May 212008

That’s the sad song the new finance minister, Naveed Qamar, is likely to be hearing from
now until the federal budget for the next fiscal year is announced on June 14, as he and his ministry struggle to cope with a plethora of bad news that has hit the economy
By Kaleem Omar

The previous finance minister, Ishaq Dar of PML(N), had barely settled into his job when he had to resign because of his party’s decision on May 15 to withdraw all nine of its ministers from the coalition cabinet headed by Prime Minister Yousuf Reza Gilani. Dar’s replacement is the PPP’s Naveed Qamar. He now has the thankless task of preparing the federal budget for fiscal 2008-09 against the backdrop of what looks like a host of bad news for the economy.

In this context, here’s a quick rundown of some of the much vaunted “positive macroeconomic indicators” that seem to have somehow suddenly turned negative – fostering suspicions that these indicators were not as great as the Shaukat Aziz government had repeatedly claimed they were.

First, according to the State Bank of Pakistan, the country’s total liquid foreign reserves further declined by $48.7 million during the first 10 days of May, 2008, to $12.207 billion on May 10. Thus, foreign exchange reserves have now declined by $4.293 billion from $16.50 billion less than a year ago.

Of the current reserves figure of $12.207 billion, the reserves held by the State Bank totaled $9.48 billion, while reserves held by commercial banks were $2.359 billion.

One of the reasons for the steep decline in reserves is the ever-rising price of imported crude oil, which hit close to a record $127 a barrel on May 15 and an all-time high of $128 a barrel the next day amid widespread fears over stretched global energy supplies. The spike in oil prices, together with stagnating exports of around $17 billion a year, have led to a further widening of the trade gap, which is currently running at about $1.6 billion a month, or $19.2 billion a year on an annualised basis.

The growing trade gap has put more pressure on the balance of payments, further eroded foreign exchange reserves and reduced the fiscal space available to the government. These factors are bound to have an adverse impact on the resources that the government expects to generate in fiscal 2008-09 for development expenditure under the Public Sector Development Programme. Previous projections made by the government in this regard may therefore have to be scaled down unless some new sources of funding can be found.

Second, international credit rating’s agency Standard & Poor’s cut Pakistan’s sovereign rating on May 15, citing increasing pressure from expanding budget and trade deficits against a volatile political setting.

The move came as no surprise to analysts, who have long been warning about deteriorating fundamentals and policy paralysis in Pakistan’s economy, or to investors who have driven the rupee down to record lows. The rupee has shed 12 per cent in value against the dollar since January 1 this year, forcing the State Bank to intervene in the money market in the past few days.

But the intervention could be a case of too little too late, and so far seems to have had no effect on arresting the rupee’s decline. Actually, the decline in the rupee’s value against the dollar works out to considerably more than 12 per cent if the sharp decline in the dollar’s value against the euro, the Japanese yen and other major currencies is factored in to the equation.

When the rupee was de-linked from the dollar in January 1981 by then -Finance Minister Ghulam Ishaq Khan had allowed to float against a “basket of currencies,” its value stood at 9.90 rupees to the dollar. Today, its value stands at over 67 rupees to the dollar.

What is intriguing about this whole exercise in an enforced devaluation of the rupee by about 10 per cent a year is that no Pakistani government in the last 27 years has ever publicly spelt out just which currencies make up this so-called “basket of currencies”, nor has any government every spelt out just what weightage is attached to each currency in the basket in order to work out the market value of the rupee.

According to the State Bank, growing macroeconomic imbalances, particularly in the widening fiscal and current account deficits, continue to create complications and add to inflationary pressures.

The State Bank says that the rise in the fiscal deficit during 2007-08 has more troubling implications than the increase in the previous year. The modest increase in the fiscal deficit during the preceding two years has been relatively less troubling, as (1) revenue growth has remained strong, and (2) the rise in spending essentially reflected the impact of post-earthquake relief and reconstruction. Excluding this, the fiscal deficit remained below 4.0 per cent of GDP. In both years, the current expenditure during the first half of the fiscal year remained below 7.0 per cent of the full year GDP. In contrast, the fiscal deficit during the first half of 2007-08 is estimated to be 3.6 per cent of the estimated annual GDP – nearly twice the figure for the last two years. “This incorporates a decline in revenue growth as well as rising current spending,” says the State Bank.

“From the (S&P) rating agency’s perspective, if the political situation has really undermined the economic fundamentals to a degree, they have to take action,” said Tim Condon, head of Asian economic research at ING.

Standard & Poor’s cut Pakistan’s long-term foreign currency debt rating to ‘B’ from ‘B+’ and its long-term local currency rating to ‘BB-‘ from ‘BB’. The outlook is “negative,” S&P said.

“More than the ratings cut, the negative outlook is going to hurt the government’s ability to raise foreign debt, especially at a time when they are trying to refill their dollar reserves,” said Asad Iqbal, managing director at Ismail Iqbal Securities.

Pakistan last ventured into the international debt market in May 2007. Political turmoil, including the lawyers’ movement triggered by the judges’ issue, has forced the country to put plans for another sovereign bond issue this year on the backburner.

ING’s Condon said the government might just have to consider asking the multilateral donor agencies such as the International Monetary Fund for more funding, since raising money from markets was going to be a lot more expensive.

“The negative outlook reflects our (S&P) assessment that the sovereign vulnerabilities may accentuate further, given that the emergence of a stable, cohesive and effective physical environment needed to tackle mounting macroeconomic imbalances doesn’t seem to be at hand,” said S&P credit analyst Agost Bernard in a statement.

Third, the economic situation has gone downhill. Annual inflation, at more than 17 per cent, is at its highest in more than three decades, the current account gap has widened, and government spending has caused the budget deficit to balloon. Food inflation is even higher – as much as 40 per cent in the case of some essential foodstuffs.

Fourth, as reported in a story published in this newspaper on May 16, “Even the ‘holy cows’ hiding under the cover of ‘security threats’ are now officially being pinpointed as part of the problem facing the economy in high-expenditure and low-tax payment areas, a pre-budget official paper reads.”

The story added: “There are strong probabilities that proposals listed for the pre-budget examination by the federal cabinet next week would be based on the worry that avoiding tough decisions would jeopardise the planning for stopping the steep downturn in crucial areas. Such steps are being advised despite the fact that ‘the only segment whose vulnerability has increased is the poor urban and rural dwellers, particularly the wage earners,’ as the study paper, examined by budget-makers and expected to form part of the preamble for the budgetary proposals list for 2008-09 for the cabinet, says.”

Fifth, microfinance institutions, operating on international donors’ grants or soft loans, face a difficult situation as their poverty-stricken borrowers are being squeezed by rising food prices and are unable to service their loans. Microfinance institutions are often the only source of credit for the poor, who form a huge chunk of the population.

Using the yardstick of a per capita income of $2 a day (a more realistic figure than the government’s yardstick of a per capita income of $1 a day, given the spike in food prices, POL prices and electricity tariffs), the number of people living below the poverty line in Pakistan is estimated at 72 per cent of the population.

That’s a staggering number, but what, if anything, do the budget-makers propose to do about it?

The only piece of good news in recent days is that remittances sent home by overseas Pakistanis continue to show a rising trend. According to the State Bank, remittances of $5.319 billion were received in the first 10 months of the current fiscal year, compared to $4.450 billion in the same period last year – an increase of 19.53 per cent.

Source: The News, 19/5/2008

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