Pakistan’s economy has continued to perform strongly over the last several years with economic growth accelerating to 8.4 percent in 2004-05, its fastest pace in two decades.
The strong economic recovery since 2002-03 accompanied by macroeconomic stability has been underpinned by prudent macroeconomic policies, wide-ranging structural reforms, fiscal discipline and consistency and continuity in polices. These policies have contributed to a marked improvement in productivity and in consumer and investor confidence leading to growing overall domestic demand, which should help to support growth at a robust level over the medium-term.
The major achievements thus far included a strong economic recovery supported by a robust performance in industry, agriculture and services; extra-ordinary strengthening of domestic demand; reduction in fiscal deficit; a high double-digit-growth in exports and imports; workers’ remittances continue to maintain its momentum, stability in exchange rate; a sharp reduction in the public and external debt burden; privatisation program moving forward with a brisk pace; and Pakistan re-entering international capital markets with major successes.
Notwithstanding these successes, some major challenges also emerged in the shape of a sharp pick up in general price level and widening of trade and current account deficits: these can be described as side effects of strong economic recovery.
On the back of strong economic recovery the current fiscal year (2005-06) was envisaged to consolidate the gains made over the last three years and also address the challenges of economic recovery mentioned above.
Accordingly, the real GDP was targeted to grow by 7.0 percent, supported by a 4.2 percent growth in agriculture, 12.0 percent growth in manufacturing and a 6.5 percent growth in all other sectors. Inflation is like toothpaste, once out from the tube, it is difficult to put it back. Knowing very well that taming inflation is a difficult job; inflation at 8 percent was targeted for the fiscal year 2005-06 - slightly lower than the last year’s average inflation of 9.3 percent.
Fiscal deficit was targeted at 3.8 percent of GDP, exports and imports were targeted to grow by 16.4 percent and 16.2 percent, respectively with trade and current account deficits amounting to $5.035 billion and $3.157 billion, respectively; and remittances were targeted at $4.3 billion.
Pakistan’s economy faced headwinds from rising energy prices, touching all time high at over $70/bl from the beginning of the current fiscal year. It was then struck by massive earthquake of October 8, causing widespread destruction of areas and human lives. These two developments have so far had a limited impact on growth but the capacity of the economy to absorb shocks of such magnitudes is not unlimited. This Report reviews the performance of the key macroeconomic indicators during the first half (July-December) of the current fiscal year.
ECONOMIC PERFORMANCE DURING JULY-DECEMBER 2005
1: REAL SECTOR: Real GDP growth is targeted at 7.0 percent for the current fiscal year 2005-06 as against an extraordinary strong growth of 8.4 percent last year. While fixing the real GDP growth target for the year it was assumed
that agriculture may not repeat its strong performance of last year as base effect would lower its current year’s growth.
Accordingly, this year’s growth will be supported by a 4.2 percent, 14.5 percent and 6.5 percent growth in agriculture, large-scale manufacturing and other sectors, respectively.
A AGRICULTURE: Pakistan’s agriculture has been suffering, off and on, from severe shortage of irrigation water in recent years. The normal surface water availability at canals heads of 103.5 million acre feet (MAF) the overall (both for Kharif and Rabi) water availability has been less in the range of 5.9 percent (2003-04) to 29.4 percent (2001-02). Relatively speaking, Rabi season faced more shortage of water than Kharif during these periods.
During the current fiscal year (2005-06) the availability of water for Kharif season (for crops such as rice, sugarcane and cotton) has been 5.4 percent more than the normal supplies and 19.6 percent more than last year’s Kharif [see Table 1]. Wide-spread rains along with melting of snow on mountains top were responsible for higher than normal availability of water during Kharif season.
Improved water situation also helped in recharge of ground water. The water availability during Rabi season (for major crop such as wheat), as of January 5, 2006, is estimated at 30.6 MAF which is 16.0 percent less than the normal availability but 32.5 percent more than last year’s Rabi. Having discussed the water situation, though briefly, we now turn to analyse the likely outcomes of the four major crops during the year.
COTTON:
Area and production targets for cotton crop during the current fiscal year were 3.25 million hectares and 15.0 million bales, respectively. The crop was, however, sown on the area of 3.124 million hectares - 3.8 percent less than the target and 2.2 percent less than last year (3.193 million hectares).
The Cotton Crop Assessment Committee of the Ministry of Food, Agriculture and Livestock (MINFAL) in its meeting held on October 25, 2005 has revised its cotton production estimates to 12.5 million bales on ex-farm basis, (Punjab 9.5, Sindh 2.9, NWFP 0.007 million and Balochistan 0.094 million bales).
