The country's economy is under stress due to delay in the implementation of key economic reforms and as per the State Bank's projections it will miss three key targets - GDP growth, fiscal deficit and inflation. According to the State Bank's first quarterly report issued on Wednesday, economic recovery suffered a setback in initial months of fiscal year 2010-11 as floods damaged about one-fourth of the country's agriculture heartland.
Due to this tragedy not only were crops and livestock destroyed, a number of agro-based industries, power plants and other manufacturing activities were also disrupted. At the same time an expected good performance by the services sector is likely to provide support to GDP growth in FY11, however despite better performance of services sector, the country will miss its GDP growth target of 4.5 percent for the current fiscal year and expected GDP growth will be between 2-3 percent, the SPB report indicated.
The combination of revisions in energy prices, higher margins on many agri-products, rising cost of imports followed by rising commodity prices and the demand stimulus from the magnetisation of the fiscal deficit all contributed significantly to the rise in inflation to 15.5 percent YoY in December 2010, up from 12.3 percent YoY in the first month of the fiscal year. The trimmed mean core inflation measure, too, continued to rise and average CPI inflation will be 15-16 percent by end June as against the target of at 9.5 percent for current fiscal year, the report said.
The report said that strong prices encourage farmers to invest in higher yields and support domestic demand. 'Therefore, the only sustainable way to protect low income groups from inflation is by targeted subsidies and the creation of ample employment opportunities', the report added.
"A part of the increase in the fiscal deficit a consequence of higher security related expenditures, flood and subsidies are responsible, however, a larger contribution to the growth in the fiscal deficit came from significant weakness in revenues, and especially the fall in non-tax revenues," it said. In this situation, the SBP has forecasted a fiscal deficit 6-6.5 percent of GDP for the current fiscal year as against the target of 4 percent.
The growing macroeconomic imbalances in the economy are still quite manageable, however, further delay in implementing critical structural adjustments risks significantly increasing the future costs to the economy, the SBP warned. In the initial months due to flood the commodity producing sector suffered the most, as many crops were damaged and LSM growth plunged back into negative after recovering in FY10.
Partly, as a consequence of floods, the government's fiscal position worsened, and the magnetisation of the deficit increased inflationary pressures, compounding the spike in prices of food staples, SBP pointed out. Moreover, while provinces had recorded a deficit last year, this year the provinces are expected to show an aggregate surplus of 0.3 percent of GDP. According to report the performance of the commodity producing sectors and Large Scale Manufacturing is expected to improve in months ahead, the report said and added that expectations of a recovery in agriculture, will however, depend crucially on the wheat harvest.
The SBP said that persistent energy shortages and growing arrears of energy payments will continue to be a drag on economic activity and commodity producing sector gains are expected to receive some support from a good showing of the services and the construction sectors.
The fiscal performance however remains a source of concern, given the outstanding issues with expenditure management as well as revenue shortfalls, it noted. 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.
According to the report the country's exports, current account deficit and workers remittances will be performed and exports will be higher then target of $20 billion to about $22-23 billion dollar. A target of $9 billion has set for the workers remittances will be achieved and SBP projected 10-11 billion dollar inflows under this head. In addition, SBP forecasted that imports will be some $4 billion higher then the earlier set target of $31.7 billion.
PROJECTIONS OF MAJOR MACROECONOMIC INDICATORS
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FY10 FY11
Annual plan SBP
targets projections
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growth rates in percent
GDP 4.1P 4.5 2.0 - 3.0
Average CPI inflation 11.7 9.5 15.0 - 16.0
Monetary assets (M2) 12.5 - 14.0 - 15.0
billion US Dollars
Workers' remittances 8.9 9.0 10.0 - 11.0
Exports (fob-BoP data) 19.7 20.0 22.0 - 23.0
Imports (fob-BoP data) 31.2 31.7 34.5 - 35.5
percent of GDP
Fiscal deficit 6.3 4.0* 6.0 - 6.5
Current account deficit 2.3 3.4 1.0 - 2.0
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P: Provisional; (*): Overall fiscal deficit target announced in the federal budget; however, this number rose to 5.3 percent of GDP as per announced consolidated federal and provincial budgets.
Note: Targets of fiscal and current account deficit to GDP ratios are based on nominal GDP in the Budget document for FY11, while their projections are based on provisional estimates of nominal GDP for the year.