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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : South Asia
Pakistan Improvements in macroeconomic fundamentals, as well as recovery in the economy, were further consolidated in FY2003. Given continued buoyancy in both domestic and external sectors in the first half of FY2004, GDP growth is likely to exceed the government target of 5.3% for the year. It seems that the foundations have been laid for significantly higher growth and it should be possible to exceed the target of 5.8% in FY2005 and move to a path of over 6% in subsequent years. Economic Assessment The recovery of the economy, which started in the second half of FY2002 (ended 30 June 2002), gained momentum in FY2003, when the economy expanded at a pace not seen in the preceding 6 years. The substantial improvement in key macroeconomic fundamentals achieved in FY2002 was further consolidated in FY2003, with the current account surplus increasing sharply, foreign exchange reserves touching new highs, the overall fiscal deficit declining further, and inflation remaining low. Export growth was also the highest in over a decade. GDP growth in FY2003 strengthened to 5.1% from 3.4% in FY2002. GNP rose by 8.4%, on the back of a sharp rise in net factor income from abroad (largely due to almost doubled worker remittances). Against a background of the population growing by 2.2%, per capita GNP increased by 6.1%. GDP growth was export led, with net exports accounting for more than three fifths of it. Government consumption picked up by 10.4%, largely because of the sharply higher government salary bill, and mainly reflected the full-year impact of the salary raise that came into effect on 1 January 2002. However, the effect of rising government consumption on the demand side was offset by a fall in private consumption, and total consumption remained unchanged at the previous year’s level. Total investment edged up to 15.5% of GDP in FY2003 from 14.7% the previous year, largely because of stronger private sector investment induced by privatization and deregulation in the oil and gas, communications, and financial sectors, as well as by accumulation of stocks. National savings rose from 17.0% of GDP to 19.4% over the same period. On the supply side, agriculture, after declining in the preceding 2 years, marked a significant upturn of 4.1% in FY2003. This stemmed from a recovery in major crops, largely attributable to the greater availability of irrigation water. The industry sector (comprising mining, manufacturing, construction, and the electricity and gas distribution subsectors) maintained robust expansion of 5.4% in FY2003 for the second consecutive year, mainly due to acceleration in the growth of the large-scale manufacturing (LSM) subsector, which constitutes about half of the industry sector. Faster LSM growth was a feature of all subsector groups (except leather products), and was most pronounced in automobiles, electronics, cement, textiles, and sugar production. Automobiles and electronics benefited from rising sales, fueled by growing availability of consumer finance at low interest rates. Higher remittances pushed up real estate prices and construction activity, leading to greater demand for cement and other construction-related products. Large investments in modernization of the textile industry-the country’s largest industry-over the past 3-4 years have boosted textile production; increased sugar production was the result of a recovery in the sugarcane crop. Growth in the services sector picked up to 5.3% in FY2003 from 4.1% in FY2002, mainly due to a sharp rise in external trade and the recovery in domestic economic activity. Expansion of wholesale and retail trade as well as transport, storage, and communications accelerated, reflecting an increased volume of external trade and rapid expansion in the telecommunications sector. Public administration and defense also registered high growth due to the full-year impact of the government salary increase and higher expenditures on defense. Although FY2003 data for unemployment are not yet available, statistics show that it had been on a rising trend in the preceding 3 years. It rose from 5.9% in FY1998 to 7.8% in FY2000 and further to 8.3% in FY2002. The female rate, at 16.5%, was more than twice the male rate in FY2002. With low employment elasticity and a burgeoning labor force, economic expansion of over 6% is required to reduce unemployment. Inflation declined to 3.1% from 3.5% in FY2002, due to a comfortable supply position of essential food commodities, lower credit costs, exce Share prices continued climbing through most of FY2003, with the Karachi Stock Exchange-100 index surging by 92.2% to 3,402 in the year to end-June 2003. Persistent high levels of worker remittances, appreciation of the rupee, low deposit interest rates, improved corporate profitability, and better relations