Following a breakaway with the International Monetary Fund, financing of the fiscal deficit – the gap between revenue and expenditures – was and still remains challenging, the State Bank of Pakistan (SBP) said in its fiscal 2011 report on the state of economy on Monday.
“With a decline in external funding following the suspension of the IMF stand-by arrangement, the government had little choice but to rely increasingly on domestic sources,” says the report.
The government borrowed Rs1.1 trillion from domestic resources in fiscal 2011, which accounted for 91% of the fiscal deficit.
Pakistan negotiated an $11.3 billion loan package from the IMF three years ago to avoid a balance of payments crisis, however, disagreements over fiscal management led to the programme’s effective suspension at the end of last year.
The heavy reliance on commercial banks not only crowded-out the private sector, but also complicated monetary management, as banks focused increasingly on short-term T-bills to place their surplus liquidity, adds the report.
As a result, private sector credit only grew by 4% compared with increase of 74.5% in the government borrowing from commercial banks. Since commercial banks were lending to the government at attractive rates, this left little incentive to fund private businesses, says the report.
Fighting the tide
Pakistan’s economy managed to grow by 2.4% in fiscal year 2011 despite devastating floods in the early part of the financial year.
Almost one-fifth of the country’s agricultural heartland was inundated, which interrupted production processes and disrupted the subsequent supply of both labour and capital. It is estimated that 6.6 million of the country labour force was out of work for two to three months, and capital stock worth $2.6 billion or 1.2% of GDP was lost, the report said.
SBP report said that while international response to the devastation was below expectations, it is commendable that the government was able to address these challenges despite severe fiscal constraints.
Acknowledging the importance of energy as a key factor of production, the report devoted a full chapter to assess the country’s energy shortage.
It pointed out that the government’s response to energy shortfall was threefold; commissioning of rental power projects, resolving circular debt issue by injecting Rs 120 billion and increasing electricity tariffs to pass on the higher cost of production. In spite of these measures, the overall situation remained largely unchanged.
The report said that commissioning rental power projects to increase generation capacity was misplaced, as the country is operating well below its installed capacity due to the circular debt problem. It also noted that the Rs120 billion injected by the government – to restart the funding of furnace oil – only happened in May 2011. In effect, for most of financial year, the acute problems in the power sector went unaddressed, the report says.
Inflation target missed again
The financial calendar turned out to be yet another year of double-digit inflation, fuelled by supply side factors including devastating floods at the beginning of the year coupled with strong global prices of oil and agriculture commodities. On the demand side, massive government borrowing from the central bank especially during the first quarter of the year added to inflationary expectations.
The supply constraints not only kept inflation high, but also hurt growth.
Actual inflation turned out to be well above the targeted level in financial year 2011, a trend now seen for the past five financial years.
Annual inflation clocked in at 13.7% in fiscal 2011 compared with 10.1% posted in the same period last year. Prices of perishable commodities were affected the most by the floods, since their supply was severely restricted.
Govt restricts growth but revenue drops
While the government restricted growth in its total expenditure, the damage was done on the other side as growth in revenues declined more sharply. Resultantly, the budget deficit to GDP ratio increased to 6.6% in fiscal 2011 compared with a target of 4%.
At the time of setting budgetary targets, the government envisaged not only a considerable containment in its expenditures but also a sharp increase in tax revenues 26.2% on the back of a promising set of tax reforms. However, it faced serious setbacks to its budgetary plans as value added tax could not be implemented and unprecedented floods which called for unplanned allocation of resources.
The government announced fiscal deficit of 4% of GDP in the budget for fiscal 2012, however, the target is likely to be missed due as there is no credible policy measures.
Inflows drop for third straight year
Foreign investment, which can play an important role in growth of a resource-constrained economy, continued to decline for the third successive year. Investors’ concerns over governance issues, energy and the prevailing security situation prevented growth in foreign direct investment (FDI) on the back of global recession, which depressed FDI across the world.
FDI inflows from advanced economies have dropped to $604.0 million in fiscal 2011 from $1,026.0 million last year whereas; from emerging economies FDI inflows have increased to $338.0 million from $105.0 million in fiscal 2010.
The largest decline was observed in the telecom where profit repatriations have surpassed new investment by Rs34.1 million. As a developing market with a teledensity of only 60%, Pakistan offers great opportunities to investors in this sector.
Not washed away with the floods
Despite experiencing substantial flood-related losses particularly in the cotton and rice crops, the agriculture sector recorded a growth of 1.2% during the year. This growth exceeded the previous year’s level, and was mainly led by the livestock sub-sector, followed by minor crops and two major crops namely sugarcane and wheat, says the report.
A higher price for the previous sugarcane crop, favourable weather conditions and timely availability of inputs, helped enhance sugarcane production by 12% to 55.3 million tons.
Encouragingly, the crop yield increased to a record level of 56 tons per hectare. The record wheat crop of 24.2 million tons shows a growth of 3.9% in financial year 2011 against a decline of 3% a year earlier.
Construction posts lowest growth in a decade
The construction industry by crawling up 0.8% posted the lowest growth in a decade. This number was particularly distressing in the backdrop of the 59-year high growth posted in FY10 of 28.44%. Growth fell short by 3%age points of the target set by the Planning Commission at the outset of the year.
The building industries face several energy-related problems. Firstly, irregular supply of gas and electricity affected industries which require constantly heat to keep the raw material malleable such as glass, steel re-rolling (gas-based), and steel melting (electricity-based). Secondly, rising fuel prices added to costs of transportation of both inputs and outputs: glass became more expensive in the south as the entire industry is north-based. Similarly, relatively cheaper steel scrap from ship-breaking at Gaddani became costlier.
Volatile year for export leader
Textile sector, contributor of almost half of the country’s total exports, was fairly positive at the beginning of financial year, although the sector faced hardship with intensified power outages and gas shortages. Moreover, devastating floods also affected textile production in the first half, however, this was made up by the surge in global cotton prices during the second half of the year. Consequently, the textile manufacturing witnessed a growth in 10.9% in the second half compared with a decline by 6.5% in the first half.
This rise in cotton prices lead to a broad-based increase in textile products across the globe, which helped Pakistan earning record $13.8 billion through textile exports. The price impact was so strong that earnings from textile exports grew by 44.7% in the second half.
Published in The Express Tribune, December 20th, 2011.