The government is keen to restore macroeconomic stability knowing it is necessary to provide a platform to generate growth, jobs, and improve quality of life. This period saw continuing and intensified security challenges. In addition, the country faced multiple adverse shocks of commodity and oil prices amid the fallout of the global financial crisis. The year under review saw the unprecedented calamity of the great floods that wiped out about 2 percentage points from the growth as well as inflicted a massive damage of $10 billion on country’s economic structure. Some 20 million people were displaced as more than 50,000 sq. km area was submerged in water. During the year oil prices also shot up from $70/barrel to $125/barrel creating a new threat to the macro framework.
The destruction of major crops, particularly rice and cotton, led to a negative growth of 4 percent in this sector. The manufacturing sector growth was adversely affected — and was negligible — due to reduced output in textiles and petroleum products (affected by submersion of refineries under flood waters and the circular debt problem). Inevitably, the overall quantum of economic activities, captured by services sector was also affected, with a growth of 4.1 percent originally targeted at 5.4 percent.
The challenges posed by exogenous shocks affected the pace of reforms as the government was forced to make difficult trade-offs and cater to unexpected demands for flood rehabilitation and the impacts of increasing oil prices. The government, while pursuing a regime of deregulation of pricing of key products was nevertheless forced to intervene in the energy and commodity markets to keep prices within reach of the public. This burden of subsidies, though significantly reduced from previous years, exerted continuing pressure on the fiscal system and the adjustment path was affected. In the second half of the year, due to a combination of austerity, resource mobilization measures and bold decisions on pricing the macro-framework was stabilized and the anticipated damage to the overall fiscal position was avoided. However, more work will be required to rebuild the reforms programs.
The most significant development during the year was the historic performance of the external sector, which is heading to register a surplus in the current account.
First, exports registered a growth of 28 percent in the first 10 months of the year compared to the same period last year. Crossing the $20 billion mark for the first time, exports are set to exceed $24 billion.
Second, remittances have been strong, crossing the double-digit mark and are set to reach the historic level of more than $11.2 billion.
Third and this is partly attributable to moderated demand for imports — the current account shows a surplus of nearly $748 million.
Finally, the combined effect of these positive developments was reflected in the growth of external reserves, which also touched a historic high of $17.1 billion at the end of April 2011.
Pakistan has enjoyed a sustained period of exchange rate stability since December 2008. The Real Effective Exchange Rate (REER) depicted unprecedented appreciation of 10 percent in 2009-10 and marginally appreciated in the first ten months of the current fiscal year. The SBP is not intervening in the foreign exchange markets and exchange rate is market determined.
The situation regarding inflation remained a key concern for the economy. For most of last fiscal year, inflation was down, but the shocks of floods and oil price have reversed the declining trends. However, in the second half of the year, the rising inflationary trend has been stemmed and inflation is now hovering around 14 percent. With fiscal consolidation and abetment of some pressures from international prices, the inflation outlook looks better than in the earlier part of the year.
Inflationary pressures inevitably brought pressure on the interest rate, and with much of the credit flowing in the government sector, private credit, despite some growth over the previous year remained weak. With development resources preempted by unanticipated expenditures on flood relief and power and petroleum subsidies, fiscal discipline required the government to reduce its public investment to a low level in many years. Accordingly, the overall investment in the year was also below its level in the recent past.
The recent measures announced for fiscal correction should contribute to a faster recovery and resumption of growth. It was felt by some observers, that the budget deficit — the key indicator of economic stability — would reach unprecedented levels due to the difficult circumstances. However, due to sound economic management and fiscal discipline, the deficit has been contained and is estimated at 5.3 percent of GDP. To settle the circular debt and get more production out of the existing energy plants, the government has decided to pay additional 120-billion rupees subsidies for previous years. This will add an additional 0.6 percent to the deficit, bringing it to 5.9 percent. However, the outlook for the next year looks bright on this account as the year has fully accounted for the subsidies falling during the year and substantial correction in such burdens is likely to be made in the years ahead.
The government has shown continuing resolve to take difficult decisions and pursue the path of reforms. The economic stabilization program of the government includes measures like:
Broadening of tax base through reformed GST and other tax measures;
Elimination of subsidies especially the power sector subsidies and
Amendment in SBP Act to place limit on government borrowing from SBP; and
Direct cash grants to poorest of the poor through Benazir Income Support Program (BISP) and Watan Card Scheme for flood affected people.
In addition to above; the reform agenda in the economic and financial sector also include:
Restructuring of public sector enterprises
Power sector reforms
Debt management strategy
Fiscal austerity to reduce fiscal deficit
Tight monetary policy to check inflation
Building foreign exchange reserves to stabilize the exchange rate
Promoting exports.
Incentivizing home remittance strengthening social safety nets to mitigate impact of stabilization measures through Benazir Income Support Program (BISP)
Promoting growth, and raising domestic revenues.
Rationalizing subsidy regime to reduce pressure on the budget.
Tax administration and policy reform to mobilize domestic resources.