The recent information indicates that the size of the cotton crop may be in the range of 12.7 to 13.0 million bales or 8.9 to 11.0 percent less than last year. Factors responsible for the decline in cotton production include: excessive rain at the time of sowing, high temperature at flowering stage, late wheat harvesting resulting in decline in area under the crop, and pest attack in some cotton growing areas in Punjab and Sindh.
SUGARCANE: For 2005-06 the area under sugarcane crop was targeted at 0.955 million hectares as against 0.966 million of last year. However, sugarcane has been sown in the area of 0.900 million hectares - 5.8 percent below the target and 6.8 percent less than last year.
Sugarcane production for the year 2005-06 is estimated at 40.1 million tons against the original target of 50.095 million tons and last year’s achievement of 47.244 million tons.
Thus, sugarcane production is estimated to be lower by 15.1 percent over the last year. Factors responsible for the decline in sugarcane production include late harvesting of wheat, farmers shifting to other competing crops and frost affecting the crop.
RICE: Area and production targets of rice for the year 2005-06 were set at 2.533 million hectares and 5.000 million tons, respectively. Area sown for rice is estimated at 2.531 million hectares - 0.1 percent lower than the target but 0.5 percent higher than last year.
The size of the crop is estimated at 5.5 million tons - almost 9.5 percent higher than last year and 10 percent higher than the original target.
WHEAT: Area and production targets of wheat - a Rabi crop, for the fiscal year 2005-06 are fixed at 8.415 million hectares and 22.0 million tons, respectively. The area under wheat crop this year is higher by 1.6 percent (8.234 million hectares) compared with last year.
Availability of water in sufficient quantity along with good price of crop last year was responsible for the increase in area sown. Large-scale manufacturing continues to maintain its growth momentum during the first five months (July-November) of the current fiscal year.
Against the growth target of 14.5 percent for the years the large-scale manufacturing has grown at an average rate of 12.0 percent during the
first five months (July-November) of the fiscal year. A relatively.
Weaker growth in large-scale manufacturing in October 2005 clearly reveals the impact of Earthquake. Industrial growth appears to have picked up in November 2005 when large-scale manufacturing grew by 15.2 percent. Most of the major industrial groups have registered high double-digit growth. The
performance of petroleum group, engineering industries and non-metallic mineral products has been relatively weak.
On the other hand, basic metal industries (the production of Pakistan Steel) and tyres and tubes have registered large negative growth. One of the coke oven batteries of the Pakistan Steel has been out of order since July 2005, causing Steel Mill to operate at around one-third of its capacity.
*Consequently, the Federal Bureau of Statistics only captures the production of Pakistan Steel. The production of a large number of small, medium and large size steel mills being operated by the private sector is not captured in basic metal industries. production of basic metal industries has registered a decline of 60.3 percent.
The production of tyres and tubes has registered a decline of 10.7 percent as manufacturers of cars are moving towards tubeless tyres. Automobile and electrical appliances industries continue to register strong growth of 33.4 percent and 28.6 percent, respectively during July-November 2005. Based on the trend of the first five months of the current fiscal year, it is safe to assume that the growth target for the year (14.5%) is likely to be achieved.
FISCAL DEVELOPMENTS: The fiscal policy stance remained decidedly growth-oriented, providing for strong public sector spending, declining debt service costs, intensification of spending on alleviating poverty and investing in infrastructure.
Pakistan has made considerable progress in recent years on fiscal side. The overall fiscal deficit that averaged nearly 7.0 percent of the GDP in the 1990s has declined to 3.3 percent in 2004-05.
Fiscal deficit is targeted at 3.8 percent of GDP for the current fiscal year which is slightly higher than the deficit level of the previous year (3.3% of GDP). Higher deficit was targeted to finance higher public sector development program (PSDP), particularly towards financing infrastructure projects. Pakistan needs to strengthen its physical and human infrastructure to sustain growth momentum.
Revenue collection by the Central Board of Revenue (CBR) was targeted at Rs 690 billion for the fiscal year 2005-06 - 17.6 percent higher than last year. Revenue collection by the CBR during the first half (July -December) of the current fiscal year has been impressive as it surpassed the target (Rs 308 billion) for the period by Rs 15 billion.
Net collection stood at Rs 323.0 billion against last year’s collection of Rs 262.5 billion, thereby registering an increase of 23.1 percent. Further breakdown of tax collection provides interesting information. The collection of direct taxes has increased by 32.9 percent on net basis - rising from Rs 78.4 billion to Rs 104.2 billion. The performance of indirect taxes has also been impressive. Net collection of indirect taxes grew by 18.9 percent - rising from Rs 184.1 billion to Rs 218.9 billion.
