Current policy mix ‘adequate’ to cater to Pakistan's economic needs: SBP report

• The macroeconomic stabilization process picked up momentum with the initiation of IMF’s Extended Fund Facility program.
• Despite stability gains, the overall confidence among businesses and consumers remained weak.
• LSM struggled with inventory build-ups amid rising input costs during the quarter.

The State Bank of Pakistan (SBP), in its newly released The State of Pakistan's Economy - First Quarterly Report 2019- 20, has termed the current economic policy mix sufficient to address the country’s macroeconomic issues and stabilize economy.

“During the first quarter of FY20, Pakistan’s economy moved progressively along the adjustment path. So far, the policy mix appears adequate to address the macroeconomic imbalances and push the economy towards stability,” stated the SBP report released on Monday.

IMF's EFF, documentation and other achievements

The central bank highlighted a number of important policy developments during the first quarter of 2019-20.

• First, the macroeconomic stabilization process picked up momentum with the initiation of the IMF’s Extended Fund Facility program. While the SBP continued to keep the monetary policy consistent with the medium-term inflation target, consolidation efforts were also visible on the fiscal front, both on the revenue and expenditure sides.
• Second, the system of a market-based exchange rate was implemented, to which the interbank foreign exchange market – barring initial edginess – adjusted relatively well.
• Third, the government abided by its commitment to avoid deficit monetization, including rollover of SBP debt, which is instrumental for ensuring effective monetary management.
• Fourth, the government actively pursued documentation efforts, including asset revaluations, tight financial scrutiny, and the introduction of structured mechanisms to formalize businesses’ value-chains.

The SBP said that while the success of documentation measures would appear in the medium term, “the payoff from the ongoing stabilization efforts has become visible in the form of declining twin deficits. Specifically, the current account deficit (CAD) in Q1-FY20 fell to less than half of last year’s level. This improvement came on the back of significant import compression and the ongoing shift towards renewables and indigenous coal in the energy mix, whereas volumetric gains were also visible in the country’s exports.

Thus, with the payments gap narrowing in the interbank, the available financial inflows helped the SBP accumulate foreign exchange reserves.

Talking about the fiscal side, SBP said that improvement came from a healthy growth in both tax and non-tax collections and containment in current spending, both at the federal and provincial levels. “As a result, the overall fiscal deficit remained lower as compared to the same period last year, and the primary balance recorded a surplus for the first time in 7 quarters.

Concern over low confidence, high inflation and LSM struggles

The central bank however pointed out that despite these stability gains, the overall confidence among businesses and consumers remained weak, as they struggled to preserve their purchasing powers and dealt with operational constraints stemming from the adjustment process.

“For consumers, the increase in inflationary pressures in the economy (especially food items) was particularly disconcerting, as it impacted their real incomes. This high inflation outcome was driven largely by the pass-through of the exchange rate depreciation, correction in energy prices, shortage of food items, and revenue measures taken by the government.”

For businesses, perceptions about the current economic conditions remained below the threshold level (index value below 50, which represents prevalence of more negative views than positive views).

In addition to the government’s revenue measures and tight credit conditions, this may also reflect the impact of the FBR’s instructions to businesses to record CNIC numbers of buyers and suppliers while filing sales tax returns.

While large businesses (especially export-oriented and import-competing industries) remained bullish on fundamentals, they refrained from taking a longterm view. “This cautious behavior, coupled with tapering demand and the compression of unregistered businesses – which dominate the network of dealership and wholesale infrastructure of registered firms – reinforced the economic slowdown.”

On the whole, a number of industries within the large-scale manufacturing (LSM) struggled with inventory build-ups amid rising input costs during the quarter. With gross margins squeezed and financing costs rising, firms scaled back their operations to save their bottom lines from dropping further. As a result, a contraction was observed in a majority of LSM sub-sectors.

Policy Perspective

The SBP said that it is important to continue with the adjustment process despite weakening economic activity, as well as the visible stability gains in terms of the falling twin deficits. “The policy continuation is warranted given the lingering vulnerabilities in the economy and the chronic nature of the structural weaknesses.”

Build on Ease of Doing Business gains 

Keeping these challenges in view, the central bank says that it is vital that the government continues to address the underlying structural vulnerabilities and put the economy on a balanced and sustainable growth trajectory.

The SBP further urged that to build on gains on the ease of doing business front, “which requires not just the capacity development in key public institutions, but also a continuous dialogue with relevant stakeholders to ensure smooth implementation.”

Side by side, it is equally important for firms to leverage on the facilitative policies, particularly the export promotion incentives, and gain a foothold in the global value chains (GVCs); this would not only align our product mix with trends in global demand, but also put the exports on a sustainable growth path.