KARACHI: Pakistan’s economic growth will slow down to 3.6 percent in the current fiscal year, and there are deepening concerns about the adequacy and sustainability of foreign currency reserves, the Asian Development Bank said in a report released on Tuesday.
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The report said the deceleration, by almost two percent, is a result of the energy crisis, which affected the textile and food sectors, which constitute almost half the manufacturing sector.
The report said that at the end of the government’s five-year term in mid-March, there was little political scope for major policy or structural reforms. Economic developments in FY13 are unfolding along broadly similar lines to those in FY12.
The economic situation weakened further in the first half of FY13 as official reserves declined markedly, food and general inflation reaccelerated in January following their earlier decline, and exports stagnated and imports contracted.
The 3.6 percent slowdown, with risks of shortfalls in agricultural production, may offset the modest improvement in large-scale manufacturing during the first half of the fiscal year.
Production of petroleum products, iron, and steel picked up, according to the report. But growth in textiles and food, which account for almost half of large-scale manufacturing and the bulk of exports, remained negligible.
The report said manufacturing performance for the fiscal year will hinge largely on power outages being limited during the summer season, when demand peaks. With little prospect for improvement of energy supply or investment, growth is expected to remain weak in FY14, at an estimated 3.5 percent.
Consumer price inflation maintained a downward trend during most of the first eight months of FY13 as food price inflation decelerated. However, year-on-year inflation at 7.4 percent in February 2013 was higher than the year’s low of 6.9 percent in November 2012 as food prices moved higher.
Nevertheless, food inflation in this fiscal year is much slower than a year earlier, reflecting improved supply.
The core-inflation situation, excluding food and energy, also improved but, at 9.6 percent in February 2013, remains stubbornly high. Many of its subcomponents stayed in double digits, reflecting entrenched inflationary pressure in the economy. However, with slower growth in food and energy prices, inflation is expected to average 9.0 percent in FY2013, or two percentage points lower than in the previous fiscal year.
On the expectation that there will be no substantive improvement in the country’s fiscal and energy imbalances in FY14, inflation is expected to edge up to 9.5 percent.
Easing inflation early in FY13 prompted further reductions in the State Bank’s main policy rate by a total of 250 basis points, bringing it to 9.5 percent in December 2012. While the banks’ weighted average rate on new loans in this period fell by about 200 basis points to 11.3 percent, overarching constraints coming from energy shortages and other uncertainties, such as law-and-order issues, will limit the impact of interest-rate reductions on investment and business conditions in general.
A modest increase in lending to private businesses in the first seven months of FY13 was mainly for working capital, with the bulk of lending going to textile firms. A modest surplus in the current account during the first seven months of FY13, following inflows of $1.8 billion from the Coalition Support Fund, reverted to a deficit of $700 million in February 2013. As disbursements of the same magnitude are not expected during the second half of the year, it is expected that the current account will post a deficit on the order of 0.8 percent of GDP.
Exports contracted by 0.9 percent during the first eight months of FY13, but a 3.5 percent contraction in imports was four times larger. Low export growth was largely the result of 2.7 percent lower textile exports, reflecting the impact of continuing energy shortages, difficulties in meeting production schedules, and slack global demand. The contraction in imports was mostly of food, transportation equipment, and petroleum.
Despite improvement in the current account, net liquid foreign exchange reserves declined further, dropping from $10.8 billion at the end of June 2012 to $7.9 billion at the end of February, reflecting higher debt amortisation payments, including payments to the International Monetary Fund, and lower financial inflows.
Low reserves adequacy, at less than two months of imports cover as of February 2013, raises concern over external sector sustainability. Pressure on reserves is expected to continue, with an additional $1.7 billion due to the IMF before the end of FY2013 and $3.2 billion during FY2014.
The financial account was in deficit during the first eight months of FY2013 despite a modest revival in portfolio inflows as foreign direct investment stagnated. The nominal exchange rate depreciated by four percent in the first eight months of FY2013.
The report said the continuing weak export prospects, combined with limited import demand held down by slow domestic growth and relatively stable global prices for oil, support a projection that the current deficit will increase marginally to 0.9 percent of GDP in FY2014. However, weak capital inflows and large debt repayments, including to the IMF, will put pressure on the official reserves and the exchange rate.
The fiscal outlook is largely unchanged from FY2012. Revenue targets announced with the FY2013 budget are unlikely to be met, as tax receipts have grown by only 12 percent in the first six months, well below the 23.7-percent increase needed to meet budget targets.
On the expenditure side, overruns on interest outlays and subsidies are again expected, as subsidy allocations of Rs120 billion have already been exceeded and will reach at least Rs200 billion along with a further build-up of power-sector arrears.
The deficit for the first half of FY2013 is 2.5 percent of GDP, including the seven percent of GDP from the Coalition Support Fund that is the single payment for the year. Given normal quarterly patterns for fiscal balances, the deficit for FY2013 is expected to breach the 4.7 percent target and is likely to come in at seven to 7.5 percent of GDP, excluding any payments to settle power-sector arrears.
Government bank borrowing continued in the first half of FY2013. The government did acknowledge requirements under the State Bank of Pakistan Act by retiring Rs399 billion of the Rs505 billion borrowed from the central bank during the first quarter of FY2013, before borrowing back Rs183 billion in the second quarter in response to fiscal pressures, which thereby breached the act once again.
Large government borrowing from commercial banks requires ever-larger injections from the central bank on a weekly basis to meet banks’ liquidity requirements and keep money market rates anchored within central bank policy rates.
Taming inflation would require shrinking these injections, which would in turn require lower government borrowing, or else higher lending rates to further crowd out credit to the private sector.
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