STATE BANK REPORT PAINTS A BLEAK PICTURE OF ECONOMY

SHAMIM AHMED RIZVI
Dec 22 - 28, 2008

The State Bank of Pakistan, in its annual report on economy covering the financial year 2007-08, has painted a bleak picture of Pakistan's economic and financial status and prospects for the ongoing financial year. Ruling out possibility of any upward trend in growth rate in the near future the central bank has projected the growth of 3.5 to 4.5% and inflation ranging between 20 to 22% during 2008-09.

The reason cited by the SBP for slow growth is sharp decline in commodity producing sector and in investment during fiscal 2008 which do not bode well for the output growth in subsequent years.

According to the report released last week, the situation demands urgent measures for economic stabilization in almost every sector. In medium to long term, the country needed to encourage and support investment by removing structural bottlenecks, reducing the cost of doing business and increasing productivity to achieve a sustainable high growth and keeping inflation under strict check.

The report revealed that growth in manufacturing sector of country has declined for the third consecutive year and posted a sixth year low growth rate in the fiscal year 2007-08. Most of the decline was seen in the Large Scale Manufacturing (LSM) while Small Scale Manufacturing (SSM) decelerated nominally. The poor performance of LSM in year FY07-08 has been owing to the structural weaknesses in the economy. Top three impediments that hit the manufacturing sector are energy constraints, capacity constraints and input constraints.

Undoubtedly, the foremost concern is the present energy crisis that has seriously stifled the manufacturing activities in the country. In fact, growth in energy supply could not keep pace with the rising demand due to sharp increase in manufacturing activities in recent years. Energy deprivation not only makes a high industrial growth in the long-term unsustainable, but it also increases the import burden on the economy. Long power outages hit the industries which obviously affect production targets and consequently this disturbs export targets of all export based industries.

Input cost had been increasing' throughout the fiscal year in which high oil and power costs played a big role. The domestic industrial sector muddled through a mix of major economic, political and structural setbacks throughout FY07-08. While the aggregate demand had already seen some relative moderation in the preceding year, rising fuel and commodity prices and intensifying energy shortages in the country further obstructed FY07-08 industrial activities. Sectors that rely more on agro-based inputs observe quite a volatile growth pattern.

Specifically, the four year low cotton harvest in FY07-08 was the sharpest blow not only to textiles growth but for the entire LSM growth during the year. The' above assessment stems from the fact that 80 percent of textile production is export based and the 60 percent growth in textile exports of Pakistan is explained by domestic cotton production.

The rise in inflation remained abnormally high. The worst aspect of this scenario was that the low-income group continued to the worst affected, unanticipated hike in global commodity rates, upward trend in fuel prices upward revision of wheat support prices pressure in wheat and wheat flour prices due to superlative shortages and sharp depreciation of rupee mainly fuelled the inflation.

Income group-wise distribution of inflation showed that the highest incidence of inflation was on low income groups throughout FY08 at 26.4 percent due to significant increase in food inflation which accounts as a greater proportion of their total expenditure. In September 2008, the highest CPI inflation (YoY) of 26.4 percent was recorded for the lowest income group earning up to Rs3,000 followed by income group of Rs3,001 to Rs5000 (25.9 percent) and income group of Rs5001 to 12,000 (24.7 percent). The highest income group of above Rs12000 experienced lowest inflation at 22.6 percent.

The steepest hike in inflation had been witnessed in the last four months of FY08. This increase in domestic inflation was exhibited by all price indices: annual average of CPI, WPI, SPI and GDP deflator. While food inflation is primarily responsible for surge in CPI and SPI, acceleration in WPI is equally contributed by both food and non-food inflation.

Consumer Price Index (CPI): After showing fluctuations during the first eight months of FY08, CPI inflation witnessed a steep rise to reach 25.3 percent in August 2008 before it dropped to 23.9 percent in September 2008.

This sharp rise inflation during the later months of FY08 was mainly driven by food inflation. CPI food inflation increased almost four times in August 2008 from 8.6 percent in August 2007. In addition, second round effects of persistent high food inflation on various consumer goods and impacts of exchange rate depreciation are also evident in education, medicare, recreation & entertainment, cleaning, laundry & personal appearance sub-groups.

While CPI food inflation showed persistency in FY07, it witnessed a sharp acceleration throughout FT08. CPI food inflation recorded annualized growth of 17.6 percent in FY08 compared to 10.3 percent during FY07. CPI non-food inflation, which was quite benign in H1FY08, accelerated in H2FY08 and reached 19.2 percent on YoY basis during September 2008 compared to 5.0 percent during the corresponding month last year.

