KARACHI: The State Bank of Pakistan (SBP) on Friday warned of extreme economic challenges in the wake of rising international oil prices, which will lead to further energy shortfall, besides increasing social and political pressure.
In its second quarterly report for FY11, the SBP while maintaining the GDP growth rate at two-three percent during the current fiscal year said that the rise in oil prices though hit global economy severely, but the impact on Pakistan could be disproportionately larger.
“If political uncertainties remains and spreads further in the Middle East and North Africa (MENA) region, oil prices could increase even more sharply than the recent past,” the SBP said.
The report projected the average annual inflation at 14.5-15.5 percent, but said that inflationary expectations are becoming engrained. Similarly, the fiscal deficit would be in the range of 5.5 percent to 6.5 percent due to high expenditures and difficulties in achieving the revenue collection target, it said.
The SBP suggested four issues to be monitored closely for better outlook, including the upside in agriculture in Rabi FY11; the status of the International Monetary Fund (IMF) programme and fiscal pressure; the risk-averse behaviour of commercial banks; and oil prices.
“Clearly, the uncertain investment horizon and an adverse law and order situation — related to the fight against extremism — will also strongly influence this outlook,” the report said.
“The lack of fiscal space implies that the domestic POL prices will have to match international prices, which means further pressure on inflation — especially food inflation.”
“Furthermore, given the increasing use of imported furnace oil for power generation, tariffs will also have to increase, which could raise social and political pressures,” it added.
The report also pointed out the issue of circular debt in the power sector and commodity financing, which continues to burden the fiscal side.
Regarding floods that hit early this fiscal year, the central bank said that although the cotton crop and rice were adversely impacted by floods, the impact was not as bad as initially anticipated.
“More importantly, there has been an upside to the floods in terms of increased area under cultivation for wheat and better recovery from sugarcane,” it added.
The report said that during July-February FY11, Pakistan’s current account deficit was only $98 million against $3,027 million during the corresponding period in FY10.
Strong dollar-denominated export growth of 20.3 percent (on the back of high textile prices), sluggish manufacturing and consumer demand (reflected in the 12.7 percent growth in imports), and strong remittances (up 18 percent over FY10) are primarily responsible for the improvement.
A preliminary assessment suggests that the external sector will remain comfortable, the report said.
“We remain cautiously optimistic about the progress on the fiscal side, as shown by the recent fiscal measures to reduce the gap by Rs210 billion this fiscal year.”
“Having said this, net foreign inflows in the financial account have declined sharply, as the stalled IMF programme has stopped inflows from other IFIs and bilateral donors. Nevertheless, the improvement in the current account has pushed Pakistan’s forex reserves to record high, while the rupee remains stable,” the report said.
On the fiscal side, the government had taken measures by mid-March by introducing 15 percent income tax surcharge, removing general sales tax (GST) exemptions on fertiliser, pesticides, tractors, sugar and plant and machinery, and an increase in special excise duty from one percent to 2.5 percent.
“Although these tentative steps are needed, we still think the government’s revenue targets are ambitious and maintain our projection that the fiscal deficit for FY11 will be in the range of 5.5 percent to 6.5 percent of the GDP,” the SBP said.
The SBP noted that enhancing the tax base is without doubt the toughest structural reform to implement and the one that needs the greatest political will.
In this scenario, the government would continue shifting its borrowing needs to commercial banks, the central bank said.
The report appreciated the government to stick with the commitment to stay below its end-September 2010 level of borrowing from the central bank.
Meanwhile, the SBP criticised the role of commercial banks for increasing exposures in government papers, which reduced the credit opportunities for the private sector.
In its remarks, the SBP said commercial banks appear almost to have given up their role as financial intermediaries. “In our view, banks would be happy with this (borrowing by the government), as it reduces their risk-weighted assets, which is especially important given the increase in NPLs. The downside is that banks’ appetite for the private sector risk appears to have dried up, which is not a good omen for the economic growth and employment generation,” it said.
The consistent cutting in development spending (public sector development programme) to meet deficit targets, suggests there are only three avenues that Pakistan can take — exceptional steps to increase fiscal revenues; reforming loss-making public sector enterprises; and eliminating end-user subsidies.
On the revenue side, although reformed general sales tax (RGST) has become the focal point, addressing revenue leakages and glaring exemptions, eg, agriculture and ineffective taxation of properties, needs serious attention, the report added.
Forecast
• GDP growth at 2-3pc
• Inflation at 15.5pc
• Fiscal deficit at 16.5pc
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