Early warning signs

The ambitious targets set by the government for 2014-15 in the Annual Plan are already beginning to look unattainable even in the first two months. This is due, first, to the setting of targets oblivious of some worsening of trends in the last few months of 2013-14 and, second, due to recent ongoing events like the happenings in Islamabad and the floods which have already wreaked extensive damage in Punjab.

The GDP growth rate target for 2014-15 is 5.1 per cent, based on the Pakistan Bureau of Statistics (PBS) estimate of growth of 4.1 per cent in 2013-14. The leading sector is expected to be large-scale manufacturing sector with a growth rate of seven per cent. Such a high growth rate has not been achieved by this sector since 2006-07.

However, there has been a visible loss of momentum in industrial production since December 2013. The growth rate in the first six months of 2013-14 was high at 6.5 per cent, but it fell to less than two per cent in the second half of the year. Consequently, the annual growth rate in 2013-14 is four per cent. This is significantly lower than the growth rate assumed for the year by the PBS.

The projected growth rate of seven per cent of the large-scale manufacturing sector is very optimistic, in view of the above developments. The textile sector remains sluggish in the absence of buoyancy in exports. The fastest growing industry in 2013-14 was fertiliser (urea), with a growth rate above 16 per cent. It contributed almost 25 per cent to the overall growth of the sector. This was primarily due to a large diversion of natural gas to the industry, which has since been withdrawn.

The impact of the floods on the agricultural sector is also becoming visible. In Punjab alone there has already been inundation of 1.2 million hectares of cropped area, especially of rice and sugar cane. The cotton crop could also be partially devastated as the water enters South Punjab. Already, there is a perception that this is one of the worst floods ever in Punjab, rivalling the floods of 1992.

A first estimate of the loss to the major crop sector of Punjab is 12.5 per cent of the annual value added. Inclusive of indirect effects on manufacturing and services, Punjab’s GDP would be affected by almost 2.5 percentage points. If impending losses to Sindh are included then the impact on the GDP growth rate of Pakistan could be up to 1.5 percentage points.

Turning to inflation, there has been some moderation in the rate of increase in the Consumer Price Index. Clearly, the substantial appreciation in the value of the rupee has had a favourable impact. Also, international commodity, including oil, prices have been declining.

This trend could be reversed in coming weeks and months. The rupee has started falling once again and the inter-bank rate with respect to the dollar has shown a depreciation of 3.7 per cent since the beginning of August. A major area of concern is the recent deterioration in the balance of payments. In 2013-14, the balance of payments position had stabilised and foreign exchange reserves had crossed nine billion dollars by the end of the year, equivalent to an import cover of more than two months.

Trade figures released for August 2014 by the PBS are extremely worrying. Exports are down by four per cent, while imports have shown phenomenal growth of 32 per cent. Consequently, the deficit in the balance of trade has jumped up by a massive 77 per cent. Hopefully, this is unusual and will not be repeated in coming months.

However, the floods could also contribute to a worsening trade balance. Last time, after the floods of 2010, Pakistan had to make additional imports of cotton and sugar of almost a billion dollars, mostly from India. Rice exports could also be affected. The Annual Plan has projected a current account deficit of $2.8 billion in 2014-15. The indications now are that it may be larger, approaching four billion dollars. There are two favourable factors namely, lower oil prices and continued buoyancy in home remittances which could limit the size of the deficit.

Financing of the current account deficit could also prove more difficult. The Fourth Review by the IMF has not yet been completed. This should happen soon if a severe decline in market confidence is to be avoided. Already, foreign direct investment has dipped and may be affected by the political agitation and instability that has emerged in recent weeks. Similarly, other donors may also become shy, although Pakistan needs more assistance for relief and rehabilitation after the floods. However, the government has not asked for such support. Down the road, the success in Zarb-e-Azb operations should bolster the confidence of investors.

It is, perhaps, too early to judge what is happening on the front of public finance. Retirement of circular debt of almost Rs300 billion, which has not been budgeted for this year, is becoming a pressing liability. Public funds will also have to be diverted, both by the federal and provincial governments, for relief and rehabilitation after the floods. Consequently, the national Public Sector Development Programme may be cut once again in 2014-15 and the deficit may exceed the target of 4.9 per cent of GDP.

Overall, Pakistan’s economy has moved into a period of some difficulty. Events described above may lead to a major fall in the GDP growth rate, jump in inflation to a double-digit rate, worsening of the external balance of payments and pressure on reserves. It will be a real challenge for the beleaguered government to stabilise the economy once again.

Published in The Express Tribune, September 23^rd, 2014.

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