MID FISCAL YEAR FILLED WITH CHALLENGES

AROOJ ASGHAR (arooj.asghar@crosby.com
Feb 18 - 24, 2008

Pakistan's economy is facing numerous challenges like trade deficits, enormous increase in oil prices in international market, electricity, wheat and cotton crisis, high inflation and political situation in the country in fiscal year 2007-08. In line with strong economic growth of last few years, finance ministry has set growth rate of gross domestic product at 7.2% for current fiscal year. From October 1999 to March 2007, Pakistan saw an overall calm political environment which was effectively utilized to improve the economic condition of the country. But since March 2007, overall political and economic environment started changing which will continue in next few more months. By the time the dust settles economic condition of the country would reach almost the same position which it has in early years of this decade. In order to meet the economic targets certain issues needs immediate attention rather requires unpopular decisions but are left for the soon elected government like increase in the oil prices, decreasing the GDP and tax collection targets etc... On one place, Governor State Bank of Pakistan (SBP), Dr Shamshad Akhtar says that despite several concerns and shocks to the economy of the country, the real Gross Domestic Product's (GDP) growth target would not be revised and it would remain 7% for the fiscal year 2008 but on the other hand, SBP also says that likelihood of achieving the target is difficult which is more logical and realistic opinion. A lot of the independent economists also estimate that GDP growth rate will be below 7.2% in 2007-08 and may remain in the range of 6.6% to 7.0% whereas World Bank, Merrill Lynch and ADB estimate it at 6.5%, 6.8% and 6.6% respectively.

All key economic indicators recorded a significant decline in the first half of current fiscal year. These negative trends continued to be more pronounced even up to February with no reversal insight. Government sources expect that things will change positively in coming days with larger inflow of FDI from Dubai, Abu Dhabi, Gulf, Saudi Arabia and the Western countries. Business has been opened more to the private sector, and 87% of all banking is now in private hands. But the worst hit is the poor, due to inflation that is in double digit which independent economists put it at more than 16%. The basic foods, like the flour, are hard to get in all cities even at prices double than eight years ago. Rice price has skyrocketed. The spiraling bill of oil and costly food imports are rapidly eating into the official forex reserves.

Benazir Bhutto's murder, debarring top opposition leaders like the two-time former Prime Minister Nawaz Sharif to contest the polls (what ever may be the reason and history), postponement of election and hue and cry of election rigging by opposition parties have added enormous heat in already charged political environment. A number of indicators show that the downturn may not go away in short to medium term. In fact it is projected to dig its heel further with the ongoing political uncertainty, and run up to the national elections, scheduled for Feb. 18. Many politicians and businessmen keep their fingers crossed over the elections aftermath. Economy is expecting to take negative to mixed trend in post-election period, particularly for foreign trade, FDI inflows, domestic investment, production and jobs. In this unhappy environment, SBP warns of the challenges and risks to the economy and business. Risks to the economy are increasing as it is clear that neither the global nor the domestic economic environment is as what it was in the past years.

In recent months, government borrowing has rose to above Rs. 200 billion which is a significant source of continuous increase in inflation. Moreover, current account deficit is mounting and is forecasted to be 5.2% of GDP for full fiscal year 2008. Besides the financial, budgetary and monetary woes, more troubling is the fact that the high and volatile food inflation is now increasingly influencing core inflation as well. The one biggest issue which dominated the first half of 2007-08 was double digit food inflation. It is said that due to involvement of the private sector and stepping out of public sector in most of the sectors is paralyzing regulators. Thus domestic economy is now more open and prone to external shocks than ever before which means that domestic prices will be more sensitive to the changes in the international prices, despite domestic availability. For example, Pakistan had sufficient exportable surplus of rice in fiscal 2008, but following a rise in the international prices of rice, domestic prices also increased. The industrial production by large scale manufacturing (LSM) decelerated to 6.9% during first and second quarter of fiscal year 2008 which is lowest since fiscal 2003, as compared to 10.4% in 2007, and 9.0% in 2006. However, the good news is that services sector which contributes 52% of the value-addition remained positive in this period.

