In a review of state of the economy, in the first quarter of FY06, transmitted to the Parliament, the central bank said that the 54 percent year-on-year growth during July to October has widened this trade deficit to $3.37 billion and pushed the current account deficit to $2.04 billion (1.6 percent of estimated GDP). "This will substantially raise the pressure for corrective action," said the SBP.
Since past experience of administrative action through raising of tariffs or bans have not worked due to porous borders and smuggling the other option would be to tackle it through the exchange rate. The report, however, refrains from clearly suggesting this in order not to pre-empt the monetary policy to be enforced by the new Governor Shamshad Akhtar upon assuming charge in January.
While appreciating the supply side measures of the government relating to food items, the SBP says that non-food inflation is still on the high side and its monetary tightening started from last September, is yet to show an impact on inflation. However, the SBP estimates that with a time lag of six months ie by February easing in non-food inflation may be seen, provided the oil sector does not show another spike.
FISCAL: The SBP observed that 76.5 percent of the rise in CBR collection during Q1-FY06 is due to collection on higher imports. This shows, says the SBP, that a drop in imports could adversely impact the revenue collection and therefore focus on tax compliance and expanding the tax net is essential.
It may be recalled that in its Annual Report for FY05, the central bank had suggested imposition of a small levy on services. And, once this levy becomes an accepted norm it could be enhanced.
INTERESTRATES: The SBP said, "as shown by a number of studies, Pakistan's imports have proved to be highly income elastic in the short run, and this tendency would probably have been strengthened by the liberalisation of the external sector in recent years. (In fact, deregulation of other sectors of the economy such as telecommunication also has contributed to higher import growth in recent years).
This suggests that short of substantially compressing aggregate demand, and thereby GDP growth the rise in imports is unlikely to be contained in the short run. (This expectation is further supported by the need for imports to support the relief and rebuilding efforts for the regions devastated by the October 8 earthquake in Pakistan).
However, the same studies also show that in the long run, the import and export elasticities are likely to converge.
"The key challenges for policy makers therefore are how to: (1) encourage and accelerate this long-run convergence in export and import elasticities; and, (2) to finance the trade deficit in the interim period."
"Historical evidence suggests that fiscal measures to contain imports are unlikely to be very effective. In particular, custom tariffs would be capped by WTO commitments, and would create other distortions in the economy, eg possibly reinvigorating the demand for foreign exchange in the kerb market to finance import demand in the parallel economy.
This suggests a greater role for exchange rate policy in containing import demand in the short run (incidentally, this would also boost exports in the short run).
However, it must be recognised here that such policies carry significant risks (and are effective primarily in the short run), and cannot correct the imbalances at their own. Moreover, it must be noted that a significant portion of the imports is also essential for generating exports.
"Perforce, policy attention must therefore shift increasingly to fostering exports. Here, Pakistan is already enjoying some success, with July-October FY06 registering export growth well in excess of the 19.5 percent target for the period.
MOREOVER, THIS GOOD PERFORMANCE WAS SEEN DESPITE A NUMBER OF SHOCKS, INCLUDING:
(1) antidumping duty imposed on bed linen by the European Union (EU);
(2) a substantial decline in the prices of textile and clothing in the international market;
(3) the relatively disadvantageous position of Pakistan after losing preferential access in EU market under Generalised System of Preference (GSP), while competitors such as Bangladesh and Sri Lanka etc continue to enjoy duty-free access to EU market under GSP plus; (While duty-free access is provided under GSP plus to least developed countries by the EU, the GSP general entails market access with some duty concessions as compared to the duty on the imports of other countries into the EU market); and
(4) the appreciation of the Rupee against the Euro and rising domestic interest rates."
"The emphasis on export growth would require more focus on competitiveness. It may be pointed out that appropriate exchange rate policy is only one element of the overall competitive challenges faced by Pakistani exporters. What is more important for them is to respond to increasingly demanding markets through efficient and innovative practices.
Under the new trading system, diversification, reliability, delivery time lines and quick adjustment to the changes in international market have become important sources of competitiveness. The role of the government would be to provide trade support infrastructure and strive for market access through regional preferential or free trade arrangements.
(The government is making efforts to improve market access in various countries eg, China, Sri Lanka, Malaysia, the USA, Thailand, Turkey, Bangladesh etc, through various trade arrangements.)
Similarly, this SBP quarterly report, unlike previous reports, also refrained from shedding light on interest rates in the future. Leaving it to the new Governor to shape the policy.
The central bank said that the relative subdued growth in money supply (M2) in July-November FY06 was a result of drawdown in the net foreign assets and domestic demand has not slowed down. However, it was observed that the growth in remittances was weak - recording 3.9 percent y-o-y increase compared to 8.6 percent in July-October FY05.
"Even this weak rise emerged due to a 10 percent y-o-y increase in remittances during October 2005 in the aftermath of the devastating earthquake in Pakistan early in the month ($26 million rise in inflows from the USA and Saudi Arabia)", says SBP to put it in perspective July-September FY05 recorded a marginal growth of 1.5 percent in contrast to 10.3 percent growth during July-September FY05. The fall in remittances from the UAE may partly be attributable to huge investment in real estate in the UAE by Pakistanis.