with India were the key factors in this. The corporate bond market showed moderately greater levels of activity in FY2003, raising PRs10.4 billion, up from PRs9.5 billion in FY2002. However, new corporate bond issues slowed discernibly in the fourth quarter of FY2003, reflecting the impact of low interest rates and the commercial banks’ aggressive lending policies. The process of improving fiscal sustainability continued, and the overall fiscal deficit declined to 4.4% of GDP in FY2003 from 6.6% the previous year. (Excluding one-time expenditures, the fiscal deficit in FY2002 was 5.2% of GDP.) The budget deficit was below the revised target for FY2003 as agreed with IMF under its PRGF. The increase in expenditures was larger than the target, but was more than offset by a much stronger rise in revenues. The process of improving debt sustainability also continued, with public debt as a share of GDP declining to 94.7% in FY2003 from 105.4% in FY2002. Exports shot up by 19.6% to $11.0 billion and imports by 20.1% to $11.3 billion in FY2003. Better access to EU markets, improved competitiveness of the domestic textile industry, and greater availability of export finance at lower interest rates helped boost exports, while the surge in imports reflected the upturn in the domestic economy. A sharp rise in worker remittances as well as a decline in interest payments on foreign debt pushed up the current account surplus by 49.5% to $4.1 billion. The capital account also showed a significant improvement because of substantial increases in FDI, suppliers’ credit, and disbursement of foreign assistance. Consequently, foreign exchange reserves at SBP more than doubled to $9.5 billion on 30 June 2003 compared with $4.3 billion held 12 months previously. The country’s external debt and liabilities also declined, by $1.0 billion to $35.5 billion in FY2003, as SBP continued to retire expensive and short-term liabilities. Policy Developments The past 4 years have witnessed several positive policy developments. The important areas of policy focus have been developing a poverty reduction strategy, addressing the issue of unsustainable public indebtedness, and controlling the fiscal imbalance through improved resource mobilization, privatization of loss-incurring public sector enterprises (PSEs), and strengthened public resource management at the national and provincial levels. The Government finalized the full Poverty Reduction Strategy Paper (PRSP) in December 2003. The areas that have been strengthened compared with the interim paper published in 2001 are employment, environment, and gender. For purposes of monitoring public expenditures on poverty reduction, the PRSP identified 17 poverty-focused sectors. The target is to raise public expenditures in these sectors from 5.2% of GDP in FY2003 to 6.0% in FY2006. In addition, nonbudget poverty-related expenditures will be doubled from 0.2% of GDP to 0.4% over this period. The Government has set a goal of reducing the incidence of poverty from 32.1% in FY2001 to 28.0% in FY2006. A Core Welfare Indicators Questionnaire Survey is being instituted to monitor and assess the short-term impact of poverty-related expenditures. The Government’s commitment to the implementation of the PRSP can be seen in its increase in the share of pro-poor expenditures from 4.5% of GDP in FY2002 to 5.2% in FY2003. Since FY2001, the Government has implemented a comprehensive debt reduction strategy by undertaking fiscal adjustment and paying off expensive outstanding liabilities. It has achieved much in implementing this strategy: the ratio of total public debt to GDP fell from 106.9% in FY2000 to 94.7% in FY2003, while the ratio of interest payments to government revenues declined from 52.5% to 33.5% over the period. This has created fiscal space for the Government to increase expenditures on poverty reduction and the development program. The Government has set up a Debt Policy Coordination Office, which is to prepare a 10-year debt reduction path for it to follow. A Fiscal Responsibility and Debt Limitation Bill was submitted in October 2003 to the National Assembly for approval. The law will bind the Government, among other things, to eliminate the revenue deficit (i.e., there will be no borrowing to finance current expenditures) by 30 June 2007 and to reduce the outstanding public debt to 60% of GDP by 30 June 2012. It will also require the Government to submit annual and midyear reports to the National Assembly on progress toward lowering public debt, so as to ensure transparency in debt management. The FY2004 budget announced various measures supporting the implementation of the ongoing tax reforms for increased revenue mobilization. In the area of tax administration, a number of medium taxpayers’ units are being set up in different cities, where taxpayers will be able to pay all their taxes (corporate income tax, sales tax, excise duty) at one