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mtgondal · #55 Monday, June 04, 2007

Strengths of the economy and some of its weaknesses

By M. Sharif

Third quarterly report of the SBP was issued on 26th May 2007. Contents of the report focus on strengths of the economy and some of its weak areas that need attention during the next financial year. Will the budget, to be presented in a week’s time, address them or not; we have to wait and see.

Highlights of the report

The report confirms official viewpoint that the real GDP growth will exceed projected target of 7.0 per cent fixed for current fiscal year. It will be fourth consecutive year of high economic growth that should be satisfying to the government. The target of reducing inflation to 6.5 per cent by the end of current fiscal will not be met. The Report observes that tight monetary policy has maintained intricate balance of containing inflation on one hand and maintaining growth momentum on the other by “removing excessive monetary stimulus from the economy.” But, “unfortunately the impact in reducing inflationary pressures has been offset partially by the rise in food inflation and supply side pressures.” The Bank has revised its earlier forecast of inflation from 6.7-705 per cent to 7.5-7.8 per cent.

Reference to supply side pressures is quite important to understand as to why inflation has persisted despite tight monetary policy that has played important role in curtailing unnecessary imports to some extent during current fiscal year. Supply side pressures are multiple. Consumption of petrol and petroleum products, food items and electric and non-electric durables is on increase because 30 million strong middle class supported by high inflow of remittances by the expatriates is making our society a highly consumer oriented society. In addition to it, high PSDP expenditure, loopholes in country’s tax levying system, non-taxation of money earned in real estate business, agriculture, and practically no tax on windfall profits earned in stocks and high corporate earnings are fuelling inflation. The report does not foresee any immediate relief to the people from the clutches of inflation as the economy is poised to enter in the new fiscal year.

Has tight monetary policy really worked? Perhaps not, to the extent it has been talked about or was desirable and expected by the SBP. Some of the measures taken by the government and the SBP to keep growth momentum going significantly contributed towards making growth of reserve and broad money stronger than anticipated. The contributory factors are concessional credit provided by the Bank to the textile industry, refinancing for exports and substantial increase in government’s borrowings from the banking system. Consequently, because of strong resurgence in broad money its growth is likely to, “exceed the original 13.5 per cent target, to fall in the range of 14.5-15.5 per cent.” The report has termed monetary growth a “key challenge” that the Bank could not meet to its own satisfaction because it struggled “to maintain a balance between sustaining strong economic growth and low stable inflation.”

The Report focuses on growth of fiscal deficit in recent years that has stood in the way of containing inflation and made tight monetary policy less effective. According to it, it is “important that fiscal policy be aligned with the monetary policy in months to come” for effectively containing inflation. The fear expressed by the SBP is not unfounded. In fact, a profound analysis of fiscal and monetary policies explicitly highlights a mismatch between the two moving in different directions.

The government is under pressure to spend more and more funds in public sector to resolve power crisis facing the country, develop badly neglected infrastructure, create employment, strengthen social sector and alleviate poverty. It has to depend on bank and non-bank borrowings, that is, from central bank and scheduled banks, PIB issuances and NSS to meet fiscal needs. The government borrowed Rs195.7 billion from scheduled banks from Feb-Apr 07 and retired Rs58.4 billion of the central bank. The Report has categorised the government’s borrowings “a worrying dependence” on various instruments that adds to fiscal deficit that the government has capped to stay at 4.2 per cent of GDP by the end of current fiscal year. This is happening because of low tax revenue collection that stands around 10.5 per cent of GDP. CBR is confident to over shoot the target of Rs835 billion. It is reported to have collected Rs656.48 during July-April 2006-7 against the target of Rs645.1 billion with a surplus of Rs11.38 billion.

Trade and current deficit have been on the increase during the current fiscal year compared to their absolute figures in previous years. The report is of the view that current account deficit, “has decelerated sharply as FY07 progressed (mainly because of sharp compression in import growth),” but, “in absolute terms it has grown to $6.0 billion by March 2007.” Nevertheless the Report comforts itself by observing, “while this was comfortably financed by even larger surpluses in the financial and capital account (with substantial non-debt components), the country’s success in attracting international capital has led to a large jump in the NFA of the banking system adding to liquidity in the domestic market,” which is not without adverse effects on economy.

