Pakistan's economy in the short run faces the risk of a continued widening of the current account deficit and difficulties in taming persistent inflation.

SHAMIM AHMED RIZVI, Bureau Chief, Islamabad
Dec 25 - 31, 2006

Pakistan's economy tuned in a strong performance for yet another year (2006), as the real GDP growth of 6.6 remains higher than the desired long-term average of 6 percent. This was supported by strong growth in private investment, foreign trade as well as remittances by overseas Pakistanis. GDP growth may rise to 7 percent by the close of financial year helped by a recovery in agriculture and industry as well as another year of robust performance by the services sector.

There is almost a consensus on these points in various reports and analysis, including IMF, World Bank, State Bank of Pakistan and independent economist. However, all such reports highlighting certain positive trends have pointed out certain grey areas, which if not checked speedily and effectively, may pose serious threat in the near future. This does not augurs well for the year 2007.

The World Bank in its outlook on Pakistan, based on the latest economic results, has indicated major risks facing the economy. The major focus of the report has been on fiscal and current account deficits, inflation, poverty and structural bottlenecks. It is not surprising that the report sees serious challenges on almost all fronts as in the short term in particular. The economy is faced with the risk of continued widening of the current account deficit and the persistent inflation.

Based on the current trends, the report envisages trade deficit at 5.5 percent of GDP and inflation at 7-7.5 percent for the current fiscal year. It shows that the government strategy to overcome inflation and trade deficit in recent months has been a failure as there has been no visible improvement in this regard. It is further worrisome to see that inflation has continued to remain high despite concerted efforts on the part of the State Bank in this regard specially in prices of food items, which ranged between 12 to 13 percent during the second half of the ongoing year despite all rhetories of the government to contain it.

The IMF report signaled 20 percent downward move in rupee value. In plain words it proposed devaluation of rupee by 20 percent. A former Pakistani Vice President of the World Bank Mr. Burki, in a recent television interview from Washington, also objected to keeping the rupee value fixed for a long time. The fixed dollar rupee parity in his view was hurting country's exports, he argued.

The IMF report said that trade deficit of the country has increased manifold which might jeopardize the macro economic stability. The report called for transparent utilization of national resources and implementation of elastic policies. It said sustaining high growth and poverty reduction through higher rates of saving and investment remained Pakistan's main medium term challenge, while the country's main near term challenge was to strengthen the balance of payments, particularly the external current account.

According to World Bank sources, Pakistan got a loan of $ 1.5 billion in the current year which was the fourth largest amount borrowed by any country in the world. This belied government claims of breaking bowl of securing loans. Based on current trends, World Bank projected that average inflation during the fiscal year 2006-07 would be in the range of 7-7.5 percent as against 6.5 percent target of the government.

The bank said the poverty rate by the end of 2004-05 stood at 29.2 percent, a decline of only five percent from 34.4 percent in 2000-01 and was well above 23.9 percent estimated by the government. The bank said its poverty estimate of 29.2 percent was just 0.8 percent better than 30 percent estimated in 1998-99 when President Musharraf assumed power.

Pakistan's economy in the short run faces the risk of a continued widening of the current account deficit and difficulties in taming persistent inflation. If first quarter trends in the trade balance continues, the current account deficit could end up in the range of 5 to 5.5 percent of GDP for the entire fiscal year. Over the first quarter of 2006-07, the trade deficit has widened by a further $ 3.2 billion in spite of a declaration of import growth to 13.4 percent. "A significant development is that over the first quarter, exports grew by only 2.8 percent to $ 4.3 billion," the bank said, adding that exports of both textiles and other goods declined. The textile exports, which accounted for 60 percent of country's exports, have declined and its market share has been claimed by Bangladesh and Cambodia, according to reports. July-November trade deficit has swelled to $ 4.51 billion and it is being feared that the current financial year may surpass the previous year's historic deficit of $ 12.2 billion. This is going to badly affect our foreign exchange reserves.

