Pak economy facing big challenges

ISLAMABAD - The Asian Development Banks Outlook 2011 presents a bleak picture of Pakistans economy as it observed that fiscal developments are worrisome due to the rollback in oil prices, partial increase in electricity tariffs, broad tax exemptions for flood affected areas and continued heavy fiscal support to the state-owned enterprises. According to the outlook, Pakistans economy faces considerable challenges, as floods in 2010 hit the agricultural output and damaged the infrastructure badly. Apart from fiscal developments, the inflation rate is still high and might further accelerate. The fiscal deficit is increasing due to delays in revenue-increasing measures, increase in oil price at international market and continued heavy fiscal support to the state-owned enterprises. Pakistans economic performance in fiscal year FY2010 (ended June 2010) and into FY2011 reflects largely the same structural weaknesses that contributed to its FY2008 macroeconomic crisis. Energy shortages and security issues held the economic rebound for FY2010 to 4.1 per cent, slowing growth for FY2008-FY2010 to an average of only 3 per cent, well below the 8 per cent needed to create jobs for the predominately young population. The outlook revealed that Pakistans fiscal balance was deteriorated in last fiscal year 2010-2011, as it widened to 6.3 per cent of the GDP against the revised target of 5.1 per cent. The fiscal deficit increased due to delays in policy measures to enhance the revenue collection and also heavy fiscal support to the state-owned enterprises. The reports also observed that Federal Board of Revenue (FBR) missed the revenue collection target and also declined as a share of GDP, reaching a 30-year low of 9 per cent in FY 2010. Pakistans current budget expenditure is relatively rigid, and it is difficult to offset overruns in one category with reductions in another. Inflexible current expenditure (such as security, interest, and pensions) alone-absorbed revenue of 7.4 per cent of the GDP in FY2010, or about 82 per cent of FBR tax receipts. Subsidies amounted to another 1.7 per cent of GDP. Pakistan might not be able to collect the revenue collection target during the current fiscal year. Revenue targets called for 26 per cent growth of tax receipts; well over the 5-year average of 14 per cent. Meeting the target would have been hard even if a reformed General Sales Tax had come into effect, said the outlook. The government sharply curtailed the federal public sector development programme (PSDP) to 3.5 per cent of GDP to ease deficit pressure. The federal government borrowing from the State Bank of Pakistan (SBP), the central bank, as well as from commercial banks rose to Rs339.7 billion (2.3 per cent of GDP), reflecting a widening deficit and lower external financing. Escalating losses from SOEs reached an estimated 1.7 per cent of GDP for FY2010 adding to pressures. Inflation fell to 11.7 per cent in FY2010 from 20.8 per cent in FY2009. As it moderated, the SBP lowered the policy rate in steps from 14pc to 12.5 per cent. From the supply side, transitory improvements in large-scale manufacturing partly reversed 2 years of declines and supported a recovery in services, led by wholesale and retail trade. Agriculture expanded by a modest 2 per cent due to weak performance by major crops. The fragility of the recovery was underscored by continued investment contractions. Infrastructure shortages and security issues contributed to a 5.1pc decline of gross private capital formation. Gross fixed capital formation contracted by 2 per cent in FY2010, coming on the heels of an 11.3pc decline the previous year. The FY2010 also saw a third consecutive year of decline in investment in large-scale manufacturing (down 15.4 per cent) and electricity and gas (11 per cent lower). Overall, the steady decline in total gross fixed investment as a share of GDP from 20.5 pc in FY2006 to 15pc in FY2010 will crimp future growth prospects. Private savings have similarly declined, owing in part to the failure of key asset rates to keep pace with inflation, leading to either negligible or negative real returns. Pakistans external reserves reached $17.4b in early Feb 2011, amounting to more than 5 months of imports of goods and services. This buildup essentially reflects IMF releases of $7.1b under the standby arrangement, an additional $450m in emergency support in Sept 2010, and support from the Coalition Support Fund ($633m) at end-Dec 2010. The central banks holdings of liquid forex reserves ended FY2010 at $13.9 billion. While the import growth remains modest, a significant expansion of exports during the first 7 months of FY2011 moved the current account deficit into near balance, at 0.5 per cent of GDP, but it is expected to widen to 1.7 per cent for full-year FY2011, reflecting higher international food and commodity prices. For the first 7 months of FY2011, exports of textiles and rice showed strong growth in value terms, mainly on higher world prices. Remittances increased further, broadly in line with inflation, but non-debt-creating inflows continued to decline, with private FDI inflows about 16 per cent below the same period of the previous year. The current account deficit is expected to edge upward in FY2012 to 2.3 per cent of GDP as projected declines in global food and commodity prices are more than offset by the impact of improved growth and increased demand for imports, including for post flood reconstruction. Energy related circular debt, which stood at Rs 446 billion at the end of FY 2010, is expected to surge by end of FY 2011.