The economy has shown modest improvements in first six months (July-December) of fiscal year 2011-12 because of better performance of the agricultural sector while the services sector, including retail activities and banks, has also recorded growth, says the State Bank of Pakistan (SBP) in its second-quarter report on the state of economy.
However, the report, released on Tuesday, pointed out that despite these positive developments, risks to macroeconomic stability have increased.
“Specifically, the position of external sector weakened at a rate faster than expected, and the fall in financial and capital inflows exerted pressure both on SBP’s foreign exchange reserves and on the rupee,” it said.
However, ample availability of key staple crops and less-than-anticipated supply disruption due to floods helped contain inflationary pressures in July-December of FY12.
The pickup in government borrowing from SBP complicated liquidity management whereas energy shortages continued to plague production activities, especially in the industrial sector.
According to the report, developments in the first half of FY12 indicated that risks to macroeconomic stability were stemming from the external sector and continued weaknesses on the fiscal side.
In terms of real sector, there has been some improvement since the publication of SBP’s annual report in December 2011.
Inflation to remain at 11-12%
“The economy is still expected to grow in the range of 3 to 4 per cent. Inflationary outlook has improved slightly on account of supply-side factors (food),” the report said.
“It is expected that FY12 inflation will fall within the range of 11 to 12 per cent, with a bias towards the lower boundary.”
Fiscal deficit a challenge
The report said in spite of the lower fiscal deficit in the first half, containing the overall deficit to its revised target of 4.7 per cent of gross domestic product (GDP) seems to be challenging.
Quarterly data for previous years has shown that the deficit remains relatively higher in the second half of the year, it said, adding the achievement of the revised fiscal deficit target depends on the realisation of three things.
These are envisaged surpluses from provincial governments, which are likely to be lower than expected; non-tax revenues, which depend on inflows into the Coalition Support Fund and auction of 3G licences; and strict control over expenditures.
According to the report, the burden of financing this deficit will fall on the banking system, specifically on commercial banks. Other than growing concerns about the supply of credit for the private sector, renewed government borrowing from SBP entails rising inflationary expectations in the economy.
On the external front, although the current account deficit is expected to be in the range of 1.5 to 2.5 per cent of GDP, there is an upward bias to this prediction.
“Given the fall in financial and capital inflows, funding this modest current account deficit could be challenging. Market players are increasingly concerned about whether the envisaged foreign inflows will materialise in time.
“This, together with the scheduled repayment of IMF loans ($1.1 billion) in H2 (second half), may draw down SBP’s foreign exchange reserves,” the report added.