Although the State Bank believes that pessimism following the catastrophic floods in August has started to dissipate, yet its prognosis of the economy continues to be bleak. According to the SBP's quarterly report released on 8th April, its earlier growth projection for FY11 in the range of 2-3 percent remains unchanged due particularly to the poor performance of the manufacturing sector caused by acute energy shortage and prevailing political uncertainty.
On the fiscal side, the unending debate about the RGST (and lack of progress) captures the real problem. Despite several revenue measures announced in mid-March, 2011, fiscal deficit during the current year is estimated to be between 5.5 percent and 6.5 percent of GDP. A major concern was that recent political support to populist demands may undermine the reform process in the fiscal area. Consistent cutting in development spending to meet deficit targets suggests the need to take exceptional steps to increase government revenues, reform loss-making PSEs and eliminate end-user subsidies.
On the revenue side, although RGST was the focal point, addressing revenue leakages and glaring exemptions also needs serious attention. Fiscal pressures and lower external funding would either crowd out the private sector further or result in unwelcome borrowings from the SBP, "which in turn, could reverse some of the positive steps taken to-date to address the country's macroeconomic problems".
State Bank's outlook for inflation was also not heartening. Average increase in CPI was projected to be in the range of 14.5-15.5 percent during FY11 but there are fears that inflationary expectations are becoming ingrained. Also, the link between SBP financing of the budget and non-administered prices was becoming more visible. Unless monetary policy could credibly contain government borrowings from the SBP, it would be difficult to change inflationary expectations. There was improvement in the external sector of the country and current account deficit was only dollar 98 million during July-February, 2011 as against dollar 3.03 billion registered in the corresponding period of last year.
This has pushed foreign exchange reserves of the country to record highs and kept the exchange rate of the rupee stable. This positive development was due to rising prices of high value-added textiles in the international market, and record inflows of worker remittances. However, pressures could build up on the external sector in the last quarter of FY11, which could be compounded by the recent trajectory in international oil prices.
The State Bank is also critical of the commercial banks' behaviour and has observed that "the banks' appetite for private sector risk appears to have dried up, which is not a good omen for economic growth and employment generation. Commercial banks appear almost to have given up their role as financial intermediaries."
In order to get a better handle on the outlook for Pakistan's economy, the State Bank has listed four issues that would need to be closely monitored. These include the upside on agriculture in Rabi crop FY11, the status of the IMF programme and fiscal pressures, the risk-averse behaviour of commercial banks and the price of oil. "The uncertain investment horizon and an adverse law and order situation - related to the fight against extremism - will also strongly influence this outlook".
We feel that there could hardly be any disagreement with the State Bank's assessment of the economy that is largely objective and based on reasonable assumptions. Also, as most of the year has already passed, projections for FY11, as contained in the quarterly report, have a much greater chance to be realised. Sad though it may be, however the State Bank, like most of the other analysts and institutions such as the IMF and the World Bank, is also of the view that most of the macroeconomic targets fixed in the beginning of the year are likely to be missed by a sizable margin. At a growth rate of only between 2 and 3 percent, the economy would neither be able to generate the level of employment needed to absorb the surplus labour force nor increase the availabilities to an extent to partly neutralise the impact of excess demand on the price level. Stagnation in per capita income, rampant poverty and an inflation rate of nearly 15 percent could further increase the level of frustration in the society and stoke lawlessness and chaos in the country. Drastic cuts in PSDP, acute shortages of energy and the reluctance of the banks to extend credit to the private sector due to a variety of reasons are also sure to undermine the growth prospects of the economy and increase the deprivation of the common man. A very positive turnaround in the external sector, which was a great source of comfort, was also not likely to be sustained. Although the State Bank seems to be more worried about the behaviour of oil prices in the international market, worker remittances could also be affected by the overall uncertainty in the Middle Eastern countries and shrinking employment opportunities in certain developed countries.
Persistent problems in the fiscal area, which have spilled over in terms of excessive borrowings from the State Bank and excessive money creation, together with a huge amount of circular debt in the power sector and issues in the commodity operations not only continue to plague the economy but have also posed challenges to the SBP. The State Bank has not only highlighted this issue in its quarterly report once again and suggested bold measures like taxing agricultural income and services but has also called upon the political leadership to do the right thing by making a credible breakthrough in this area, which would pave the path for Pakistan's economy going forward. This could be interpreted as a very timely message to the parliamentarians as the budget for FY12 is going to be presented in just about two months. While the problem of fiscal deficit is stubborn and endemic, we can, nonetheless, at least see a silver lining emerging on the horizon in the form of greater awareness about the relevant issues. For instance, in the recent meeting of the Economic Advisory Council (EAC) headed by Hafeez Pasha, there was a consensus on taxing all incomes irrespective of the source of origin, including agriculture and services.
The EAC members went to the extent of warning the government that they would stay away from future consultations if their recommendations were not made a part of the next budget because they were contributing their time and expertise in the larger economic interest of the country. Finance Minister, Dr Hafeez Sheikh has also disclosed that all incomes, including from agriculture, services and real estate, have to be taxed with effect from next year to broaden the tax base. Besides, PSEs would also be restructured soon.
We feel that pressures from all sides including the State Bank, multilateral institutions and most of the economic analysts, to remove all kinds of tax exemptions and undertake a major overhaul of the fiscal regime is so great at the moment that it would be hard for the parliamentarians to resist the calls for an equitable and bold approach to improve the budgetary position. Although this would be the right way to move forward to rehabilitate the economy but impediments in the way of such a strategic shift should, nonetheless, not be underestimated.
While there could hardly be any argument against the above prognosis of the economy, the State Bank, instead of complaining, could itself initiate certain measures to rationalise the credit behaviour of commercial banks. The risk-averse tendency of the financial institutions, for instance, could be curbed to a certain extent by prescribing a ceiling on the holding of government paper or reducing the rate of return available on TBs etc through taxation or some other measures.
The role of banks as financial intermediaries could also be enhanced by narrowing the discount window of the State Bank and forcing them to rely more on deposit mobilisation through narrowing the spreads and offering better rates on deposits. However, as is well-known, the best option in this regard would be to reduce the need of the government to borrow from the commercial banks by reducing the budget deficit to manageable levels. Overall, the quarterly report is expected to enhance the level of understanding of the general public about the state of the economy and could particularly be useful for policymakers of the country.