place. This follows the establishment of the Large Taxpayers’ Unit in Karachi last year, which has been very effective in realizing greater tax receipts in the area that it covers. As part of the income tax reforms, with effect from FY2004, all returns are filed under the self-assessment system, which places the responsibility for determining tax liability on the taxpayer (and not on the tax officer, as was the case in the past), with a certain percentage of tax returns selected randomly for audit. In line with the plan to have one corporate tax rate by FY2007, tax rates for banks and private limited companies were further reduced. To broaden the tax base, the Government announced the withdrawal of 20 more exemptions from income tax in the FY2004 budget. As part of the policy to phase out excise duty, duties on paper and paper board as well as on cables and wires were withdrawn and those on cement were lowered by 25%. Tax reforms implemented over the last 4 years have started paying off, with the tax-to-GDP ratio up by 0.8 percentage point to 13.7% over the past 2 years. Also over the last 2 years, the rate of privatization of PSEs has accelerated. The Privatization Commission has increased the use of the stock market for divesting government shares in PSEs, which has the added advantage of deepening and strengthening the stock market. The value of divestments of government equity through the stock market rose from PRs7.5 billion in 2002 to PRs9.3 billion in 2003. The sale of 5% of the shares of the Oil and Gas Development Corporation for PRs6.9 billion in 2003 was the largest sale of PSE shares through the stock market to date. In December 2003, the Privatization Commission finalized the sale of 51% of equity in Habib Bank Limited for PRs22.4 billion, and with this, almost 80% of banking assets are now with the private sector. In addition to increasing efficiency, privatization also reduces the burden on the federal budget. For example, the cumulative equity injection from the national government budget into public sector banks until FY2002 amounted to PRs46.6 billion. Following significant macroeconomic reforms at the federal level, the provincial governments have started implementing fiscal and financial management reforms. Sindh and North-West Frontier Province started these programs in 2002, and Punjab in 2003. Under its program, the Punjab government has implemented measures to enhance revenue mobilization; rationalize and restructure public expenditures; and improve effectiveness, predictability, and accountability in financial management. To enhance revenues, it introduced a new system of property tax assessment, raised user charges for water supply in all major cities, and rationalized irrigation water charges. The Punjab government has introduced facility-specific contractual employment in the education and health departments, which is expected to help contain pension liabilities, enhance accountability of teachers and health personnel, and upgrade service delivery in these sectors. Outlook for 2004-2005 In a context of brisk growth in the real sectors of the economy in the first half of the year and of several factors conducive for growth, it is expected that GDP will rise more strongly than the government target of 5.3% in FY2004. The agriculture sector is expected to expand by 4.2%. Major summer crops other than cotton have shown higher output, and the winter crop prospects have improved due to greater availability of water in reservoirs, timely winter rains, and an increase in the support price of wheat. A sharp upswing in agricultural credit in the first half of FY2004 and a larger offtake of fertilizers in October 2003-January 2004 also point to better prospects for winter crops. The industry sector is likely to post higher growth in FY2004, propelled by continuing double-digit rises in textile exports and by domestic demand for consumer durables that has been fueled by a threefold increase in consumer credit in the first half of FY2004. LSM production rose by 14.7% during that period, compared with 5.3% in the same period in FY2003. Industrial growth should also benefit from higher hydropower generation resulting from greater availability of water. The services sector looks set to record continued strong performance with an upturn in output in the financial sector, as indicated by financial results for major banks and other financial institutions in the first quarter of FY2004. Telecommunications, particularly cell phone services, and electronic media (TV and radio stations) are also expanding rapidly, and the recent deregulation of the sector and issuance of licenses to new operators should sustain this trend. Inflation started rising in the second quarter of FY2004 in the wake of reports of a wheat shortage. However, despite this, SBP continued its easy monetary policy during the first half of FY2004, when money supply (M2) growth accelerated slightly to 9.1%, from 8.6% in the same period in FY2003. Private sector credit picked up further, and as a result, interest rates have started inching up.
