ECONOMY IN 1H-FY08

MULAZIM ALI KHOKHAR
Research Analyst, PAGE

Feb 18 - 24, 2008

Pakistan's economy has been the 3rd fastest growing economy in the region for the past few years. But today it is confronting huge problems where its inflation is going out of control, the major exporting textile sector is observing all time low productions, energy supply has gone very low and the global financial crisis, violent political condition is creating increasing concerns for domestic and foreign investors and lenders and hiking oil prices are indicating increasing trade gaps.

FISCAL IMBALANCES

Today our current account deficits are standing at $6.14bn about (Rs.380bn) showing an increase of 31.2% as compared to $4.7bn (about Rs.277.3bn) for the same period last year. The trade deficits are even wider than that with $6.4bn which has multiplied at 18.8% as against last period figures of $5.4bn. Another basis of widening current account deficits, along with trade deficit, is increasing services accounts deficit. Our net services are footing at net negative amounts of $3.2bn indexing an increase of 33.9% to the last year's figures of $2.5bn. Our net incomes deficits have increased by $123mn (increased by 6.8%) but the current transfer inflows have increased by $500mn (increase by 10.12%). [See Table # 1]

There are many reasons behind the hike in current, trade and services deficits, however these are mainly emanating from domestic money depreciation (3.7% from July-Jan FY08), global oil price escalations (oscillating at highz $ 90-100/barrel) and domestic industrial crisis coupled with energy shortage (Energy shortage of 3062 MW), and last but not the least the domestic inflation rates which have been increasing at a 5 year CAGR of 20%.

Whilst, on the other hand, the financing inflows (to finance the existing debts), which mainly come from portfolio investment, have declined by 93% amounting to $1.2bn decline, while the overall financial inflow decline is recorded as 6.9% amounting to $274mn. The huge gaps of portfolio investment are the results of political uncertainties and industrial and energy output shortage which compelled the foreign investors to square there positions for the time being and remain out side the market. This has also negatively impacted the stock market performance which is struggling to cross the 14000 points for the last month and long.

The sum of the total errors has also widened by $466mn (increase by 100%) in also indicating the increasing concerns of the budgetary planners that the targets might slip out of their hands.

All this will certainly result in added external current account deficit to GDP ratio to a much higher level than the targeted 5.0 percent. Apart from putting pressure on foreign exchange reserves, the depreciating money will be an additional pressure on inflation in the next two quarters.

INFLATIONARY PRESSURES

Inflation is already touching skies as our CPI rates are floating at and above 8.8% which is way high than our stated targets and is 25.7% higher than last year figures of 7%. Although the figures confirm it to be less than the corresponding period last year CPI of 8.9% by 1.12%. Currently our food inflation index is inflating at a weekly average rate of 18% and the half year figures are also in double digits at 12.2%. [See Table # 2]

To curb these inflationary pressures, State Bank of Pakistan has been applying the tight monetary policy for the last few year and it has further tightened it amid new wave of mounting food and energy prices. She has increased the discount rate by 50 basis points up till now, curbed money supply and regulated the exchange rate and many other measures to ensure she gets hold of inflation

MONETARY POLICY QUESTIONED

The question is, "Will the tight monetary policy be able to normalize the situation?" State Bank of Pakistan (SBP) deduces that the risk to inflation over weighs the risks to growth in current situation, and hence tight monetary policy is the solution. But the ground realities indicate that the risks to business are increasing with the inflating interest rates coupled with inflating cost of productions and oil and energy prices. Our budgetary planners and the people of federation have been, times and again, suggesting that the inflationary pressures are the result of supply side shortage along with boosting demand. The tight monetary policy certainly has reduced money supply which is revealed in SBP data [in Table # 3] but the decreasing production and supply of goods and services and reducing tax collection and increasing tax refunds and frauds, increasing tax gaps are all indicating a situation very different of what SBP depicts.

INTIMIDATIONS AND NEEDS AND OPPORTUNITIES

There is a strong and urgent need to nurture an environment that facilitates the foreign inflows and to improve the prospects for adequate financing of external current account deficit, which has so far resulted in foreign exchange reserve drawn down of US$403.2 million.

The base of all problems lies in political chaos which is expected to settle after 18/2 election 2008 and it is hoped that the new Prime Minister will harmonize with President Pervaiz Musharraf and will continue the economic policies till the desired targets are achieved, otherwise the picture is quite hazy.

Government need to Finance its deficits through Global Depository Receipts (GDRs) and Sovereign Bonds which finance almost 41% budget deficits previously, so that the domestic money can be efficiently utilized to finance private sector investment which is very vital in this scenario.

They need to enhance tax recovery system so as to reduce frauds and erroneous refunds and need to create some tax balance in direct and indirect tax so as to provide more benefits to middle class working groups and increase the opportunities for them to invest.

There are greater opportunities to be realized on different fronts like retail sector, agriculture sector, energy sector, manufacturing and construction and related sectors. They need increased attention and stimulus from Government to induce private domestic and foreign investors to devote their resources in these sector offering higher profits and greater future coverage.

Overall the Economy has the potential to come out of this vicious situation to more prominent and stable condition, but the need is to focus on the real sectors which hold such impetuous and which can prove to be healthy.

TABLE 1

BALANCE OF PAYMENTS

JULY-DECEMBER

MILLION US$

.

FY07

FY08

% CHANGE

Current account

-4,679.00

-6,137.70

31.18%

Trade balance

-5,363.00

-6,368.70

18.75%

Exports

8,343.00

9,091.00

8.97%

Imports

13,706.00

15,459.70

12.80%

Services net

-2,451.00

-3,281.00

33.86%

Income net

-1,808.00

-1,931.00

6.80%

Current transfers

4,943.00

5,443.00

10.12%

Capital account

177

14

-92.09%

Financial account

3,964.00

3,690.00

-6.91%

Direct investment

1,873.00

2,066.00

10.30%

Portfolio investment

1,295.00

100

-92.28%

Errors and omissions

464

930

100.43%

Overall balance

-74

-1,504.00

.

Source: SBP


TABLE 2

INFLATION INDICATORS

FY07*

1H-FY07

1H-FY08

CH. TO 1H-FY07

CH. TO FY07

CPI

7

8.9

8.8

-1.12%

25.71%

Food group

9.7

12.7

12.2

-3.94%

25.77%

Non-food group

5.1

6.2

6.3

1.61%

23.53%

Non-food non-energy

5.7

5.7

7.2

26.32%

26.32%

20% trimmed

6.5

6.3

8.7

38.10%

33.85%


TABLE 3

MONETARY AGGREGATES (FLOWS)

ACTUAL

1-JUL

19-JAN

BILLION RUPEES

FY07

FY07

FY08

Money Supply (M2)

658.3

199.8

234.4

Growth

19.3

5.87

5.77

Annualized growth

-

13.6

19.2

NFA

274.6

-9.1

-161.9

SBP

222.7

-1

-79.3

Scheduled banks

51.9

-8

-82.6

NDA

383.7

208.9

396.3

SBP

-66.8

112.2

240.4

Scheduled banks

450.5

96.7

155.9

Net budgetary support

102

46.7

234

from SBP

-58.6

70.9

237.1

from Scheduled banks

161

-24.2

-3.1

Private sector credit

365.7

216

256.7

Growth

17.3

10.22

10.35

Reserve money

209.1

166.5

116.2

Growth

20.9

16.63

9.6

Export finance scheme

26.8

25.6

-35.9

Source: SBP