Research Analyst
May 12 - 18, 2008

Pakistan economy is experiencing very serious macro economic situation where almost all stabilization indicators have been deteriorating. Economy is facing persistent inflationary pressures, burgeoning fiscal and current account deficits, severe power shortages, weakening of exchange rate and lower foreign investment which have been affecting the macro economic performance. Consequently, Pakistan economy is expected grow at 6% in FY08 lower than an annual average rate of 7% for last five years.

Inflation is touching new record levels every month; in March 08 it stood at 14% which is of grave concern for SBP. Current account deficit has touched Rs 14.46bn just in 9 months and expected to be 6% of GDP in current fiscal year, fiscal deficit is highest ever stood at Rs336bn as on 19 April 2008 and expected to be 5.2% of GDP in FY08, looming power shortage stood at 2500MW, foreign investment inflows have slowed down stood at $3bn in 9 months of FY08 as compared to $5.55bn in same period last year, showing decline of 46.3%. All economic indicators are depicting unfavorable picture of the state of economy.

Although State Bank of Pakistan has been trying to use effectively the interest rate tool in response to drastically changing economic environment of Pakistan to keep growth momentum stable & to rectify macro imbalances, but impacts of monetary stances have been diluted due to destabilization given below macro economic indicators.



March is the third consecutive month where CPI has touched new records owing to rising international food prices and domestic food supply disruptions. The CPI inflation in Pakistan is mostly food driven which is observable from the co-movement of the general and food inflation measures plotted in the graph. It can be projected from the trend inflation will hit new records in days to come. During March CPI (General) has touched the level of 14% which is highest ever from 11.3 % in Feb-08.

The State Bank of Pakistan in its second quarterly report has also identified the rising good prices as one of the major inflation drivers which have been diluting the impact of monetary stances. External reasons of soaring food prices include increasing demand for food crops, especially corn (or maize) for ethanol and other biofuel, increased energy and freight prices and soaring edible oil prices (Pakistan is edible oil importer as well). Domestic supply disruptions reasons include low agricultural productivity, exporting to neighboring countries before meeting domestic demand at higher prices and hoardering.


Government has been pursuing expansionary fiscal policy-high government expenditures, on other hand, slow growth in revenue collection and weak external receipts which translated into ballooning fiscal deficit, which has been expanding. In the 1H-08 tax-to-GDP ratios stood at 4.5% where as expenditure-to-GDP ratio at 9.8%, highest in the last four years. Government resorted to borrowing from SBP and commercial banks in order to fill revenue-expenditure gap which stood at almost Rs 365 bn during nine months of current fiscal year. The sharp rise in budgetary borrowings was the major driving force behind the high annualized M2 growth, which stood at 8% as on March 29, 2008. This was a source of concern for SBP as it had pushed inflation up and has the potential to add to the excess demand pressures in the economy ultimately worsen the current account status.


Pakistan is oil importing country, which constitute major part of import bill. Currently International oil prices are hovering around $ 120/ barrel and expected to remain above $115/barrel, which has negatively affected the Pak current account. New elected government has increased the domestic oil prices for the 4th time just 3 months, in response to its adjustment almost prices of everything has risen.


Performance of the external sector of the economy has been disheartening. Trade deficit has hit an all time high of $14.49bn in the initial 9 months of FY08 as compared to $10bn in the corresponding period last year, showing growth of 44.27%.

The import bill has reached $27.96bn in initial nine periods of FY08 owing to soaring oil prices, higher imports of unnecessary consumer items and import of food and palm oil at the back of hiking international prices of the same. Exports amounted to just $13bn which is not even sufficient to finance our half of imports. Major reason behind slow growth is declining textile exports (constitute almost 65%of total) due to slow textile imports from the US and the UAE, power shortages which resulted in lower production and political instability which hindered exports to meet their export orders.

In consequence of these unfavorable developments, exchange rate has been weakening against all major world currencies of world (US$ 1= 67 PKR as on 6-May-2008). It is worth noting despite weakening exchange rate exports have been declining and imports have been increasing.

In order to finance burgeoning current account deficit and stop further depreciation of Pak rupee, SBP uses its hard earned foreign exchange reserves from time to time. Foreign exchange reserves have declined to $12.6bn as on 18-4-08 from $14.6bn in Jan 08. It can be inferred from current economic situation reserves will decline further by the end of FY08 where foreign investment has been declining, sale of national assets seems undesirable option and external sector performance has been depressing.


Economy is once again at a critical juncture, after a period of robust economic performance since 2003, the country is facing very serious economic strains.

If these issues are not addressed as early as possible, a new way of problems could arrive like further weakening of exchange rate, unmanageable inflationary pressures, decline in imports of machinery, credit and economic outlook rating of country could be down graded.

Now it is also depends upon newly elected democratic government policies and its priorities. New government is facing dilemma which option to choose growth versus stabilization, both can not be achieved in given macro economic conditions. Government should focus on stabilization of macro economic indicators in current scenario. A comprehensive set of actions is needed to control the twin deficits and inflation. Though government has few options to address above issues in short term, but if government try to attract foreign investment, curtail government's non-developmental expenditures, take steps to stop imports of non-essential items, ensure loans taken by borrowers from banking sector are not used for hoarding purpose will certainly help in achieving its objectives. And in the long run government should take steps to improve tax base, switch to alternative energy sources, address problems of textile sector which is biggest beneficiary of subsidized loans but it is not producing desired results and takes steps to improve agricultural growth.