SBP - THIRD QUARTERLY REPORT - ECONOMY ON COURSE TO RISE

MARIAM NASIR
June 04 - 10, 2007

The SBP released its third quarter report on the state of Pakistan's economy in the previous week. According to the State Bank, the economy is on course to comfortably achieve the GDP growth target in the range of 6.8%-7.2% on the back of better performance from the agriculture sector and continued strength in the services sector. Though growth in the manufacturing sector may be below target it would still be better than last fiscal year numbers. On the downside, inflation is projected to remain between 7.5-7.8%, well above FY07 target of 6.5%. Further, strong growth in money supply (M2) is another area of concern as it could eventually ignite demand side inflationary pressures in the economy. The fiscal deficit is expected to remain at 4.2% of GDP, as targeted, due to solid growth in CBR revenues. However, current account deficit, now forecasted at 4.8% of GDP, would significantly breach the initial estimate of 4.3% due to rising trade and income account deficits.

INDICATORS

(UNIT)

FY06A

FY07T

FY07E

GDP Growth

(%)

6.60

7.00

6.8-7.2

Inflation

(%)

7.90

6.50

7.5-7.8

M2-Growth

(%)

15.20

13.50

14.5-15.5

Fiscal Balance

(%)

(4.20)

(4.20)

(4.20)

Current Account Balance

(%)

(3.90)

(4.30)

(4.80)

Exports

(US$Bn)

16.60

19.80

17.60

Imports

(US$Bn)

25.00

27.40

27.20

A-Actual, T-Target, E-Estimated

GDP GROWTH

Recent Statistics indicates that the Pakistan's economy is likely to show robust growth for the fourth successive year, with real GDP growth rate now expected to exceed the 7.0% annual target in FY07 as against the achieved GDP growth of 6.6% in FY06.

INFLATION

Inflation for FY'07 is expected in the range of 7.5%-7.8% as against the initial target of 6.5%. Due to rising food prices both CPI and SPI measures of inflation recorded an increase. Inflationary pressure is particularly evident in headline CPI inflation which rose by 8.01% in the nine month period of FY07. As a result of the unexpected resilience of food inflation and likely pressure in near term due to increase in the prices of milk and edible oil, SBP forecast for the FY07 has been revised upward from 6.7% - 7.5% to 7.5% - 7.9%.

AGRICULTURE SECTOR GROWTH

Agriculture sector is expected to grow at 5% on the back of strong performance of major crops, especially wheat and sugarcane. The minor crops and livestock segments are also estimated to show good performance. The upward revision, in the production figures for cotton (the outcome of the third and final picking was better than earlier estimates) and sugarcane means that value addition by important major kharif crops grew 2.7 percent (in contrast to the marginal decline indicated by earlier figures). However, the most significant contribution to the improvement in the agricultural growth estimates was from the exceptional FY07 wheat harvest. The 23 million tons wheat harvest is not only well above the target of 22.5 million tons, it is the largest ever recorded in Pakistan. A rise in the area under cultivation for wheat, higher

SERVICE AND MANUFACTURING SECTOR GROWTH

The momentum in services sector is also expected to continue though growth would be lower compared to last year's stellar performance as slowdown in import growth decelerates expansion in wholesale & retail sub-sector. Manufacturing sector growth may be below target due to slower than expected expansion in large-scale manufacturing. However, compared to 9% increase in FY06, LSM growth should remain in double digits during the current fiscal year.

FISCAL DEVELOPMENTS

Government has indicated that it remains committed to achieving the fiscal deficit target of 4.2 percent of GDP for FY07. The strong growth in direct taxes seen in the first half of FY07 lends confidence that fiscal deficit would be well within limits.

MONEY AND BANKING

According to SBP the country will continue its tight monetary policy stance to offset inflationary pressures. The M2 growth, which has been showing gradual slowdown relative to the corresponding period till Feb 2007, accelerated sharply afterward to reach 12.1% during ten month period of current fiscal year compared to 10.8% rise during the matching period last year. The rise is mainly attributed due to strong government borrowing and rise in net foreign assets. SBP has revised its M2 growth projection to 14.5%-15.5% in FY07 as compared to the original target of 13.5% for the year.

FISCAL AND CURRENT DEFICIT

The report talks about the fiscal and current account deficit and mentions that both deficits need to be reduced While the third quarter report is largely restricted to FY07 economic outlook, SBP appears rather cautious about longer term outlook as manifested in its comment that "the long run health of the economy requires a lower sustainable current account deficit, concurrent with a rise in the domestic savings rate and a gradual reduction in the fiscal deficit".

BALANCE OF PAYMENT

Pakistan's current account deficit continued to widen during Jul-Mar FY07, rising to a record US$6.0b, up sharply from the corresponding period of FY06. Trade deficit has contributed approximately 76.0% in the absolute rise in current account deficit during 9M/FY07, while the share of the income deficit is 41.3%.

REMITTANCES

Home remittances rose 21.9% to US$3.9bn in 9M/FY07 as compared to US$3.2bn in the same period last year mainly on the back of significant increase from Middle East and the USA. A historic peak of US$520m in the month of Mar 2007 was observed. Original target of US$4.5bn was set for FY07, which has been revised by SBP to US$5.3bn- US$5.5bn, as compared to US$4.6bn in FY06.

PRICES

Strong increases in food inflation continued to underpin inflationary pressures in the economy, and offset much of the gains from the abatement of non-food inflation through a tight monetary policy. Thus, principally due to rising food prices, CPI and SPI measures of inflation both recorded year-on-year increases in April 2007, after steep falls in the previous months (when food inflation had dropped sharply). The influence of food inflation is also evident in the WPI; although the WPI inflation has seen a year-on-year drop this is simply because a surge in its food component was largely offset by a sharper decline in its non-food elements.

FUTURE OUTLOOK

Pakistan economy is continuing to perform well. The main concerning factors are the rising trend of commodity prices in the international market, higher demand for furnace oil by the thermal power plants and anticipated increase in the import of power generating machinery may put upward pressure on the import bill. On the export side, Pakistan's textile industry needs to be more competitive as it would face increased competition in international markets after the abolishing of China specific textile and clothing safeguards in 2008 by the EU and the US. In this backdrop, there is need to focus on devising a comprehensive export promotion strategy to narrow down the trade gap. Major issues to be addressed in the export strategy are: a) lack of exports diversification, b) supply side constraints, c) low labor productivity, d) relatively low quality of products, e) delay in the adoption of international standards, f) lack of scale economies, and g) inefficiencies caused by infrastructural bottlenecks.