State Bank's quarterly report released on 2nd February, 2011 has confirmed once again fears that Pakistan's economy continues to be in a very poor shape and any "further delay in implementing critical structural adjustments risks significantly increasing the future costs to the economy."
Persistent energy shortages, growing arrears of energy payments together with weak consumer and business confidence have taken their toll on the domestic economy, which is now projected to grow only in the range of 2 to 3 percent, as compared to the annual plan target of 4.5 percent and actual growth of 4.1 percent during FY10.
Given the outstanding issues with expenditure management and revenue shortfall, fiscal performance also continues to remain a source of concern. A large part of increase in the fiscal deficit was explainable, being a consequence of higher security-related expenditures and the floods, but a larger contribution to the fiscal weakness came from significant weaknesses in revenues.
A variety of tax reforms have been suggested to improve the fiscal situation, including the much-maligned RGST, wealth tax, agri-income tax, capital gains tax and improved tax governance but, according to the SBP, such a controversy was unnecessary "as arguably all of these proposals should be implemented to ensure widening of the tax base."
These reforms will induce cost-push inflationary pressures in the economy in the short run, but would help sustain high growth in the long run. A major worry for the State Bank was that larger fiscal deficit, non-availability of non-bank finance and a reluctance to borrow from the market by the government was contributing to the magnetisation of deficit.
As a result, it was the government sector that had dominated the 15.94 percent YOY M2 growth during the current year so far. Growing exposure of banks to government-related lending has also led to a downgrading of five major banks by Moody's.
Inflationary pressures too have strengthened more than anticipated during the first half of FY11. Although post-flood shocks will fade away, "the fiscal expansion, proposed reduction in energy subsidies and prospects of rising imported inflation will continue to drive inflationary expectations.
Consequently, SBP estimates for FY11 have been revised upwards from 13.5-14.5 percent to 15.0-16.0 percent." Nonetheless, the State Bank was not in favour of direct government intervention as it would lead to market distortions. The external sector situation also looks grimmer due mainly to an expected fall in flood-related receipts, increase in international commodity prices, especially for energy and uncertainty about capital and financial account receipts.
Financing problem of an anticipated current account deficit will put pressure on the country's forex reserves and could increase volatility in the exchange rate. We feel that a pessimistic view of the economy, as projected by the State Bank, is a true reflection of the unfolding situation that is really dire and should serve as a warning to the authorities to make extra efforts to stop the rot before the gathering storm becomes a deadly tornado.
It needs to be mentioned, nonetheless, that in the unique context of Pakistan, one could now also include the leaders from the opposition parties in the circle of authorities due to their newly assumed power of overruling the government's policy plans, making the task of policy-making of the country doubly tedious and cumbersome.
Anyhow, the State Bank has revealed nothing extraordinary in its quarterly report, but followed its script of analysing the economic parameters based on reasonable assumptions. Its estimates, like most of the other analysts, indicate very clearly that most of the macroeconomic targets fixed in the beginning of the year are likely to be missed by a sizeable margin.
At a projected growth rate of only between 2 and 3 percent, the economy would not be able to generate the level of employment needed to absorb the surplus labour force and the standard of living of the ordinary people would not improve due to a stagnation in the per-capita income.
The rate of inflation, which was projected to be in single digit, is now estimated to be around 16 percent. Although the data on poverty is not yet available, it is definitely going to increase since a large number of people in the country were already living on the margin and factors like increasing inflation and unemployment would worsen their plight further.
Regrettable though it may be, but a combination of such negative developments could increase the level of frustration in the society and stoke lawlessness and chaos in the country. Early signs of such disquieting events are already visible in some urban areas of Pakistan.
Unfortunately, the PSDP and increased availability of private sector credit, which could serve as a driving force to accelerate development and absorb the increasing levels of the labour force entering into the market, have both been direct victims of a marked deterioration in the public finances of the country. Most of the ills of the economy could only be removed by pruning expenditures, increasing revenues and bridging the gap in the fiscal position of the country to a reasonable level, but it is easier said than done.
One area, which was a source of some comfort, was an improvement in the external sector account during the first half of FY11. Due to a variety of factors, such a turnaround, according to the State Bank, may also not be sustainable. Against this perspective, it is the considered view of the SBP to continue with the structural programme of the IMF to soften the external financial constraints, as well as to enhance the resilience and robustness of the economy.
This is a very well-judged remark of the State Bank on the current economic situation but, given the present level of resentment against the IMF in the country and a number of violations in the conditionalities under the existing SBA, whether such a proposal would be really implemented or useful is anybody's guess.
Also, the State Bank has rightly linked the manageability of the growing macroeconomic imbalances with implementing the agenda of critical structural adjustment reforms. Such a link is of course of paramount importance but the developments during the year show that it is nearly impossible to tread such a path due to consistent resistance by the groups with vested interests and the opposition parties, who are bent upon browbeating government and preserving their own interests.
The imposition of the RGST, which could have been a very useful tool to document the economy and broaden the tax net, remains mired in controversy and the practice of fixing domestic oil prices in line with the international prices, has been abandoned for the time being. Nobody is now talking about taking measures to raise revenues or reduce subsidies.
On the other hand, the whole emphasis seems to be on getting more facilities or relief from the present government. The parliamentary representatives, who were given the task of forging a consensus on various economic reforms are not making satisfactory progress, but only adding to the fiscal problems of the country by postponing certain crucial decisions.
In this kind of situation, we see only little hope of the faithful implementation of the necessary reform agenda, on which the improvement in key areas of the economy depends. In all probability, therefore, the next quarterly report of the State Bank will also not reveal any good news. This would, of course, be sad but the destiny of nations depends on taking the right decisions at the right time.