Within indirect taxes, the performance of sales tax has been equally impressive. Sales tax on net basis grew by 20.8 percent - rising from Rs 109.4 billion to Rs 132.1 billion. Custom collection has been in line with other taxes in terms of its performance. Custom collection on net basis stood at Rs 61.5 billion as against Rs 51.2 billion of comparable period of last year, thereby registering an increase of 20.1 percent.
The collection of central excise stood at Rs 25.3 billion during the first six months of the current fiscal year as against Rs 23.6 billion in the same period of last year, thus registering a growth of 7.4 percent.
Pakistan continues to maintain fiscal discipline. The overall fiscal deficit for the first half (July - December) of the current fiscal year stood at Rs 160.2 billion or 2.1 percent of the projected GDP for the year. Furthermore, fiscal deficit stood at 56.2 percent of the full year deficit target of Rs 285 billion
Total revenue for the first half amounted to Rs 498.4 billion as against Rs 423.8 billion in the same period last year, thus registering an increase of 17.6 percent. Tax revenue stood at Rs 364 billion which was 22.1 percent higher than the corresponding half of the last year. Similarly, non-tax revenue amounted to Rs 134 billion and was up by 6.7 percent in the same period. Total expenditure on the other hand stood at Rs 658.6 billion as against Rs503.3 billion in the same period of last year, thus registering an increase of 30.9 percent. Current expenditure amounted to Rs 537.5 billion which was 25.7 percent higher than the corresponding period of last year.
The higher growth in current expenditure was mainly on account of earthquake related spending amounting to Rs 30 billion or 0.4 percent of GDP. Excluding earthquake related spending the current expenditure stood at Rs 507.5 billion and was up by 18.7 percent.
Development expenditure amounted to Rs 121.1 billion and was 40.3 percent higher in the same period of last year. A substantially large growth in development spending simply points toward growth -oriented fiscal policy stance adopted by the government. The overall fiscal deficit excluding earthquake-related spending amounts to Rs 130.2 billion or 1.7 percent of the projected GDP for the year or 45.7 percent of the full year deficit target of Rs 285 billion.
MONEY AND PRICES: Monetary policy stance of the SBP has undergone considerable changes during 2004-05, switching from a broadly ‘accommodative’ stance to an aggressive tightening in the second half of the fiscal year, more so since April 2005. The SBP sought to strike a balance between promoting growth on the one hand and controlling inflation on the other.
The SBP opted to raise interest rates moderately throughout the period, but kept the benchmark rates well below inflation. The gradual and continuous rise in core inflation raised the pressure for a significant rise in interest rates. The SBP, therefore, raised the discount rate in April 2005 by 150 basis points to 9.0 percent.
As against the revised Credit Plan target of 14.5 percent, the actual monetary expansion during FY05 registered a growth of 19.3 percent. In absolute terms, however, monetary expansion of Rs 479.1 billion during FY05 was significantly higher than Rs 407.8 billion expansions in FY04.
The major causative factor for NDA growth during FY05 was the continued growth in credit to private sector. Net credit to the private sector registered an expansion of Rs 428.8 billion during FY05 compared with Rs 325.2 billion during FY04.
Manufacturing sector had been the largest recipient of bank credit. Within manufacturing, textile sector witnessed a growth of 26 percent (on stock), and absorbed Rs 88.2 billion of credit during the year.
Consumer finance continued to grow at robust pace during FY05 registering an expansion of Rs 84.7 billion compared with Rs 45.9 billion in FY04.
CREDIT PLAN 2005-06: According to the credit plan for 2005-06, the SBP has set the target for monetary expansion to the tune of Rs 380 billion or 12.8 percent higher than last year (FY05) on the basis of a growth target of 7.0 percent and inflation target of 8 percent. The net domestic assets (NDA) and net foreign assets (NFA) of the banking system were set to increase by Rs 365 billion and Rs 15 billion, respectively.Within the NDA, the credit to private sector was projected to expand by Rs 330 billion, accounting for 86.8 percent rise in broad money supply (M2)
The money supply (M2 definition) during July-December, 2005 of the current fiscal year expanded by Rs 236.3 billion as compared to an expansion of Rs 244.5 billion in the corresponding period of last year.
Slower expansion in monetary assets during first six months of the current fiscal year was attributed primarily to a large contraction of Rs 64.6 billion in NFA. In the same period of last year the NFA recorded an increase of Rs 3.3 billion.
