KARACHI- The State Bank of Pakistan released its Third Quarterly Report for FY14 on the state of the economy today. According to the report, Pakistan’s economy appears to have turned a corner during the third quarter. Revival of economic activity is a key development in FY14, with real GDP growth of 4.1 percent, which is the nation’s highest growth rate in the past five years.

The report adds that after many years of low growth, sentiments about the economy seem to have improved. Manifestations can be seen in the rebound in real GDP growth; the rise in the private sector credit; a contained fiscal deficit; the subdued inflation outlook; the sharp increase in FX reserves and the appreciation and subsequent stability in the exchange rate.

Also, economic improvements arose due to the government’s resolve to address the energy shortage, a growing perception of business friendly policies, and external inflows that had recently been acknowledged. More specifically, the auction of 3G/4G licenses; a larger-than-projected inflow via Eurobonds; program loans from the IFIs; and SBP’s efforts to support the FX reserves, have sharply improved the outlook of the country’s external sector, and to some extent, its fiscal position.

However, the report emphasized, “These signs of improvements should not discount the challenges faced by the economy; efforts for much needed-structural reforms should continue.  These positive developments provide a strong platform to move towards sustained economic growth in the medium term.”

The Third Quarterly Report exposed the stabilizing influence of the recent influx of external resources on the exchange rate and the following sharp increase in SBP’s FX reserves. On this matter it stated, “While the PKR’s appreciation improved business sentiments and its subsequent stability has eased inflationary expectation, the sharp increase in the country’s FX reserves provides some comfort for domestic and foreign investment.”

The average inflation during Jul-Mar FY14 was 8.6 percent.  Now the stability of PKR, stable international oil prices and softer global commodity prices should contain inflationary expectations.

Based on the data released by the Ministry of Finance, the SBP Report informed that fiscal deficit during the first nine months of FY14 was only 3.2 percent of GDP— significantly lower than the average deficit in the last five years.  However, it does point out that despite efforts for fiscal consolidation on the expenditure side, tax mobilization still remains lackluster as FBR is still operating on a narrow tax base.

While the FBR should take concrete steps to plug tax leakages and increase documentation of all financial transactions, provincial governments (having the constitutional right to tax services and agricultural income) also need to implement provincial taxes more effectively.

With regard to finance, the Government mainly relied on domestic sources during Jul-Mar FY14.   However, external financing has increased subsequently with the issuance of Eurobonds, fresh loans from IFIs, and bilateral assistance. Although the resumption of external inflows is important for a resource-constrained economy, this will add to Pakistan’s external debt. The SBP Report showed the total public debt (external and domestic) crossing the limit of 60 percent of GDP, as set by the Fiscal Responsibility and Debt Limitation Act (2005) for FY13 onward. Hence, any addition to the external debt should at least be matched with an equivalent reduction in the domestic debt outstanding.

Pressure on the balance of payments has eased as bulky re-payments to IMF subsided after November 2013, and the country experienced an influx of external grants, loans and foreign investment (like Eurobonds). 

The policymakers should formulate an industrial policy that prioritizes production efficiency and job creation.