The report also observed that large surpluses were recorded at $373 million during first nine months of current fiscal year in the capital and financial account. They comfortably offset the current account deficit. It is to be appreciated that the large surpluses to which the Report has referred to accrued because of foreign inflows from the US financial assistance under different heads amounting to around $2.0 billion a year, proceeds of privatisation, borrowed money from international financial market and multilateral organisations and remittances. These resources are welcome for any developing economy but it cannot sustain itself on exogenous resources alone.

It has to generate indigenous financial resources through domestic savings, tax revenue generation according to its fiscal needs and trade surplus. Pakistan economy is short on many accounts and nothing substantial has been done to improve upon them during current fiscal year. In fact quite a few fiscal indicators have shown downward trends. The Report has been quite explicit about them. It has not taken into account development of social sector which is of great importance for a country like ours whose economy is sailing into two boats: one of free market economy and the other where state is to play an important role for the well being of a large number of the people who are caught in between the wages of free market economy and a state that is in the process of abandoning its people at the mercy of free market but still claims to be standing with them.

Budget-2008: what should the focus be?

Budget for FY08 is being prepared under quite pressing circumstances conspicuous among them are ongoing judicial and political crisis. It is being anticipated that the former is likely to last at least 3-4 weeks till full Supreme Court bench decides about the CJ of Pakistan case. The case is not without political overtones. It could influence country’s political landscape even after its decision. The political crisis is likely to persist because year 2007 is an election year. Political stakes for contenders of power are so high that they can go to any extent to retain or gain political power. In addition to these subtle factors, ground realities of the economy are hard for the common man despite some green patches like substantial increase in FDI, tremendous increase in capitalisation of stocks, stable dollar-rupee parity, high GDP growth, comfortable foreign flows, quantum increase in foreign exchange reserves and a booming stock market that is attracting portfolio investment from domestic and foreign investors because of high returns.

The government’s posture on budget preparation is upbeat. It is showing no signs of discomfort because of somewhat high inflation in food items like edible oil, rice and wheat at a time when new crop has landed in market and government has stopped its export. The push in price is primarily because of profiteering and hoarding by market manipulators.

The SBP has already indicated that in order to reduce inflation to 6.7 per cent during next fiscal year, it will keep pursuing tight monetary policy but exact contours of the policy would be clear when the SBP will announce monetary policy for July-December 2007 somewhere in July. The government has announced to strengthen supply side of economy to reduce inflationary pressure. Import bill of food items during first ten months of current fiscal year has touched $2.36 billion mark and if demand kept on soaring during next fiscal year also that is quite possible, food import bill could be still higher. The government cannot help it.

Press reports indicate that government is to present a mega budget for forthcoming fiscal year. One of the major reasons is that FY2007-08 is an election year. The other important factor is realisation that it could not take national economy on road to self-reliance for not addressing serious problems of power crisis, infrastructural inadequacies, human resource and social sector development, good governance, higher competitiveness and productivity of industrial and agriculture sector. In fact, it should have started much earlier when it had got enough fiscal space to launch development programme.

Press reports also indicate that volume of forthcoming budget is likely to be around Rs1.5 trillion; up from outgoing fiscal year’s budgetary lay out of Rs1.02 trillion. PSDP is planned at Rs520.0 billion: Rs485 for public sector inclusive of provinces share of Rs115 billion and Rs35 billion for rehabilitation of earthquake hit areas. The allocation is 19.5 per cent higher than current fiscal year’s allocation of Rs435.0 billion. PSDP as percentage of GDP will increase from current fiscal year’s level of 4.2 per cent to 4.8 per cent. The government is confident that by increasing PSDP, it would not only be catering for a number of infrastructural inadequacies that the economy faces. It will be generating more employment, sustaining economic growth and alleviating poverty also. The government has also jacked up revenue collection to more than Rs1.0 trillion for next fiscal year against the target of Rs835.0 billion for current FY that CBR is sure to over shoot.

Conclusion

SBP report is an objective analysis of the economy. It states facts that give quite a clear picture of the economy and its fiscal health. Figures about some of the allocations and targets to be achieved sound quite satisfying but, more important and crucial questions relating to fiscal management will come to limelight when budget proposals will be implemented. Right now, the important question that needs attention is: how would the government bridge huge gap between financial resources and expenditure to meet a number of fiscal commitments? We may have to wait till announcement of the budget to find answers to these questions and many more like them.