State of the economy- Towards recovery?

The state of the economy is shaky but not unsalvageable according to State Bank reports. Below is a summary of the recent issues and policies under the State Bank

The Friday Times, November 19-25, 2010

Macroeconomic indicators: According to State Bank (SB) reports, the economy showed an improvement in macroeconomic indicators during the 2009-10 fiscal year. The economy grew at a rate of 4.1 percent, compared to 1.2 % in 2009. Other signs for improvement seem to be a decline in annual inflation and current account deficit.
The decline in the current account overshadowed worsening of the financial account and thus allowed the external account balance to record a surplus in FY10 (after a gap of two years). Foreign exchange reserves rose to $16.9 billion by end-June 2010. The combination of declining imports and higher reserves meant that the import coverage improved.

Yet the 4.8 percent depreciation of the rupee during FY10 is a puzzle. According to the Business Recorder (Oct 26) the explanation lies in the fact that the larger part of the financing for the current account deficit was in the form of loans from multilateral agencies (predominantly the IMF), which do not enter the interbank market. Moreover, the SB had also stopped the provision of liquidity for oil purchases, with the interbank market shouldering this additional demand as well.

Economic Indicators (2009-2010)

Indicators 2006-07 2007-08 2008-09 2009-10 (Jul-Sep)
(Billion $)
17.01 19.22 17.79 19.63 5.24
(Billion $)
30.54 39.96 34.82 31.05 8.21
Trade Balance
(Billion $)
-13.53 -20.74 -17.03 -11.42 -2.97
(Billion $)
5.13 5.15 3.72 2.21 0.39
Foreign Investment
(Billion $)
8.42 5.19 2.67 2.14 0.46
Worker Remittances
(Billion $)
5.49 6.5 7.81 8.91 2.65
Forex Reserves
(Billion $)
15.18 10.83 12.23 16.07 17.10
Exchange Rate
(Rs. / US$)
60.50 71.0 88.90 86.21 85.94
GDP Growth 7.00% 5.80% 2.10% 4.10% 4.10%
Inflation 7.90% 10.30% 13.10% 11.17%

Source: State Bank of Pakistan (SBP), Federal Bureau of Statistics (FBS)

Structural weaknesses: In its annual report on the State of the Economy the SB stated that while the above developments marked an improvement from the FY09, fundamental structural weaknesses in the economy remained unaddressed, the most important of which was weak fiscal performance.

The fiscal deficit was at 6.3 percent of GDP in FY10 i.e. 1.1 percentage points higher than in the previous year.

In 2010, the fiscal policy has been that of continued expansion in fiscal and quasi-fiscal operations. This has crowded out and damaged private sector activity, caused double-digit inflation, and increased total public debt and liabilities from 68.7 percent of GDP in FY09 to 69.5 percent in FY10.

Furthermore key reforms have failed to get a grip in the economy. Firstly there have been persistent disagreements that have led to the deferment of a proposed expansion of the tax net through the introduction of a broad based GST. Secondly, the proposed restructuring of public sector enterprises, to improve efficiency and lower the fiscal has not taken place. Lastly, after some initial work, there has been little or no progress in resolving the energy sector debt chain, i.e. the “circular debt” problem, or substantially improving electricity supply.

The floods: The SB has said that FY11 macroeconomic targets have suffered a serious setback early into the year due to the floods. SB estimation is that the direct impact of the flood-related supply shock will be limited. The impact of the floods has strengthened the inflationary expectations for FY11; the August 2010 Consumer Price Index, included a 15.6 percent year-on-year rise in its food component. The shortages of minor crops are not expected to persist beyond 2 to 3 months as supply line improves and fresh crops enter the market.

The SB has pointed out that any rise in domestic prices would be capped by low international prices and that prices of dairy products were already continuing on a secular rise even before the floods. Livestock losses in the flood would exacerbate this rising trend, but only to a small extent.

The report states that even with the worsening of macroeconomic variables, “there is an argument that the central bank should respond to the rising inflationary pressures and excessive increase in the fiscal deficit, and on the other, the demand-shock stemming from the flood damages argues for a countervailing monetary easing to help revive the faltering economy.”

New bills: The National Assembly on Thursday, November 6, unanimously passed new bills, including The Industrial Development Bank of Pakistan Reorganisation and Conversion Bill 2009 and The State Bank of Pakistan (Amendment), Bill 2010 .

The Industrial Development Bank of Pakistan (IDBP) bill states that bad portfolios have exacerbated IDBP’s problems, harming the financial condition of the bank. Thus the IDBP needs financial restructuring and conversion in to a public limited company. All permanent employees and officers of IDBP shall become the employees of IDBP as a public limited company.

Presenting the State Bank of Pakistan Amendment Bill, Minister for Finance Hina Rabbani Khar said the State Bank of Pakistan Act, 1956, being old law could benefit from being updated to current emerging functions of a modern central bank and to best international practices. The proposal is to replace the Monetary and Fiscal Policies, Co-ordination Board and give the current Monetary Policy Committee statutory status with external experts to be appointed by the Federal Government. According to the Minster, The main object for introducing this statutory committee is to facilitate the State Bank’s autonomy in performance of its essential functions in the changing financial environment. Furthermore, lending to the Government has been restricted, functions pertaining to open market and credit operations and international reserves have been elaborated and clarified, and Section 52 of the SB Act which provided for the supersession for the Central Board by the Federal Government since the State Bank was privately owned has been repealed in conformity with the current autonomy of the Central Bank, and international practice. Thus the SB will be able to decide and implement the exchange rate policy, determine the limits and nature of advance loans to be extended by the bank to the government and approve and issue the monetary policy statement.

Saadia Gardezi



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