The central bank releases the first quarterly report for the current financial year

Jan 06 - 12, 2003

After reading the first quarterly report for the financial year the critics of General Pervez Musharraf must accept that he has succeeded in fulfilling his commitment with the nation. Apart from the other many problems faced by the country, there two very pressing needs: 1) saving the country from potential default on its external payments and 2) revival of the economy. On the first front the country has achieved a level whereby foreign exchange reserves exceeds US$ 9 billion. The revival of economy is also evident from increasing import of plant and machinery. The improvement in economic activities is supported by the higher GDP growth rate achieved as well as increasing exports.

There has been very strong criticism that despite the improved economic performance the benefits have not trickled down to masses. With the installation of an elected government the pressure has also increased that the government must come out with populist policies. However, the Report clearly warns against following such policies. It says, "the induction of the newly elected government has generated expectations in some quarters that fiscal discipline, institutional restructuring, social economic policies and good governance practices pursued during the last three years will gradually give way to more populist policies. This, if it happens, will be most unfortunate."

The report, most probably for the first time, raised the apprehension that the official statistics understates the true improvement, particularly of the large-scale manufacturing (LSM). This point has come up due to the weak growth recorded by the LSM, and the (apparently complementary) lower net credit from banks, relative to first quarter of year 2002. It is puzzling and inconsistent with the behaviour of other aligned indicators such as corporate earnings, manufactured exports expansion, domestic sales tax collections and import of machinery and raw materials.

On the external account, remittances spearheaded the remarkable US$ 1.296 million improvement in current account. This was strongly supplemented by the large payments by the US for logistic support. The strong and growing remittances appear to support the view that these flows are durable, being driven by the switch of inflows from the informal to the formal markets as well as the absence of capital flight through the informal sector. Although the trade deficit figure saw little change in absolute terms, exports grew strongly on the back of substantial increase in both volumes and unit prices of key textile products. While imports also increased by about 11 per cent, non-food and non-oil imports dominated this increase, suggesting industrial revival.

The Report has rightly warned by stating, "In the short-term, key textile exports to important markets are threatened by possible anti-dumping actions and import restrictions based on allegations of over-programming of quotas in key categories." The Report also says, "If the current account inflows into Pakistan are sustained, the Rupee will inevitably strengthen further; in such environment, export growth will require increasing focus on enhancing efficiency and value addition. Over the longer term, the need to diversify the export base and export markets and productivity gains, should remain the focused areas."

The central bank continued its support for only gradual appreciation of Rupee and accumulation of forex reserves by mopping up excess liquidity in the interbank market. The liquidity injections due to the forex purchases were largely mopped up through T-bill auctions and to retire holding of government papers. This effective sterilization of the SBP interventions was made possible by the fact that the government did not need to utilize the higher banking sector borrowings to finance the budgetary deficit.

It is note worthy that interest rates for all tenors remained below the corresponding auction yields throughout the quarter, testifying to the market expectations of an interest cut. These market expectations were realized in November 2002, with the SBP reducing the discount rate by 150 basis points to a new all time low of 7.7 per cent. The SBP timed this decision when it became obvious that inflationary pressures remained subdued, private sector net credit from commercial banks was not picking up, government demand for bank borrowings was lower than expected, the differential between domestic and international rates had widened.

Exceptional growth in tax receipts aided by fiscal discipline kept the overall budgetary deficit for the quarter at approximately one per cent of GDP. This was achieved by: 1) tax and non-tax revenue collection was substantially higher, 2) growth in expenditure was contained and 3) the resulting lower budgetary deficit was mostly financed by external and domestic non-bank borrowings. This allowed a net retirement of banking sector borrowings, helping contain inflationary pressure.

Pakistan is poised for achieving higher growth, new employment opportunities and poverty reduction. This required that on going reforms and privatization must continue and revenues should not frittered away on subsidies. The next phase of reforms should be aimed at developing infrastructure and larger spending on health, education and capacity building. Monetary and credit policy should be geared to channel banking sector resources towards agriculture, small and medium enterprises, housing, consumer finance and micro credit. Increased public sector investment and higher private sector credit is the key to revival of growth, employment generation and poverty reduction.