The State Bank of Pakistan (SBP) has projected that the country will miss its Gross Domestic Product (GDP) target by 1.5 per cent in the fiscal year 2009 and the expected growth rate of economy would be some four per cent, which would be lowest in the last six years.
The country was witnessing over 6.5 per cent GDP growth rate since fiscal year 2003 and during the last fiscal year, 2008, the country’s economy registered a growth rate of 5.8 per cent.
However SBP has projected that the overall growth in the economy is expected to trim down to four per cent during the current fiscal year 2009, which would be lowest during the last six years.
The central bank in its detail monetary policy statement has presented the outlook of the economy and said that poor law and order situation, besides structural weaknesses such as power shortages etc. are mainly responsible for slowing economic growth during the current fiscal year and four per cent growth rate has also linked with expected developments in the fiscal, external and monetary sectors and inflation outlook.
“Although, growth during 2009 would be lower than the target of 5.5 per cent and the actual estimated growth of 5.8 per cent in FY08, the economic growth would be maintained or even sacrificed depending on the evaluation of the trade-off between inflation and growth,” SBP said.
The central bank said that the importance of coping with inflation and other challenges and mitigating the risks appear all the more important given the fact that even if the current encouraging trends in international prices and domestic demand pressures continue, the end of the year situation, although shows improvement over the current and the fiscal year 2008 levels, the outcome appears to be still away from the desirable and sustainable levels.
Specifically, inflation is expected to decelerate during the second half of the current fiscal year 2009, as the global commodity prices are declining and the monetary tightening measures adopted in May and July 2008 are anticipated to have a lagged impact on inflation.
Thus, the YoY headline inflation is projected to come down from 25 per cent in October 2008 to around 14 per cent by June 2009, while on average basis, inflation will be closed to 21 per cent for FY09; well above the 11 per cent target for the year, the SBP said.
Although the deceleration in inflationary pressures are encouraging, the need to bring it down to single digit level remains a top priority as the level of inflation consistent with sustainable growth is estimated at 4-6 per cent for the Pakistan’s economy. “Achieving this objective in the medium-term requires aligning aggregate demand in the economy in line with the aggregate supply,” SBP said.
Increasing imports are anticipated to slow down considerably owing to the falling international commodity prices and domestic demand moderation. Assuming the current level of international oil prices continue for the remainder of the current fiscal year and a slowdown in domestic demand is realised due to a depreciated rupee, import growth for FY09 is expected to be around two per cent and may even turn negative.
On the other hand, the growth slowdown/recession in Pakistan’s major trading partner countries, particularly US, EU and Japan is likely to have an adverse effect on our exports. It is projected that export earnings may register a growth of around 10 per cent during FY09.
Based on these projected imports and exports and assuming a continuation of existing trend in workers’ remittances, SBP estimated that the external current account deficit is estimated to lie between 6.2 to 6.8 per cent of the GDP.
“Although trade deficit is showing improvement over the last year, it is still interim unsustainable. Given the uncertainty regarding the foreign inflows and the need to build up the country’s foreign exchange reserves to end -June 2008 levels, the ‘financing gap’ is expected to be around $4.5 billion,” the central bank said in its monetary policy statement.
Given the urgency and commitment of the government to eliminate reliance on borrowing from the SBP to finance the fiscal deficit and the lower availability of external financing, the fiscal deficit will have to be cut considerably, even lower than the projected 4.7 per cent of the GDP target for FY09. This translates into a very well-defined prioritisation of expenditures and strong revenue mobilisation efforts.
However SBP said impact on the monetary sector of these expected developments in the external and fiscal sector will be reflected in a monetary growth of around 12 to 13 per cent.
The projected improvement in the external current account deficit and the government’s efforts in further reducing its fiscal deficit than initially planned, will not only allow monetary growth to remain within this desirable limit, but also help in improving the composition of M2 i.e. by increasing the share of Net Foreign Assets (NFA) and containing the growth in Net Domestic Assets (NDA).
Moreover, the lower government’s financing requirement from domestic sources will allow higher credit to private sector.
With a slowdown in aggregate demand as expected due to declining external current account and the fiscal deficit, the overall growth in the economy is expected to trim down to four per cent by the end of the current fiscal year 2009.
While removing these bottlenecks is imperative in achieving sustainable economic growth, in the interim period focus of macroeconomic policies should remain on curtailing domestic demand.
The central bank said that it must be remembered that tight monetary policy is only one ingredient of the macroeconomic stabilisation programme, while several stabilisation and structural adjustments in the fiscal, external, and financial sector are required immediately and in the medium term to put the economy back on a stable path.
The crux of this programme revolves around building the country’s foreign exchange reserves supported with appropriate exchange rate policy and bringing the fiscal deficit to sustainable levels by rationalising expenditures and strengthening tax revenue generation, the SBP said, adding that “it is anticipated that fiscal tightening of the desired level will ensure that monetary tightening stance is not undermined”.
It may be mentioned here that post-July 2008, the SBP took a number of measures at appropriate times and in phases to avoid other attendant risks.
Cumulatively, SBP has released close to Rs270 billion through lowering of reserve ratios as well as around Rs10 billion by providing 100 per cent refinancing to banks under Part I of Export Finance Scheme (EFS) to meet the growing working capital financing requirements of the exporters.
Furthermore, 100 per cent finance will also be provided against Part II of EFS and
Long-Term Financing Facility (LTFF) to promote real investment in the country.
This will inject an additional amount of Rs39.5 billion in money market, making the cumulative size of liquidity comfort provided to commercial banks to Rs319.5 billion.
These measures, aimed at accommodating exceptional liquidity requirements of the banking system, must not be construed as a change in the SBP’s monetary policy stance.
Active and calibrated liquidity management is a part of SBP’s prudent monetary management necessary to ensure effective monetary transmission mechanism which is critical to achieve financial as well as overall macroeconomic stability.
At the same time, given the persisting demand pressures, the SBP is raising policy rate from 13 to 15 per cent, which will not only help in aligning aggregate demand with supply but also provide room to accommodate government’s financing requirements from the commercial banks.
In addition, this will help calm the sentiments in the foreign exchange market and will also stem the second round impact of high inflation from spreading further. Appropriate monetary policy stance is only one ingredient of the macroeconomic stabilisation programme and as such its effectiveness depends on coordinated fiscal and external sector actions to ensure swift and sustainable stability.