Feb 7 - 13, 2011

Contrary to the depressing reports about GDP growth estimated at 1.5 per cent on the back of flood devastations and of course bad law and order situation, the State Bank of Pakistan has come out with a good news that the growth rate is expected to be in the region of 2-3 per cent during current fiscal 2011.

The impressive performance by the services sector is bound to provide support to gross domestic product growth. A rise in the price of almost all agriculture produce led to a significant increase in nominal income of the farmers, which helped sustained private aggregate demand besides strengthening inflationary pressures in the economy.

According to an estimate, the services sector is expected to surpass its official growth target for the year on the back of strong growth in social, community and personal services led by massive relief and rehabilitation efforts in flood affected areas.

Despite negative growth reported from the large manufacturing sector as well as decline in the cash crops like rice and cotton primarily due to flood devastations in the rice and cotton growing belt of Punjab and Sindh, the services sector has come to play a significant role by lending a significant support in the growth rate.

In fact, cotton and rice harvest declined significantly during Kharif season. However, sugarcane output registered a slight increase due to substantial yield gains on non-flood areas. However, despite low water availability at sowing time, area under cotton increased due to attractive price. According to official reports, the floods damaged cotton crop on about 0.6 million hectares, hence area under cotton cultivation fell to 2.5 million hectares. Cotton crop was also damaged by heavy rains in major cotton growing districts. Consequently, cotton production dropped to 11.7 million bales by 9.4 per cent during financial year 2011.

Somehow, more encouraging is the 6.3 per cent Year on Year (YoY) growth in voluntary payments of taxes that supported an increase in the relative share of voluntary payments in the gross income tax collection. A breakup of the income tax collection for the first quarter of the fiscal 2011 indicates an overall increase of 13.4 per cent in gross collections, mainly on the back of higher contributions from voluntary payments and without taxes.

In its first quarterly report on the country's economy, the central bank has estimated that the real gross domestic product is likely to grow between 2 and 3 per cent in the current fiscal year thanks to better contribution by the services sector, and improvement in the performance by the commodity producing sectors.

The performance of the commodity producing sectors of the economy is expected to improve in months ahead. However, expectations of a recovery in agriculture will depend crucially on the wheat harvest (including increased production from the rain-fed - "barani" areas), and the livestock sector. Similarly, large-scale manufacturing growth is expected to turn positive again in the months ahead, as strong agri-prices support demand, and with the additional capacities coming on-line in some industries including fertilizer, cement and steel.

However, the growing macroeconomic imbalances in the economy are still quite manageable but further delay in implementing critical structural adjustments risks are increasing the future costs to the economy significantly.

The report pointed out that inflationary pressures have strengthened more than anticipated during the first half of FY11. "A part of this, reflecting post-flood shocks will fade away, as will part of the price rise of sugar, but the fiscal expansion, proposed reduction in energy subsidies, and prospects of rising imported inflation will continue to drive inflationary expectations," the report said. 'Consequently, SBP estimates for financial year 2011 inflation have been revised upwards from 13.5 per cent to 14.5 per cent, to 15 percent, to 16 per cent', the report added.

'Therefore, the only sustainable way to protect low income groups from inflation is by targeted subsidies and the creation of ample employment opportunities.'

'In contrast to inflation, the current account deficit (CAD) is likely to deteriorate in the second half of the financial year while significantly strong growth in imports is expected to more than offset the gains from rise in exports and workers' remittances. The financing of the CAD will be challenging as inflows under financial accounts are likely to be significantly lower. In this perspective, the continuation of the structural adjustment program of IMF would be helpful in softening the external financial constraints, as well as to enhance the resilience and robustness of the economy,' the quarterly review said and pointed out that the one bright spot in the economy, ironically helped somewhat by the floods, was the strength of the external sector.

'A jump in remittances and aid flows for flood relief, helped by robust growth in exports largely due to sharp increase in the prices of cotton overshadowed the growth in imports, turning the current account for July-December financial year 2011 to a surplus.

However, uncertainty over the extent of damage to private and public infrastructure and the policy response to floods, direct and indirect impacts of supply disruptions, energy shortages and weak consumer and business confidence, took its toll on the domestic economy during the initial months of the fiscal year 2011.

The fiscal performance however remains a source of concern, given the outstanding issues with expenditure management as well as revenue shortfalls. 'The implementation of fiscal reforms and elimination of subsidies in the power sector are likely to broaden the tax net and reduce distortions in the economy. While, these reforms will induce cost-push inflationary pressures in the economy, in the short run, but these will help sustain high growth in the long run.