Hopes and fears in the back of economic turnaround and rising inflation


Apr 25 - May 08, 2005


With the fast approaching federal budget 2005-06, only two months away, different segments of the trade and industry have started preparing proposals pinning hopes that they would be incorporated in the budget by the government.

These pre-budget proposals authored by small and large representative bodies of the trade and industry usually focused on a single point agenda seeking relief in taxes and duties. Some of these trade bodies get a success in convincing the budget makers and their proposals find way in the budgetary documents but the success in the form of relief directly goes into their own pockets and hardly passed on to the people!. To give an example of the trend, cement industry which was given a big relief in the shape of waiver of Central Excise Duty and drastic cut in their cost of production due to shift from oil to cheaper natural gas provided by the government, yet for no avail. Cement is being sold at the same old prices rather on higher prices. In order to get better results of good economic decisions taken by the government it should be tied up with the rider that any incentive given should pass on to the consumers.

It is because of the higher cement prices and other related materials recording mounting price inflation whξle growing real estate and the construction industry have started to show sign of decline. The real estate prices in Karachi are said to have come down by 30 percent mainly because of price spiral and bureaucratic hurdles in implementation of various government decisions.

As far as the common man was concerned, he apparently seems least bothered about the budget because it hardly carries anything for him. He has a pre-disposition about the announcement that no new tax is being levied in the budget which means that there would be no increase in the general prices. He, however, knows that prices would continue to rise throughout the year. The budget, however, carries an eye wash for the government employees in the form of some increase in the pay scales, hence they lend an ear to the budget speech.

Without any reservation, people are talking about strongly growing economic indicators and the economic turnaround in the country but with a touch of criticism instead of appreciating the efforts of the economic managers. Their criticism, however, seems justified to a great extent as they substantiate their arguments with the plea that what benefits they were getting out of the growing economy. The price inflation, in the back of unprecedented rise in petroleum prices and unaffordable electricity prices causing a widespread impact on the general prices, which has formidably entered in double digit zone. The Consumer Price Index (CPI) indicates 10.25 percent inflation in the month of March 2005.


We, however, should see the mounting inflationary pressures in isolation, the sharp pick up in commodity prices and unprecedented rise in international price of oil leading to the re-emergence of inflationary pressures across the globe. Perhaps, China is currently witnessing the highest inflation during the last seven years. The trend is also witnessed in Taiwan, Thailand and India suffering highest inflation in six, five and three years, respectively. Though the economic managers had succeeded to contain inflationary pressures by keeping low at 4.0% environment for the last five years (official figures).

Pakistan is currently witnessing higher inflation for a variety of reasons. The persisting inflationary trend in Pakistan is the outcome of pressures emanating from growing demand and supply side. Two and a half years of strong economic growth (5-7%) have given rise to the income levels of various segments of the society.

Whether is right or wrong but it is said that the rising levels of income have strengthened domestic demand and put upward pressures on prices of essential commodities. Besides oil prices and expansion in credit to private sector were other factors putting fire to the inflation.

The prices of other food items such as beef, mutton, chicken etc. also registered sharp increases owing to 'sympathy effect' on the one hand and demand pressure on the other. In addition to the demand and supply side pressures the base effect is also responsible for the current higher level of inflation. It may be pointed out that current inflation is being measured from a very low base of last year.


The distribution of private sector credit remained broad-based during the first half of 2004-05. The bulk of credit went to the manufacturing sector (52.2% or Rs127.5 billion) followed by consumer financing (15.9% or Rs39 billion), commerce (11.4% or Rs27.8 billion), services (8.3% or Rs20.3 billion) etc.

The up gradation of textile sector — the mainstay of the domestic industrial activities — continued through the employment of imported machinery and as such, its credit off-take increased by 25.4 percent to Rs94.4 billion. The dominance of the textile sector can be gauged from the fact that its credit off-take accounted for 39 percent of the total credit off-take and 75 percent of the total credit utilized by the manufacturing sector.

Credit to agricultural sector (on gross basis) by scheduled banks continued to exhibit rising trend as their combined credit disbursement grew by almost 50 percent to Rs49.1 billion during the first half of the current fiscal year. Commercial banks remained the lead providers of credit to the agricultural sector. Their combined credit disbursement grew by almost 75 percent to Rs28.5 billion while their share in total credit disbursement increased to 58 percent as against 49 percent in the same period last year.

