Pakistan likely to miss its GDP growth target

Sep 29 - Oct 12, 2008

There cannot be two opinions that Pakistan will miss major economic targets set for the current fiscal year. The factors substantiating this perception are scaling down of the GDP growth target to 4.5 per cent, inflation rising to 20 per cent and fiscal and current account deficits going beyond budgeted limits.

Crude oil prices still hovering around $100/barrel, power deficit reaching alarming level, high interest rates affecting new investment and macroeconomic imbalances even raises doubts about achieving the revised or toned-down growth target. High inflation is expected to persist as domestic fuel, food, and power subsidies will be gradually phased out. Although efforts could be made to contain the imbalances, factors plaguing the economy cannot be eliminated quickly.

As the government faces mounting budget deficit the easiest solution is to cut down development expenditure, particularly money to be spent on infrastructure development, education and healthcare. Cutting down development expenditures will act as deflationary force resulting in underused production capacity and higher unemployment.

One of the most alarming issues is acute shortage of irrigation water during Rabi season. Over all, the agriculture sector contributing about 25% to the GDP may not be able to achieve production targets for key crops. The country is bound to face shortage of wheat, sugarcane, rice and cotton. Shortage of these produce will necessitate their import and further erode foreign exchange reserves at a much faster rate.

Lower than required production of cotton and sugarcane will impair the performance of large-scale manufacturing because textile and sugar industries have relatively higher weightage in the sector. Lower capacity utilization will on the one hand raise the unit cost of production and on the other hand reduce the revenue collection.

The services sector is expected to post robust growth, although it will be affected by the tax measures announced in the budget and by power shortages. Banking sector is expected to remain under pressure due to enhancing of minimum paid up capital, higher provisioning and declining credit offtake by the private sector.

On the demand side, private consumption in current year will be hit by higher prices as food, oil and power subsidies are rationalized. The investment levels will be restrained by uncertainty, low capital inflows and power shortages. Private investment has fallen to 14.2 per cent of GDP while national savings as a share of GDP declined even more, widening the savings-investment gap.

It was often said that the government headed by Prime Minister Yousuf Raza Gillani has not been able to address the key issues facing the economy. After three months of being in power Finance Minister Naveed Qamar announced the much awaited economic stabilization package. Its salient features include: 1) further increase in POL prices and electricity and gas tariffs; 2) drawdown in subsidies, especially those on electricity by the end of FY09; 3) Privatization of public enterprises in the Oil & Gas sector; 4) increase in import duties and increase in L/C margin on 350 items and 5) cutting down development expenditures

As stated these measures are aimed at achieving macroeconomic stability by strengthening the Balance of Payment position and reducing external imbalances, by removing numerous price distortions in the economy. These measures in turn should help in containing depletion of foreign exchange reserves of the country. However, some of the analysts and experts are critical of the plan. They believe that achieving the stated targets will not be possible.

The IMF team has reportedly termed these measures as insufficient to stabilize the economy or to contain inflationary pressures. The Fund has advised that the stabilization package should not be overly dependent on external financing and has urged for further reduction in liquidity and Rupee depreciation.

It is true that a lot needs to be done to increase tax collection, promote export growth and restrict imports of nonessential items. However, the rationale for draining liquidity from the financial system and containing further erosion in Rupee value seems difficult. This will only exacerbate an already volatile situation and have extreme negative implications for the economy. .

This argument is based on the fact that the domestic financial and industrial sectors are already facing serious challenges. These include a severe credit crunch and a substantial increase in cost of doing business because of the hike in domestic interest rates, power shortages and inflation. In the prevailing conditions removal of the required level of liquidity can potentially cause a hemorrhage of the financial system.

As regards further depreciation of Rupee, it must be kept in mind that the Rupee has already depreciated by more than 25% against the US Dollar.

Keeping in mind that exchange rate stability is a must for macroeconomic stability, there is no need for devaluing Rupee. Pakistan's 45% imports comprise of inelastic primary food and fuel commodities. Depreciation of Rupee against Dollar and other leading currencies has not contained imports in any significant manner but added to inflation.

In fact erosion in Rupee value has intensified cost-pushed inflation in the country and increased the debt servicing burden. The sharp erosion in Rupee value has seriously battered investors' confidence leading to a net outflow of portfolio investment.

The GDP growth rate cannot be accelerated with overcoming some of the contentious issues facing the economy. The government will have to take further demand management measures i.e. maintaining fiscal austerity and increasing import substitution in the forthcoming months. If appropriate measures are taken could help in bringing down fiscal and current account deficits.

It is encouraging that the government has shown firm resolve in not availing the IMF bailout program. However, a lot more needs to be done in order to assure donor countries that Pakistan's economy is heading in the right direction.

It would also be advisable that government abstains from selling the family silver under stress. Foreign investors will not be interested in making any substantial investment decision, partly because of Pakistan's volatile situation but more importantly due the global economic turmoil.