Fiscal deficit set at 6.5 percent: SBP forecasts GDP growth at three percent

Despite some tentative tax measures the government's revenue targets are ambitious and the fiscal deficit for the current fiscal year would be in the range of 5.5 percent to 6.5 percent of GDP, which is expected to post a growth rate of 2.0-3.0 percent by end-June against the target of 4.5 percent, said the State Bank of Pakistan (SBP) in its second quarterly report on Pakistan's economy, issued on Friday.
The SBP one again has predicted that fiscal deficit, GDP growth, inflation and monetary assets growth targets would be missed during the current fiscal year, while exports, for the first time in the history of Pakistan, will touch $24 billion mark. According to the Report, on the fiscal side, the unending debate about the proposed 'RGST' and lack of progress captured the real problem.
"Having said this, several revenue measures, including 15 percent flood surcharge on existing income tax payers, removal of GST exemptions on fertiliser, pesticides, tractors, sugar and plant & machinery and increase in Special Excise Duty, have been announced in mid-March 2011. Although these tentative steps are needed, SBP still thinks the government's revenue targets are ambitious, and maintain our projection that the fiscal deficit for FY11 will be in the range of 5.5 percent to 6.5 percent of GDP," the report said.
On GDP side, the State Bank has stuck to its earlier projection of Gross Domestic Product growth of 2-3 percent for the current fiscal year (FY11), accounting for the catastrophic floods in August 2010. However, the SBP has warned that the uncertain investment horizon and adverse law & order situation - related to the fight against extremism, will also strongly influence this outlook.
According to SBP, the consistent cutting in development spending (PSDP) to meet deficit targets suggests that there are only three avenues that Pakistan can take exceptional steps. These include to increase fiscal revenues, reforming of loss-making public sector enterprises and eliminating end-user subsidies.
Although the floods dominated in the first quarter, persistent problem on the fiscal front, which spilled over in terms of excessive government borrowing from SBP, still continues to plague the economy. "At macro level, the stalled IMF program centered on the growing fiscal deficit, which forced the government to seek a nine-month extension in the Standby Arrangement (SBA) to September 2011", the report said. The lack of fiscal space implies that domestic POL prices will have to match international prices, which means further pressure on inflation-especially food inflation, it said.
Further, given the increasing use of imported furnace oil for power generation, tariffs will also have to increase, which could raise social and political pressures. "Then, there is the issue of the circular debt in both power sector and commodity financing, which continues to burden the fiscal side,' the report said.
The external sector has been comfortable during July-February FY11 and Pakistan's current account deficit was only $98.0 million, against $3.027 billion in the corresponding period in FY10. A preliminary assessment suggests that the external sector will remain comfortable, the Report said, adding: "We remain cautiously optimistic about progress on the fiscal side, as shown by the recent fiscal measures to reduce the gap by Rs 210 billion this fiscal year".
"Having said this, net foreign inflows in the Financial Account have declined sharply, as the stalled IMF program has stopped inflows from other international financial institutions and bilateral donors. Nevertheless, the improvement in the current account has pushed Pakistan's forex reserves to record highs, while the Pak rupee remains stable', the Report observed.
Beyond this, the impact on the rest of the economy could be as follows: oil prices will hit the external sector and domestic increase in POL prices will hit the demand for automobiles and construction and its affiliated sub-sectors. In addition, rising furnace oil prices will exacerbate the energy shortfall that currently exists, the SBP Report added.
"We also remain concerned that recent political support given to populist demands may further undermine the reform process - more specifically, resistance to the passthrough on POL and power tariffs; restructuring of loss-making public sector enterprises (PSEs); and implementing the RGST," its said. With fiscal pressures and below-target external funding, domestic financing pressures could increase. This will either crowd out the private sector further, or result in unwelcome borrowing from SBP, which in turn could reverse some of the positive steps taken to date to address the country's macroeconomic problems.
"In our view, despite the staggering humanitarian cost of the August 2010 floods, there is a possible upside for the agriculture sector. Other than better-than-expected wheat production this year, we are also optimistic about cotton, sugarcane and rice in FY12. "Finally, the real fear is the rising price of oil. If political uncertainty remains and spreads further in the Middle East/North Africa (MENA) region, oil prices could increase even more sharply than the recent past. Although this will hurt the global economy quite severely, the impact on Pakistan could be disproportionately larger," it said.