By looking at the pace of agricultural credit disbursements, it appears that the current fiscal year may end up with Rs100 billion credit disbursements-feet targeted to be achieved by the end of the next fiscal year (2005-06). The developments on growth and inflation front during the first half of the current fiscal year necessitated to review the credit plan for 2004-05.

Accordingly, the SBP has not only revised the credit plan but also changed its monetary policy stance from 'accommodative' to 'neutral' with commitment to continue supporting investment and growth. Money supply is now projected to grow by 14.5 percent or Rs360 billion, mainly on account of supporting higher credit disbursement to private sector (Rs350 billion).


The SBP continued to pursue a relatively easy monetary policy during the last three years with a view to inducing banks to reduce their lending rates in order to provide low-cost credit to private sector and as such, promote investment and spur growth. The weighted average lending rate which was as high as 13.97 percent in June 2001 declined to 7.58 percent in June 2003 and further to 5.05 percent in June 2004 — a decline of 892 basis points in 3 years. The weighted average deposit rate also declined substantially during these periods.

It was 5.0 percent in June 2001, declined to 1.9 percent in June 2003 and further rises to 1.21 percent in June 2004 — a decline of 379 basis points in 3 years. It may be noted that the decline in lending rate was much higher than decline in deposit rate. Accordingly, the spread (difference between average lending and deposit rate) shrunk from 8.97 percent in June 2001 to 3.84 percent in June 2004.

The spread is one of the best yardsticks to measure the efficiency of the banking sector. Therefore, a substantial decline in spread represents significant improvement in the efficiency of the banking sector in the last 3 years. The 6-months T-Bill yield serving as benchmark for the short-term interest rate also declined significantly during the last 3 years, reflecting the presence of massive liquidity in the banking system. The 6-month T-bill yield was as high as 12.88 percent in June 2001, declined sharply to 1.66 percent in June 2003 but move slightly upward to 2.08 percent in June 2004 — a decline of 1080 basis points in 3 years.


Up by 10.5 percent in the first six months (July-December) Pakistan's exports for the current fiscal year — rising to $6495.9 million from $5881.0 million during the same period last year. The increase in overall exports has come almost entirely from the non-traditional export items accounting for 98 percent of the increase followed by 11 percent from other manufacturers and 6 percent from primary commodities exports, while textile manufactures contributed negatively by 15.6 percent to the increase in exports.

Exports of textile manufacturers declined by 2.5 percent but within the textile group the more value-added items such as knitwear and towels registered an impressive growth of 41.3 percent and 20.2 percent, respectively.

It may be noted that exports of knitwear and towels are also up by 28.9 percent and 23.4 percent, respectively in quantity terms. Bed wear exports have registered a decline of 23.0 percent in value and 18.5 percent in quantity. Other manufacturers exports are up by 6.6 percent and within this category, exports of petroleum products, chemicals & pharmaceuticals, and engineering goods are up 79.3 percent, 11.3 percent and 29.2 percent, respectively. It may be noted that Pakistan has lost $57.6 million in export earnings because of the decline in unit values of its major export items. Had unit values remained at last year's level the export growth would have been 11.4 percent instead of 10.5 percent during July-December 2004. It is also important to note that the increase in exports is almost driven by the rise in unit values.


Pakistan's imports are up 34.8 percent in the first six months of the current fiscal year — rising from $6604 million to $8905 million. The extra-ordinary increase in imports owes mainly to strengthening domestic demand and higher prices of crude oil and petroleum products. The surge in domestic demand fueled a 36 percent increase in non-food and non-oil items.

In particular, imports of machinery, chemicals, metal group (iron and steel) and textile group are up 33.6 percent, 37.5 percent, 49.2 percent and 24.8 percent, respectively as domestic investment has come back to life owing to stronger domestic and external domain.

The machinery and chemical groups alone account for 44 percent of total import, clearly reflecting the growing level of domestic investment

Rising prices of international oil are a major negative area for Pakistan.

The unprecedented rise in oil prices has struck the economy at a time when domestic demand is showing signs of acceleration as imports of both crude and petroleum products are up by 25.1 percent and 14.0 percent, respectively in quantity terms, pushing the total oil import bill up 37.9 percent to $1869.8 million in the first six months of the current fiscal year. Accordingly, the share of oil import bill in total import has risen to 21.0 percent from 20.5 percent in the same period last year. Both quantity and prices are responsible for the surge in imports as 61 percent rise is accounted for quantity while the remaining 39 percent is due to the rise in prices of major import items.


