Low tax-to-GDP ratio, high imports, continued energy shortages, and undocumented economy must be dealt with otherwise the key imbalances of the macro-economy might not be manageable
By Mehmood-Ul-Hassan Khan
SBP has published its first quarterly report for the year 2010-11 in which it indicated many ills of the macro-economy along with their solutions. The ongoing energy saga, circular debt and weak business confidence have shaken the economy, which is now projected to grow by 2 to 3 per cent only. The report has reaffirmed the fact that the economy is not in a healthy shape and any further delay in implementing critical structural reforms would increase the costs to the economy.
The report also indicated some serious concerns held by the central bank. The current account deficit is likely to deteriorate from January to June, 2011. Stronger growth in imports is envisaged to offset the gains from the rise in exports and workers’ remittances. The report states that the continuation of the Stand-By Arrangement (SBA) Programme of the IMF would help to soften the external financial constraints, as well as to enhance the resilience and robustness of the economy. (Table-1)
The above table clearly shows that increasing fiscal deficit, low tax-to-GDP ratio, declining levels of foreign direct investment (FDI), and widening gap between imports and exports are the major barriers confronting the macro-economy.
The SBP report stated that the recent devastating floods played havoc with the economic recovery process as floods damaged about one-fourth of the country’s agriculture areas. There were colossal losses to cash crops and livestock and a large number of agro-based industries, power plants and other manufacturing activities were also disrupted. It is hoped that an expected good performance by the services sector will provide support to GDP growth in FY11. Furthermore, a disproportionate rise in the prices of almost all agricultural products led to a significant hike in the nominal income of farmers, offsetting part of the negative impact of floods on domestic demand.
Large-scale manufacturing sector
According to the SBP report, cumulative LSM production declined by 2.3 per cent during July-November of FY11 compared with 0.5 per cent in July-November FY10. YoY LSM growth turned negative in August 2010, for the first time in 11 months and remained in the negative in the following four months.
A decline was expected in the initial months of FY11 after heavy rains and floods, which particularly affected construction, petroleum refining, cotton textiles, and agro-based industries. The main reasons were continued energy crisis, poor law and order situation, temporary supply disruptions and raw material shortages caused by unfavourable weather.
The report further shared that a recovery in agriculture will depend crucially on the wheat harvest and the livestock sector. According to the report, LSM growth is expected to turn positive again in the months ahead, as strong agri-prices support demand, and with the additional capacities coming on-line in some industries including fertiliser, cement and steel.
The services sector is expected to surpass its official growth target for FY11 on the back of strong growth in social, community, and personal services led by massive relief and rehabilitation efforts undertaken in flood-battered areas. The finance and insurance and transport sectors are also likely to have substantial growth contribution, as is reflected by the performance of these sectors during Q1-FY11.
It has remained as one of the main problems for the government and it gained momentum more than anticipated during the first half of FY11. The combination of revisions in energy prices, higher margins on agri-products, rising cost of imports and rising commodity prices and poor supply chains all geared-up the ratios of inflation. The average CPI inflation will be 15-16 per cent by end June as against the target of at 9.5 per cent for current fiscal year. The SBP report also suggested that to protect the marginalised communities from high inflationary pressures, targeted subsidies and the creation of ample employment opportunities is needed.
The report reveals that the total stock of domestic debt and liabilities posted a surge of 6.7 per cent in the first five months of current fiscal year. It said that this expansion in the domestic debt was witnessed on account of higher fiscal deficit and limited availability of external financing.
Private sector credit
The SBP report said that net credit expansion to the private sector remained weak. The combination of increasing non-performing loans (NPLs) and high risk-adjusted returns on government papers is clearly crowding out more productive private sector activities in the country.
Increase in NPLs
With regard to NPLs, these reached Rs494 bn in January 2011 as against Rs34.2 bn in June 2010. The rise in NPLs was considerably higher than in the four quarters of FY10. The SBP report further said that advances fell by Rs49 bn, further aggravating the ratio of NPLs to loans. The increase in NPLs discloses that the banking industry is not performing up to mark.
Growing fiscal and budgetary deficits are a source of chief concern to the central bank. The low tax-to-GDP ratio is one of the main reasons for this phenomenon. SBP suggested a number of tax reforms to improve the fiscal situation, including the implementation of the much contentious RGST.
The central bank disclosed that the situation related to the external sector remained poor because of delayed receipt of flood aid, substantial increase in global commodity and oil prices, and uncertainty about capital and financial account receipts.
In its latest report the SBP revealed great concern for the looming fiscal deficit and lack of availability of non-bank finance. There was a swell up to 15.94 per cent in government borrowing from banks. Owing to this, the international credit rating agency Moody’s degraded credit ratings of five major banks.
The central bank projected that the performance of the commodity producing sectors is expected to improve in the months ahead. The expected recovery in agriculture will however, depend on wheat harvest and livestock sector. LSM growth is estimated to turn positive again in the months ahead due to strong agri-prices support demand. However, the persistent energy shortages and growing arrears of energy payments will continue to be a drag on economic activity. (See Table-2)
According to the report, the country’s exports will be higher than the target of $20 bn. A target of $9 bn, set for the workers’ remittances, will be achieved and SBP projected $10-11 bn inflows under this head. In addition, SBP forecasted that imports will be $4 bn higher than the earlier set target of $31.7 bn.
The central bank’s quarterly report clearly reflects some perpetual deficiencies in the economy which are hurting our chances to have socio-economic prosperity. Low tax-to-GDP ratio, high imports, continued energy shortages, and undocumented economy must be dealt at once otherwise; key imbalances of the macro-economy might not be manageable after some time.
TABLE-1: SELECTED ECONOMIC INDICATORS
Economic indicators FY09 FY10 FY11
Growth rate (%)
LSM Jul-Nov -5.5 0.5 -2.3
Exports Jul-Dec 9.4 -4.9 20.6
Imports Jul-Dec 12.8 -16.3 19.6
Tax revenue Jul-Nov 26.2 7.1 7.6
CPI Dec 20.3 13.6 13.9
Private sector credit (Jul-Jan 8) 0.9 5.3 8.6
Billion US dollars
Total liquid reserves Jan 18 10.0 15.2 17.1
Worker remittance Jul-Dec 3.6 4.5 5.3
Net foreigner investments Jul-Dec 2.1 1.2 0.8
Percentage of GDP
Fiscal deficit Jul-Sep 1.1 1.5 1.6
Trade deficit Jul-Dec 5.0 3.3 2.9
Current account deficit Jul-Dec -4.8 -1.5 0.0
Source: SBP first quarter report (2010-11)
TABLE-2: PROJECTIONS OF MAJOR MACRO-ECONOMIC INDICATORS
FY10 FY11 SBP
Annual plan target Projections
GDP 4.1 4.5 2.0-3.0
Inflation 11.7 9.5 15.0-16.0
Monetary assets (M2) 12.5 – 14.0-15.0
US Dollar billions
Worker remittances 8.9 9.0 10.0-11.0
Exports 19.7 20.0 22.0-23.0
Imports 31.2 31.7 34.5-35.5
Fiscal deficit 6.3 4.0 6.0-6.5
Current account 2.3 3.4 1.0-2.0
Source: SBP quarter report (2010-11)