US$ 3.4 billion, the realized trade deficit was brought down from US$ 1.4 billion in 1999-2000 to US$ 1.2 billion in 2000-2001. Except for oil and textile machinery, all other imports declined in 2000-2001.

Pakistan's monetary policy faced some conflicting goals. On the one hand, there was need to shift government borrowing from SBP to banks. On the other hand, efforts to increase private sector investment pushed in the opposite direction. Even with the increase in liquidity, total M2 growth was below the target.