A major problem is coming from fiscal side and on the external sector mainly on account of unpredictable rise in oil prices. At the current prices, officials concede that the oil import bill would reach to $10.5 billion and may result in Rs152 billion hit to the budget, if domestic prices remain frozen. Fiscal indicators were turning weaker primarily due to development expenditure rising by 89.5% to Rs130 billion during the first quarter of 2007-08 compared with the same period last year and the current expenditure increasing simultaneously by 34.34% to Rs340 billion. A slower economic growth than targeted is unlikely to yield estimated tax revenue. It is widely believed that the government will have to revise downward its fiscal targets set for the current financial year. This was evident much before the assassination of Ms Bhutto while the situation today is extremely alarming. Due to the ongoing load-shedding and the decision of the Federal Bureau of Revenues to revise its targets downward and the unprecedented losses that occurred between December 27 to 31, the government is left with no option but to urgently revise to lower its fiscal targets. There was a revenue shortfall and export growth was declining while imports were rising and trade deficit was widening. Government might scale down the size of Public Sector Development Program (PSDP) to meet the situation. There is a serious problem of current account deficit and nobody knows how long the government will finance this deficit through uncertain foreign capital inflows. Then subsiding energy is becoming a serious issue.

In Pakistan, inflation in food products has been a cause of concern for policymakers in recent months. Year-on-year growth in food inflation was above 10% in January 2008 over a year earlier, which will further shoot up in coming days. Any movement in the food component of CPI, with a weight of 40% has an impact on overall inflation. The rise in food inflation could be partly explained by the supply side problems. There has been some deceleration in supply growth which has driven prices up. For instance, there has been a drop in production and yield of pluses like mung, massah, masoor, in oilseeds like rapeseed and mustard, including canola and off course how can one forget the scarcity of wheat, flour and probable shortage of rice in next few months. Government is importing wheat to overcome shortage and also monitoring Pakistan Afghanistan border which is biggest source of shortage of food items in Pakistan but entails more concentrate steps. Finance ministry report claims that the highest ever increase in food inflation in any month of the fiscal year 2007-08 was due to an extraordinary surge in demand, particularly for fruit, vegetables, milk, meat, poultry and cooking oil during Ramazan. A sharp rise was also witnessed in wheat and flour prices, driven by extra-market forces. Although, the prices of wheat and flour declined lately, their contribution to inflation was already realized. Shortage of wheat in the country has forced the government to import one million tons of wheat from Russia at an estimated cost of US $510 million to meet its domestic demand. High cost of import of wheat and subsidy by government has pushed up the expenditure budget and further enlarged the budget deficit.

In addition to food inflation and shortage of necessary food items, another issue which emerges badly in the first half of 2007-08 is shortage of electricity. Obviously one doesn't always desire to criticize government; alas one finds it difficult to find happy moments in energy sector. Pakistan has miserably failed to add additional megawatts in last few years whereas chances of any improvement in near future are remote. Due to long hours of load shadings, exporters especially the textile industry is loosing export order.

Since first half of the fiscal year was overshadowed by the wheat, power, oil, political crisis and left positive developments unattended. SBP's tight monetary policy is showing its results. A moderate increase in KIBOR and banks' lending rates, almost flat Monetary Conditions Index (MCI), a fall in the effective CRR, and persistently high annualized M2 growth rate are few of these developments.

All in all, first half of 2007-08 was full of issues which hamper the economic growth of the country. On top of that, few critical decisions which were required to take last year but deferred till the new government sworn in. The worst part is that retailers, manufacturers, importers have already increased the prices much before the effective increase in the oil price. Therefore one can imagine how they would react when government will actually increase the prices of oil products most probable in March this year. As a consequence of being an election year, foreign inflows and privatization receipts are also expected to slow down. Therefore, it is rightly said this fiscal year will not be so good, continuity of previous performance may not be repeated worst. Above all Pakistan's economic targets get unimaginable damage due to indecisiveness of policy makers and will not only impact full year results of current year but will also have an impact on next fiscal year.