FAISALABAD (May 07 2009): Pakistan's macroeconomic imbalances are rooted in the sharp rise in international prices of oil and food in 2007-08, combined with policy inaction and internal political turmoil.
To avoid a balance of payments crisis and default on foreign debt payments, the authorities developed the stabilisation program, which was supported by the IMF through a 23-month Stand-By Arrangement (SBA) in November 2008, said an updated report of South Asia Poverty Reduction and Economic Management Unit (SASEP), World Bank.
According to the report, the program includes a medium-term macroeconomic framework (MTMF), with fiscal and monetary tightening to bring down inflation and reduce the external current account deficit to sustainable levels. At the first quarterly review of the SBA in February 2009, the stabilisation program remained on track.
GDP growth in Pakistan's export markets is likely to fall sharply in 2009, which would translate into a starker-than projected decline of Pakistan's export growth in the medium-term, put pressure on Pakistan's external balances and complicate growth recovery.
Risks to the domestic financial sector may increase, and it seems almost certain that even the downward-revised revenue target will not be met in this fiscal year. Stringent implementation of the government's IMF-supported economic stabilisation program will be critical to success, and timely responses of fiscal and monetary authorities to emerging risks will be essential to ensure it remains on track.
WB report revealed that the rapid decline in international commodity and oil prices since August 2008 has reduced the risks, and facilitated improvement in the external position and the achievement of set targets. However, given the global economic crisis, the medium-term outlook presents significant downside risks.
The sharp deterioration in the global economic and financial outlook poses significant risks to exports, remittances and external financing. Even though projections in these areas as well as forecasts about the speed of real economy recovery were significantly moderated during the first programme review in February 2009, they may still turn out to be optimistic.
Over the last few months, WB report stated that the stabilisation efforts together with a decline in international commodity prices have succeeded in reducing external imbalances, rebuilding foreign exchange reserves, narrowing fiscal overruns and lowering inflation.
However, the sharp deterioration in the global economic and financial outlook poses significant risks to exports, remittances and external financing. Even though projections in these areas as well as forecasts about the speed of real economy recovery were significantly moderated during the first program review in February 2009, they may still turn out to be optimistic.
For example, economic growth countries to which Pakistan exports is likely to continue to fall sharply in 2009, which would translate into a decline in Pakistan's export growth, put pressure on Pakistan's external balances and complicate growth recovery. The risks to the domestic financial sector may increase. The medium-term revenue projections are ambitious and will be difficult to meet.
The March 2009 Federal Board of Revenue tax collections fell short of the downward revised revenue target. This highlights the need for a rigorous implementation of reforms, while protecting core development spending, in particular social spending, to ease the adjustment for the poor and vulnerable people.
Stringent implementation of the economic program will be critical to success, and timely responses of fiscal and monetary authorities to emerging risks will be essential to ensure it remains on track. In the current economic environment, any medium-term projections are uncertain and regular adjustments are necessary in response to changed circumstances.
Given the global economic crisis, WB report revealed that the medium-term outlook presents significant downside risks. The external environment is expected to deteriorate further, with global growth turning negative and a gradual recovery starting only 2010.
In the government's revised MTMF, Pakistan's real GDP growth is projected to remain low in 2008/09 and 2009/10, and increase gradually from 2.5 per cent in 2008/09 to 6.5 per cent by 2012/13, although longer-term projections are particularly uncertain in view of the volatile global economic environment.
Aided by increasing public investment-among other things in infrastructure, power, and transport-gross capital formation is projected to rise and contribute to growth recovery and facilitate private sector activity. In parallel, gradually increasing private sector credit growth is projected to help economic activity.
Agriculture is showing good growth prospects, while manufacturing and services are expected to recover only gradually as the domestic aggregate demand picks up and the availability of power improves as a result of investments in power generation. With the global recovery, exports are also projected gradually improve and reduce Pakistan's external vulnerability.
The government's revised macroeconomic framework targets projects a decline in the fiscal deficit (excluding grants) from 4.3 percent of GDP in 2008/09 to 2.3 percent of GDP in 2012/13. The cornerstone of this outlook is a significant increase in Federal Board of Revenue tax revenues, which are projected to rise by 3.1 percentage points of GDP to 12.7 percent of GDP by 2012/13.
Excluding grants, overall revenues are projected to rise from 14.3 percent of GDP in 2007/08 to 17.3 percent of GDP in 2012/13. To meet the ambitious revenue targets, WB report observed that the authorities consider implementing bold and comprehensive tax policy and administration reforms. This would include quick and decisive implementation of value-added taxation (VAT) of goods and services, elimination of tax exemptions and zero-ratings, and revamping of the tax administration.
This would be the key measure to expand the tax base and revenues, since currently services, which account for about 60 percent of GDP, currently remain outside the tax net. In the meantime, as part of the 2009/10 budget, the government may adopt significant legal changes to the current General Sales Tax (GST), moving it closer to VAT by minimising exemptions and zero-ratings, and thereby broadening tax base and revenues. Significant untapped revenue potential remains also at the provincial level, which would warrant attention.
Owing to this sizeable revenue effort, total expenditures are projected to slowly climb back to about 20 percent of GDP in 2012/13. In line with current projections of low oil and commodity prices, and following the elimination of power and fuel subsidies and maturing of the remainder of high interest-yielding Defence Savings Certificates, current expenditures will decline as a share of GDP and make space for a steady increase in development spending from 3.2 percent of GDP in 2008/09 to 5.6 percent of GDP in 2012/13.
According to WB report, the external current account deficit is projected to decline to about 4.2 percent of GDP by 2012/13. Foreign exchange reserves are expected to build-up from $9.1 billion by end-June 2009 to about $11.9 billion by end-June 2012/13. The sharp decline in international commodity prices, reduced private sector credit growth, and the economic recession are expected to curtail import growth in 2008/09 and 2009/10.
Exports are projected to start recovering from 2009/10 onwards with gradual global recovery and imports from 2010/11 onwards, but the growth of both remains moderate during the medium term. Remittances are projected to grow over the medium term. Foreign direct investment, after a drop in 2008/09, is projected to start gradually recovering in 2009/10 with the re-launch of the privatisation process, and portfolio flows are predicted to turn positive only from 2010/11 onwards.
In the medium term, increased productivity and export competitiveness are necessary to generate growth and reduce external vulnerability. To this aim, structural reforms to strengthen the investment climate and competitive environment are required.
These will include measures to ease firm entry and exit, reduce barriers to competition and trade, and enhance the labour market flexibility. In addition, efforts to improve the financial sustainability and efficiency of the power sector will be essential to attract investment in new power generation, WB report maintained.
