The World Bank report "Global Economic Prospect (GEP)" released Wednesday states that relatively weak growth rates in Pakistan and India, which together account for close to 90 percent of regional GDP, reflect a combination of domestic imbalances (including large fiscal deficits and high inflation), weakening investment rates, and a challenging external environment.
The GDP growth in Pakistan, South Asia's second largest economy, has also been relatively weak in recent years, averaging 3.5 percent in factor cost terms since 2010, below the nearly 5 percent average growth during the previous decade. Pakistan's growth is expected to moderate slightly to 3.4 percent in fiscal year 2013-14, reflecting necessary fiscal tightening, and then rise to 4.5 percent in the medium term. Even with a cyclical rebound in Q3, full-year industrial output growth for South Asia was very weak at an estimated 1.5 percent year on year, although industrial activity picked up at a decidedly faster pace in Pakistan.
The report pointed out that in Pakistan, investment as a share of GDP has been falling (albeit at a slowing pace) in recent years. In Pakistan, both monetization of large fiscal deficits and structural constraints contributed to inflationary pressures. Flows to Pakistan, however, rose 9.5 percent year on year in the same period, compared with a 5.6 percent increase in FY2012-13.
Pakistan's fiscal deficit was 8 percent of GDP in the 2012-13, although planned fiscal consolidation (including tax administration reforms) is expected to gradually reduce this deficit. Subsidies on fuel and other items (including food and fertilisers) were 2.6 percent of GDP in India and 3.1 percent in Bangladesh, while energy subsidies were close to 2 percent in Pakistan, according to the International Monetary Fund estimates and national sources.
Reserve buffers in the region have been depleted in recent years, but external debt ratios are relatively modest. International reserves as a share of imports have been drawn down in several South Asian countries in recent years, as a result of slower increase in exports, capital inflows, and remittances. International reserves have fallen below two months of imports in Pakistan.
After declining for several years, the investment-to-GDP ratio in Pakistan is also expected to improve over the medium term. As the presence of international forces in Afghanistan winds down, reductions in Coalition Support Funds for Pakistan are likely to be offset by continued disbursements under the International Monterey Fund's (IMF) Extended Fund Facility (EFF) and robust inflows of remittances, maintained in the GEP.
The State Bank of Pakistan (SBP) said on Wednesday that the country's GDP growth for the current fiscal year will be higher than International Monetary Fund's (IMF) forecast. According to SBP's annual report "the state of Pakistan's economy", Pakistan is likely to miss its annual GDP growth target of 4.4 percent for FY14 mainly due to deprived performance of the agricultural sector and energy sector and overall GDP growth will be up to 4.0 percent as against IMF's forecast of 2.5-3.0 percent.
"The government's GDP growth target is based on the assumption that energy supplies would improve; that weather conditions would not impact the agriculture sector; and the positive sentiments created by the smooth political transition in May 2013 would continue into FY14. While the payment of the circular debt appears to have improved energy availability this year (FY14), it believes that GDP growth will remain below target," it added.
On the supply side, the factors that supported the recovery in large scale manufacturing should continue to sustain industrial growth in FY14. In addition, the expected launch of 3G services is likely to boost value addition in telecom services, the report said. However, growth in agriculture is likely to remain below its target of 3.8 percent, as recent rains have damaged the upcoming rice and cotton crops in Punjab; furthermore, the central does not expect minor crops to repeat the strong 6.7 percent growth seen in FY13.
"In overall terms, SBP projects GDP growth in the range of 3.0-4.0 percent for FY14, which is higher than the IMF's growth forecast of 2.5 - 3.0 percent," the report said. While, managing expectations in the external sector will remain a pressing challenge for policymakers, the government must push ahead with fiscal reforms, the SBP urged. "More specifically, a concerted effort must be made to increase revenue collection in a more equitable manner, and to restructure loss-making Public Sector Enterprises (PSEs) to reduce the subsidy burden on the federal government. Only then will domestic investors secure a sounder footing to put the country on a much needed growth trajectory," it added.
In SBP's view, the degree of fiscal contraction via the phasing out of energy subsidies and the rise in tax collection that underpins the IMF program, could explain the differing growth projections for the year. The FY14 budget envisages a fiscal deficit at 6.3 percent of GDP, which assumes: (1) a Rs 120 billion inflow under 3G licenses; (2) a 27.8 percent growth in FBR tax revenues; (3) a Rs 127.1 billion reduction in subsidies (to Rs 240.4 billion against Rs 367.5 billion incurred in FY13); and (4) a combined provincial surplus of Rs 23.1 billion.
While, the government appears determined to cut power subsidies quite aggressively, the FBR revenue target seems less credible. The task ahead for FBR is likely to be more challenging with subdued growth and a slowdown in imports, the report said. Furthermore, the prospect of achieving provincial surpluses is also a little suspect, as only Balochistan has shown a budget surplus for the current fiscal year in its budget documents. This suggests the need to improve co-ordination between the federal government and the provinces, especially during the budget making process.
"We also expect some pressure from interest payments this year, owing to the steep increase in short-term domestic debt incurred during FY13. According to in-house estimates, repayments on T-bills and PIBs issued in FY13 alone, would increase interest payments by Rs 277.5 billion in FY14, which is almost a third of the entire interest expense on domestic debt during FY13," the report pointed out.
Furthermore, the market is focusing on several risk factors like: (1) the current account deficit in the first quarter of FY14 is not consistent with the annual target; (2) international oil prices (Brent) have risen by 4.8 percent by end-November 2013; (3) exports may not perform well because of the continuing global slowdown and energy shortages at home; (4) remittances may suffer if the country experiences future bouts of PKR volatility; (5) CSF inflows may not be as high as in FY13; and (6) the quarterly targets to build unencumbered FX reserves in the second half of FY14, appear to be challenging.
However, SBP believes this outlook is misplaced, as it does not account for the following factors: (a) inflows from other IFIs (WB & ADB) come with a short lag, and the resulting structural reforms could solicit foreign investment; (b) a sovereign bond issue is quite likely during the course of the year; (c) although there is some market fatigue concerning the inflows from the 3G licenses and Etisalaat, these inflows will significantly narrow the external gap; (d) subsequent quarterly targets could be revised as the IMF program plays out; (e) the government has prepared a detailed disinvestment and privatisation list; and (f) CSF inflows during the drawdown of Nato troops from Afghanistan in 2014, could be stronger than expected, the report added.