Over the first quarter of 2006-07, the current account deficit has increased to $ 2.7 billion, roughly equal to half the magnitude of the full year deficit in the previous year. "Inflationary pressures have continued to persist, but core inflation has started declining." The bank said in the current fiscal year, the reliance on domestic borrowing has increased, with government borrowing from the central bank reaching Rs. 86 billion at end of October 2006, an amount roughly equal to two-third of the amount targeted for the whole fiscal year.

The bank criticized the government for allowing institutional investors to invest in national savings to finance the deficit at a higher cost and said that the opening of NSS to the institutional investors might have an adverse effect on the stock market as mutual funds had begun switching out of capital markets to invest in NSS. Pakistan's tax system continues to under perform in fundamental ways," said the World Bank.

"The tax revenue at 10.3 percent of GDP remains low against government's spending needs. The revenue structure is heavily skewed towards indirect taxes, with six major items alone accounting for more than half of the total collection in indirect taxes. The World Bank pointed out that agriculture and services sector remain outside the tax net, depriving the system of additional revenue resources. Sub national revenue collection, the bank says, is weak, amounting to less than one percent of GDP. This is partly due to weaknesses in the tax policy, and partly due to limited incentives of the provincial governments to collect their own taxes.

There had been visible improvements in the economy before certain challenge in the shape of burgeoning twin deficits, higher inflation, higher interest rates and changing debt dynamics started to destabilize the system. Yet again It is believed that after a certain phase, the government needed to fine tune the economic policies to save the process from derailing. However, it did not happen and this procrastination resulted in damage to the economy, which was manifested in the shape of downslide in almost all the important macroeconomic indicators of the economy. Had the process of fine-tuning started in time, it would have made the situation much easier for economic managers.

It is strange that in spite of healthy growth, the economic fundamentals do not sound healthy. In the earlier phase when the government focused on restoring semblance of stability, it achieved great success, but then the focus shifted towards growth and it appears that our economic managers failed to realize the need of consolidating earlier gains in their exuberance to make Pakistan a fast growing economy in the region.

While most of these aggregates are easily verifiable, an intriguing aspect of the Outlook is the huge difference between the World Bank and the Pakistan government about the measurement of poverty level in the country. The government in its latest Economic Survey had given a pleasant surprise to the nation by revealing that poverty in the country had declined by 10.56 percentage points from 34.46 percent in 2001 to 23.90 percent in 2005. The extent of decline in urban and rural areas amounted to 7.79 percentage points and 11.6 percentage points, respectively. Figures of the World Bank, on the other hand, are much less encouraging. According to its estimates, poverty rate at the end of Fy05 stood at 29.2 percent, a decline of only about five percentage points from 34.4 percent in 2000-01. Moreover, the poverty estimate of 29.2 percent was just 0.8 percent better than 30 percent estimated in 1998-99 when President Musharraf assumed power. The poverty incidence in urban and rural areas in 2004-05 stood at 19.1 percent and 34 percent, respectively. This is not for the first time that policy makers of the country have been cautioned about the deteriorating trends in a number of key areas in the economy. Nor they can be so na´ve so as to be unaware of these unhealthy developments.

According to the World Bank, which used a survey carried out in 1997-98 for the data it provided, the bottom 10 percent of the population received 3.7 percent of national income while the share of the top 10 percent was 28.3 percent. The ratio between these two shares was 7.6 percent. In other words the rich had average incomes almost eight times as much as the average for the poor. Looking at the quintiles, the bottom 20 percent's share was 8.8 percent and that of the next segment was 14 percent. For the third quintile, the share was 15.9 percent; and for the upper 20 percent of the population it was 42.3 percent. This was the situation, which prevailed during 1997-98. Since then the equation has much worsened. According to independent economic analysts now about 80 percent of country's wealth and income is onward and shared by 20 percent of population, while 80 percent live on the remaining 20 percent.