All sub-groups of non-food group recorded higher inflation in FY08 as compared to FY07. However, the major contributors in recent upsurge of non-food inflation are transport & communication, house rent index, cleaning, laundry & personal appearance and fuel & lighting subgroups reflecting the impact of high international commodity prices and pass through of high global oil prices to domestic prices of key fuels during H2FY08.

As a result "the gulf between rich and poor is widening and a large segment of the population hovering around the poverty line. Contrary to the declining trend of absolute poverty in Pakistan, it has increased reflecting a rise in rich-poor divide", the report revealed.

The State Bank projected the 'current account deficit at 6.2 per cent to 6.8 per cent of GDP for the current fiscal year against 8.4 percent last years.' It said that revenue collection in FY08 fell below target, placing Pakistan among countries having the lowest tax-to-GDP ratio.

Pakistan's ratio (10 per cent) stands below the region's average and is the second lowest in the region, Bangladesh being at the bottom. The report said that an important contributor to slowdown in the GDP growth was investment demand, reflecting investors' cautious response to political uncertainty, law and order and inflation expectations.

The FY08 contribution of investment demand to overall GDP remained the lowest at 0.7 per cent during the past four years. The demand was affected by a fall in the investment-to-GDP ratio 21.6 per cent in FY08 from 22.9 per cent in FY07. With savings-to-GDP ratio falling to 13.9 per cent in FY08 from 17.8 per cent in FY07, despite a lower investment demand, the saving-investment gap widened by 3.2 percentage points.

"The decline in savings and investment rates both are sources of concern," the SBP said. It said that since the beginning of 2008-09, the government and the central bank had developed a macroeconomic stabilization package whose implementation was under way and had helped to secure a "buy-in" from the international agencies. The prograrmme is now a cornerstone of the stand-by arrangement negotiated with the International Monetary Fund for a 23-month period," said the report.

It said that setbacks to growth had not been due to interest expenses (as these constitute a very small fraction of the cost of goods sold), but because of inflation that has toll on input costs as well as wages. In addition, problems of a poor infrastructure and heavy cost of doing business had magnified in the recent years as electricity outages grew.

The report said that industrial sector suffered a mix of economic, political and structural setbacks throughout FY08. Rising fuel and raw material prices and intensifying energy shortages in the country hampered industrial activities in FY08. "The heightened political uncertainty and law & order issues during the year also took their toll." Other than the construction sub-sector, all other industrial sub-sectors performed below their long-term trend in FY08. The manufacturing sector's growth continued to decline for a third consecutive year and posted lowest growth in six years during FY08.

The SBP said the deterioration in the current account deficit continued for the fourth successive year, touching 8.4 per cent of GDP during FY08. "This is the highest level in the last thirty years," said the State Bank, adding the country's risk perception was heightened by 'domestic political developments', which compromised the country's ability to tap resources from international capital markets.

The report of the central bank is being described as eye-opener in the concerned circles. Poor nations living beyond their means land themselves in deep trouble just like we have done. This is precisely the message the central bank sends across in its annual report on the economy. Economies across Asia grew, most of them faster than us, on the back of strong global demand, low commodity prices and cheap credit in the last several years to 2007. Pakistan's GDP also increased by an average 7.3 per cent during four years to June 2007, but failed to improve the living conditions of most people.

While most others used high growth to prepare themselves for any possible downturn in their fortunes, we used the opportunity to encourage passive consumption and import luxuries. Little was left to build up a modern economic and social infrastructure for sustainable growth. Nor did we use macro-economic stability in those days to attract investment in tie production sectors - manufacturing and agriculture- for creating jobs and ensuring a more equitable distribution of wealth.

No wonder then, when the crunch came, we had little money left to support the sudden jump in the import which reached a record $40bn last year. Nor did we have the infrastructure or competitive manufacturing skills to push exports to bridge the current account gap. Inflation, which had already begun rising due to loose monetary policies, has skyrocketed to 25 percent in the first five months to November of the current fiscal.

Now the bank says that macroeconomic imbalances are expected to improve, but GDP growth will moderate to 3,5 to 4.5 per cent, The average headline inflation, however, is unlikely to decline below 20 per cent, meaning another round of interest rate hikes could follow to curtail domestic demand. Unfortunately, we have been forced to slow down growth at a time when most countries are cutting interest rates to boost lending to protect production and jobs. This means that the economic slowdown will not only affect domestic sales but also make exports uncompetitive. This could lead to industrial closures, massive job cuts and increasing poverty. The next couple of years are going to be challenging, particularly for the lower and middle classes, as the state will be forced to cut down on essential spending, healthcare, food, education etc. But these years can also be used to put the economy on the road to sustainable and equitable growth.