Pakistan's trade deficit is likely to widen beyond target for the current fiscal year owing to a much faster increase in imports than exports. During the first six months (July-December) of the current fiscal year, trade deficit amounted to $2409.1 million or 80 percent of the full year target of $3.0 billion and up sharply from $723 million in the same period last year. According to current estimates, it is said that the trade deficit may touch the level of $6 billion at the end of the year.


Due to the widening of trade deficit the current account balance (excluding official transfers) was in deficit to the extent of $909 million during July-December of the current fiscal year as against surplus of $1411 million in the same period last year. However, inflow of private transfers has raised from $2806 million to $4109 million — an increase of 46.4 percent. Given the trends in exports and imports there are indications that the current account balance may end up with a deficit of around 1.3 percent of GDP in 2004-05.


The corporate sector in Pakistan must be the happiest segment of the economy in view of the tremendous growth achieved during the current financial year. The sturdy financial results of the corporate sector, however, helped the revenue collection efforts of the government not only to hit the target of Rs580 billion but collect additional revenues of Rs10 billion revising the target to Rs590 billion for the financial year ending June, 2005. On one hand, the higher oil prices in the international market helped the oil marketing companies on inventory gains while on the other hand increase in oil consumption gave a quantum jump to their sales and profits.

A review of the financial results of the petroleum sector indicates huge profits made by the oil companies operating in Pakistan.

According to market sources, Shell Pakistan's financial results for the nine months ended March 31, 2005 showed a phenomenal growth in earnings to Rs1.60 billion as against Rs0.81 billion during the corresponding period of last year.

This translates into an Earning Per Share (EPS) at Rs45.63, 97% higher compared to Rs23.20 previously. Sales marked a 27% increase and gross margins improved by 142bps. Shell Pakistan has attributed the improved profitability to better product mix and higher international oil prices. Volumes saw an industrial decline in motor fuels as a result of extended period of rains in the country. Shell has also stated that the aviation business continues to show a growing trend and volumes in the current quarter show an improvement of 20% from the same period last year. This is mainly the consequence of higher exports during the current quarter.

Shell's profitability during last 9 months of the financial year has received a considerable up-lift on the back of the approx. 23% increase in petroleum prices since December 2004. An increment in petroleum prices leads to inventory gains and translates into higher rupee margins. After freezing oil prices for almost seven months, the government finally decided to lift the cap in mid-December in order to recoup its budgetary losses. International crude prices have considerably mounted on the back of global demand-supply imbalances with the price outlook going forward extremely upbeat.

According to financial experts, Pakistan Petroleum Limited July-March 2005 earnings estimated around at Rs6.32 billion (EPS: Rs9.22), which is to mark a considerable YoY growth. Last year's corresponding figures are not available. PPL's profitability growth is to result from the combined effect of surge in gas production and higher gas prices. The gas prices for PPL's two main fields, Sui and Kandhkot are revised every six months and follow the crude oil price trend. Gas well-head prices have mounted ensuing from the buoyant global oil price trend. PPL's gas production during FY05 has been boosted on the back of higher output from the company's joint venture gas fields. During the half-year ended December 2004, the company's sales volume of natural gas was up approx. 7% to 155,662MMcf. PPL's earnings for the half-year ended December 2004 amounted to Rs4.05 billion, 47% higher. The Company also announced Rs2.5/share interim cash dividend. Regarding PPL's exploration activities, the company is a working interest owner in 14 exploration blocs of which 8 (including 2 offshore blocs) are company operated and the remaining 6 are partner operated.

The Pakistan Oilfields (POL) another active player in the energy domain made windfall profits during the year. POL is to immensely benefit from the continuous rocketing of international oil prices, as crude oil has the highest contribution to the company's revenues. Despite the recent softening of oil prices, the outlook going forward is robust ensuing from mounting global consumption and geopolitical turmoil in oil producing regions.

POL earlier this month communicated that it had successfully completed drilling of Pariwali well No. 5 in the Pariwali D&P lease. The announcement stated that the well test oil and gas from two horizons. On production, testing after acidizing, the well flowed 2786 barrels of oil and 21m cubic feet of gas at a choke of 36/64" with a Well Head Flowing Pressure of 4242 psi. Production has commenced from this well and presently the production is 1774 barrels of oil and 10.5m cubic feet of gas along with 17 million tonnes of LPG.

