EXECUTIVE SUMMARY

The assessment of the first six months performance of the economy in 2014-15 by the Finance Minister is generally positive.

He has indicated that the economy is on track to achieve the high GDP growth rate of 5.1%; reserves have risen to above $15 billion; average inflation is down to 6%; FDI is on the increase; home remittances have been buoyant with a growth rate of over 15%; Government borrowing from SBP has decreased by Rs 425 billion and the fiscal deficit has been contained at 2.4% of the GDP. 

This six monthly IPR report analyses whether the optimism is justified and if the targets for 2014-15 will be met. On the GDP growth rate, it appears unlikely that it will reach 5%. There has been a visible slowdown in the large-scale manufacturing sector with the growth rate down to 2.5% in the first five months, as compared to the target of 7%. Agriculture has been hit by the floods, albeit less than originally anticipated. Exports are showing a decline and investment trends are not so positive. Overall, IPR projects a growth rate of 3.8 to 4.3% in 2014-15.

Turning to inflation, there has been a precipitous drop in oil prices internationally and this is reflected mostly in domestic prices. On a year-to-year basis, the inflation rate has come down from 7.9% in July to 4.3% in December. However, there are reasons to believe that the rate of inflation is understated. It does not reflect the rise in the price of electricity, inclusive of the fuel charges adjustment and the higher rate of inflation in the larger cities. Also, oil prices are likely to have bottomed out and may start rising again. Further, the procurement/support prices of wheat and sugarcane have been increased. IPR expects that the average rate of inflation will range from 5 to 5.5% in 2014-15.

There is evidence that expenditures at the Federal level have been artificially controlled to achieve the six monthly deficit target agreed with the IMF. Releases for the PSDP show a growth of only 6% and are equivalent to only 24% of the annual target. There is also negative growth in expenditure on debt servicing. This explains the curtailment of the fiscal deficit to 2.4% of the GDP.

The performance of FBR revenues has been disappointing with a growth rate of about 13%, compared to the target growth rate of over 24%. While direct tax revenues have been somewhat buoyant, the growth in GST revenues is only 7%. The domestic component of this tax has shown growth of less than 2%. This reflects, in particular, the lack of dynamism of the manufacturing sector and the negative impact of the fall in POL prices.

On the financing side, while borrowings from SBP are negative, there has been an extraordinarily high level of borrowing from the scheduled banks, non-banking sector and households of almost Rs 955 billion. In addition, the flotation internationally of Ijara-Sukuk bonds of $1 billion has been a significant source of financing. However, the high level of borrowing from the banks has led to a ‘crowding out’ of the private sector with credit to it falling by 38%.

Over the next six months, expenditures are likely to rise rapidly due to the pending debt servicing obligations, expenditures on security arising from implementation of the National Action Plan and rehabilitation of IDPs, retirement of circular debt of the power sector and so on. Coupled with the slow growth in tax revenues, IPR expects the fiscal deficit to approach 6% of the GDP as compared to the target of 4.9% of the GDP.

The balance of payments position has improved in the latter part of the period. This is attributable to the release of $1.1 billion from the IMF and $ 1 billion from the flotation of Ijara-Sukuk bonds. Overall, net external borrowing has been $2.4 billion, while the increase in foreign exchange reserves is $1.4 billion, in relation to the end-June level.

The rise in reserves, due to borrowings, hides the deterioration in the balance of trade. Exports have declined by 2% while imports have risen by 4%. This has been partially compensated for the buoyancy in home remittances. Overall, the current account deficit has risen by 18%, in relation to the corresponding period of last year.

IPR is particularly concerned about the large appreciation in the value of the rupee, especially with respect to the Euro. It appears that among 11 major Asian currencies, the only currency which has nominally appreciated with respect to the US$ is the Pakistani rupee. This explains the fast growth in the volume of imports and the lack of competitiveness of Pakistan’s exports. Fortunately, with lower oil prices, the current account deficit for the year is likely to remain restricted at 1.4% of the GDP.

In summary, the year 2014-15 may not see the kind of strong revival and greater stabilization of the economy as anticipated by the government at the start of the year in the Annual Plan. The growth rate of the economy may show little improvement, private investment will remain shy, the fiscal deficit could rise sharply and the balance of payments position will improve, but not as much as anticipated. The silver lining will be a sharp fall in the rate of inflation.