The net domestic asset (NDA) on the other hand expanded by Rs 300.9 billion as against almost Rs 241.2 billion in the same period last year. Higher expansion in the NDA of the banking system is due mainly to a larger expansion in credit to private sector (Rs 297.7 billion as against Rs 284.7 billion in the same period last year).
Credit to private sector grew by 4.5 percent (Rs 297.7 billion) during July-December 2005 as against a credit growth of 22.3 percent (Rs 284.7
billion) in the corresponding period of last year. Credit to private sector continued to exhibit strong demand, reflecting confidence of this sector on the improving macroeconomic environment in the country.
The distribution of credit to the private sector has been broad-based. The manufacturing sector continued to be the largest recipient of bank credit, utilising Rs 68.9 billion during July-November 2005-16.2 percent more than the same period last year. Within the manufacturing sector, textile industry received Rs 59.2 billion followed by cement industry (Rs 8.5 billion) and fertiliser industry (Rs 1.7 billion).
The credit off-take of the construction sector rose by 82.4 percent to Rs 5.0 billion. A strong growth (188.0%) is witnessed in commerce related credit off-take which stood at Rs 34.3 billion. The growth in consumer loans continued its strong momentum, expanding by 61.2 percent to Rs 38.7 billion. Most of the consumer loans were acquired to finance a range of products, including automobiles (Rs 13.0 billion), personal loans (Rs 12.2 billion), credit cards (Rs 6.5 billion) and housing loans (Rs 5.9 billion) The government borrowing for budgetary support stood at Rs 78.3 billion as against Rs 25.4 billion in the same period last year.
Higher government borrowing for budgetary support reflects a large spending on reconstruction and rehabilitation of the earthquake affected areas and the people. Monetary expansion in fact picked up substantially after the October 8 earthquake when broad money supply increased by 7.8 percent, after a contraction of 1.2 percent until the first quarter (July-September).
**INTEREST RATE ENVIRONMENT: **Fiscal year 2004-05 witnessed a gradual shift in monetary policy stance, as rising inflation attracted response from the SBP. Although it raised interest rates until March 2005, monetary policy largely remained accommodative to support economic recovery; the weighted average lending rates remained negative in real terms and private sector credit rose by a record Rs 428.8 billion during the year.
The sharp pick up in inflation in April 2005 changed the SBP’s monetary policy stance from measured to aggressive tightening - a policy still being pursued.
The benchmark 6-moths T-bill interest rate has been increased by 274 basis points (bps) since March 2005 and until December 2005. However, since March 2004 the 6-months T-bill interest rate has been increased by 650 bps. Accordingly, the weighted average lending rate increased from 6.57 percent in March 2005 to 9.77 percent in November 2005 - an increase of 320 bps.
Since March 2004 the weighted average lending rate has been increased by 508 bps but the deposit rate has not increased with the same pace, resulting in widening of spread by 400 bps in the same period to 7.4 percent. However, in December 2005 the lending rate declined a bit to 9.53 percent and deposit rates inched up to 2.55 percent.
The large banking spread reflects the inefficiency of the banking system. The discount rate was also increased by 150 bps to 9.0 percent in April 2005 as part of the tight monetary policy. The gradual tightening of monetary policy and the attendant rise in interest rate is however consistent with global rise in interest rate. The LIBOR has also started moving upward from as low as 1.87 percent in June 2004 to 4.69 percent in December 2005 .an increase of 282 bps.
STOCK EXCHANGE: The buoyant mood in Pakistan’s stock markets prevailed during FY05. The Karachi Stock Exchange (KSE) share index and aggregate market capitalisation (AMC) recorded increase of 41.1 percent and 50.0 percent respectively during FY05. The Karachi Stock Market remained as one of the best performing markets around the world during FY05.
During the first half of the current fiscal year (FY06), the stock market maintained its robust business mood. The KSE share index increased from 7450 points in June 2005 to 9557 points in December 2005, recording a growth of 28.3 percent. Similarly aggregate market capitalisation has increased from Rs 2037 billion ($34.1 billion) in June 2005 to Rs 2748 billion ($45.9 billion) in December 2005 - an increase of 34.9 percent.
The buoyancy in the stock markets can be attributed to a number of positive factors including: a continuation of pro-growth macroeconomic policies; a stable macroeconomic environment; a strong growth momentum taking firm hold; continuation of privatisation program in brisk pace; appropriate reform initiated by the Securities and Exchange Commission of Pakistan (SECP); the availability of adequate liquidity in the market; good operating financial results from the majority of blue chip companies; and a visible improvement in the India-Pakistan relationship. These factors are expected to continue to drive the equity market during the remaining period of the current fiscal year (FY06).