As extended testing continues, the well has the capacity to produce 2,500 barrels of oil and 20m cubic feet of gas. POL is the operator of Pariwali Field with 82.5% working interest. The well is expected to increase oil and gas production by 20% and 35% respectively. Thereby a significant impact on the company's revenues and earnings was expected.

Kot Addu Power Company Limited (KAPCO) another profit making player has announced Rs3.5/share interim dividend along with its 3Q/FY05 financial results. The company's earnings during the nine months ended March 2005 stood at Rs4,748 million as against Rs3,766 million during the corresponding period of last year.

Recently, the government had offered 20% of its share holding (176m shares) of KAPCO at Rs30/share. Being an Independent Power Producer (IPP), KAPCO's earnings and cash flows are determined by the scalable component of the capacity purchase price of the tariff. A major advantage of KAPCO over other IPPs is that this element is to remain flat from year three onwards.

Pakistan Telecommunication Company Limited (PTCL) July-March 2005 earnings, according to market reports was estimated at Rs21.57 billion (EPS: Rs4.23), 10.5% higher compared to Rs19.53 billion (EPS: Rs3.83) during the corresponding period of 2004. PTCL's profitability growth is to result from the cumulative impact of significant additions in the fixed line network, beneficial implications of the successive tariff re-balancing packages, higher call traffic and provision for value-added services. During 1H/FY05 the company provided 0.66m new telephone lines. During 1H/FY05, PTCL's profit after taxation at Rs14.52 billion showed a 9.4% growth.


Looking at the global cotton situation, the International Cotton Advisory Committee (ICAC) states that cotton supply and demand are reaching historical highs in 2004/05. Production is estimated to soar to an all-time high at 25.9m tonnes, up 5.2m tonnes (25%) from the previous year. World cotton mill use is expected to mount 8% or 1.7m tonnes to 23m tonnes. However, at the same time as production is to largely outpace consumption, world ending stocks are also projected to improve to 10.7m tons by end-July 2005, the highest in six seasons.

In a significant move, the government has raised the phutti or raw cotton support price to Rs975 per 40 kg for the 2005-06 seasons. The move seems to be aimed to encourage cotton cultivation by the farmers after the slump in cotton prices during the prevailing season. Textile sector margins during FY05 have received a considerable uplift on lower cotton costs. Average mill cotton costs this fiscal year have ranged between Rs1,800-2,000/MD, almost 40% lower compared to the levels prevailing during FY04. The huge domestic cotton crop (final figures around 15m bales) as well as the softening price trend internationally resulted in the plummeting of domestic cotton prices.

Meanwhile, earnings of the textile sector during the quarter ended December 2005 depict a healthy picture. Revenues and gross margins of leading companies mark a significant YoY improvement.

Looking at the performance of the prominent textile units, the gross margins of Nishat Chunian, Nishat Mills and Azgard Nine respectively improved by 11.1, 5.4 and 2.8pps. Similarly, the margins of Colony Textiles, Tata Textile and Samin Textile rose by 2.7, 8.6 and 3.9pps respectively.

Almost all of these companies showed double-digit growth in revenues with Nishat Chunian's and Colony Textile's sales soaring by 36% and 32%. Azgard Nine's sales were up nearly 16% on higher exports and impact of capacity additions.

According to ICAC, the Cotlook A Index will average 53 cents per pound this season, 22% lower compared to 68 cents per pound during 2003/04. The ICAC estimates that world production is to decline by 10% to 23.2m tonnes in 2005/06. At the same time, a firming up of prices is likely to curtail the rate of growth of mill use to 2.5%. International cotton trade is forecast to soar by 15% or one million tonnes to reach a record of 8 million tonnes in 2005/06.


An overall view of the national economy portrays a rosy picture. Exports are well poised to pass over the target; growing imports an indication of vibrant economy, revenue collection seems to yield beyond the target, cash flows from external resources are also improved. The agriculture has lent a strong hand by producing record 15 million cotton bales and 22 million tonnes of wheat. The large scale manufacturing sector coupled with strong corporate results are enough to raise hopes that the economy has some good news in the store to be announced on the occasion of the forthcoming budget especially regarding relief in POL and electricity prices.