On calendar year basis, the KSE has been the best performing market in the world in 2005. Out of the 21 leading stock exchange markets in the world, the KSE share index increased by 53 percent, followed by Seoul, Colombo, Mumbai, Tokyo and others.
**PRICES **A sharp pick up in commodity prices and unprecedented rise in international price of oil have led to the re-emergence of inflationary pressures across the globe. After living in a low inflationary (4.0%) environment for the last five years, Pakistan witnessed higher inflation for a variety of reasons.
The higher inflationary trend in Pakistan is the outcome of pressures manating from demand and supply side. Three and a half years of strong economic growth (5-8.4%) have given rise to the income levels of various segments of the society. The rising levels of income have strengthened domestic demand and put upward pressures on prices of essential commodities. Supply side pressures emanated from a variety of factors. A 38.3 percent increase in the support price of wheat in two years, shortage of wheat owing to less than the targeted production, and mismanagement in wheat operation in one of the wheat deficit province resulted in sharp increase in the prices of wheat and wheat flour.
The prices of other food items such as beef, mutton, chicken etc also registered sharp increases owing to ‘sympathy effect’ on the one hand and demand pressure on the other. Unprecedented rise in international price of oil is yet another component of supply side pressures.
Inflation during the first six months (July-December) of the current fiscal year is estimated at 8.4 percent as against 8.8 percent in the samem period last year. Food inflation is estimated at 7.5 percent as against 12.6 percent of last year.
Non-food inflation at 9.1 percent is on higher side compared with 6.2 percent in the same period last year. The non-food non-energy inflation which is also known as core inflation has also moved up and estimated at 7.6 percent as against 6.6 percent in the same period last year.
The Central Banks around the world tend to focus on core inflation that excludes the impact of food and energy prices. Core inflation basically represents policy (fiscal, monetary, exchange rate policies) induced inflation. The persistence of relatively high core inflation compelled the SBP to change its monetary policy stance from ‘accommodative’ to ‘neutral’ to aggressive tightening.
House rent index also played an important role in building inflationary pressure this year. With second largest weight in the CPI (23.4%) after food (40.3%), the persistent rise in this index has contributed substantially to the increase in CPI based inflation.
From a level of 4.5 percent in 2003-04, the index recorded an increase of 11.3 percent in 2004-05. During July-December 2005-06 the index has increased to 11.1 percent as against 10.4 percent in the same period last year.
Cognisant of the impact of inflation on the economy, most importantly its adverse and disproportionate effect on the poor and vulnerable segments of society as well as its deleterious effect on purchasing power of the fixed-income group, the government responded in a multi-pronged manner to the rise in the price level. A strategy of regular monitoring of domestic stocks of key commodities and their prices was adopted, by which the government was able to respond in a timely manner to shortages by importing substantial quantities of wheat and other essential commodities to augment supplies.
To ease off the demand pressures generated by the rising level of economic activity, the State Bank of Pakistan began to tighten monetary cycle rather aggressively since April 2005. The easing of demand pressure through monetary policy and improving the supply situation of food items through raising their production (for example, wheat this year) and through imports the government succeeded in reducing inflation from 11.1 percent in April 2005 to 7.9 percent in November 2005. Most importantly, food inflation which was as high as 15.7 percent in April 2005 brought down to 8.1 percent in December 2005.
The sharp decline in food inflation in a short period of seven months provides ample evidence that government’s policy to liberalise import regime by allowing duty free import of wheat, wheat flour, sugar, livestock and other essential food items have been a success. It is important to note that after staying at above 8 percent for the last 11 months, the CPI-based inflation declined to less than 8 percent in November 2005. It moved to above 8 percent in December 2005 purely on account of base effect.
Going forward, the base effect of petroleum prices and transport charges will play an important role in further lowering inflation. Until December 15, 2005 the high prices of petroleum products and the attendant rise in transport charges are measured against the froze prices of petroleum products and transport charges during May - December 15, 2004.
The government started raising the prices of petroleum products, and transport charges started increasing accordingly after December 15, 2004, therefore, the gap in petroleum prices and transport charges between last and current years will start narrowing down with consequential decline in overall inflation rate. Based on the above facts and stability in food prices it is safe to assume that the current fiscal year is going to end with an inflation rate of 8.0 percent (as targeted).
Mywish, ab khush ho.