SBP is expected to continue its easy monetary policy in the second half of FY2004, to sustain the economic recovery. M2 growth is likely to surpass the full-year target of 11.0% in the wake of ongoing rapid expansion in private credit and a substantial increase (16.4%) in reserve money in the first half of the fiscal year. Although interest rates are expected to continue rising in the second half of FY2004, they are still likely to remain at historically low levels because of excess liquidity in the banking sector and continuing subdued demand for credit by the Government. Due to the tight fiscal stance, continuing excess capacity in the LSM sector, appreciation of the Pakistan rupee, and global price stability, annual inflation, while higher than the previous year, is unlikely to exceed 4.2%. The fiscal balance improved significantly in the first half of FY2004, when the budget deficit declined to 0.8% of GDP from 1.6% in the same period in the previous year, reflecting a sharp increase in revenues and containment of expenditures. Revenues strengthened by 13.9%, but expenditures went up by only 3.6%. Tax receipts, which exceeded the target in the first 8 months of the year, are expected to be on target for the whole year in view of the broad-based recovery in the domestic economy and the robust increase in imports. Public expenditures are also expected to remain under control, particularly following the easing of tensions with India. After a sharp decline in the fiscal deficit in the first half of FY2004, the prospects for meeting the 4.0% budget target for the year look promising. Exports grew by 18.3% to $7.2 billion and imports by 14.3% to $7.5 billion in the first 7 months of FY2004, compared with the same period in FY2003. The current account maintained a comfortable surplus of $1.9 billion in the first 7 months of FY2004, though slightly down on the $2.5 billion in the same period in FY2003. Robust growth in exports as well as a continued high level of remittances (despite some decline) in the first 7 months of FY2004 point to a comfortable balance-of-payments position for the whole year. With the global recovery gaining momentum and the domestic economic upturn continuing, both exports and imports are expected to maintain double-digit growth in the rest of FY2004. However, as domestic economic recovery strengthens in the second half of the fiscal year, imports are expected to outpace exports, resulting in a wider trade deficit. The current account is forecast to remain in surplus for the year, although substantially lower than in FY2003. Several developments on the domestic and external fronts have improved the medium-term prospects for the economy. The political atmosphere has cleared somewhat with the passage of the 17th Constitutional Amendment, which provides cover to reforms and policies implemented in the last 4 years, and a vote of confidence received by the President from members of the national and provincial assemblies and the Senate in December 2003. This, along with sound macroeconomic fundamentals, is providing a favorable environment for investment. Better relations with India will further enhance the investment climate and give a boost to economic activity. Medium-term economic prospects have also strengthened with the acceleration in the global economy and the signing of the South Asia Free Trade Area (SAFTA) agreement by the members of the South Asian Association for Regional Cooperation (SAARC). The performance of the two most important commodity-producing sectors, namely agriculture and manufacturing, is expected to improve in the medium term. Agriculture will be bolstered both by investments made in irrigation infrastructure in the past few years to combat drought, as well as by the adoption of water-saving techniques by farmers during the drought years. A surge in public expenditures in rural development in the past 3 years, as part of the Government’s poverty reduction strategy, will also help the sector, as will the apparent end to the drought of the past 4-5 years. The agriculture sector, always highly weather dependent, is therefore expected to expand, by 4.3% in FY2005 and by 4.4% in FY2006. The significant investments in the textile industry, as indicated by a more than doubling of imports of textile machinery in the past 3 years, have substantially improved the industry’s prospects. The Government’s policy of assigning a greater role to the private sector, as reflected in its deregulation and privatization programs, has also encouraged investment in the overall private sector, particularly in LSM. Fixed capital formation in the private sector expanded by 16.0% in FY2003, the highest rate in the last decade. Investment in LSM rose by 25.9%, following a 35.6% increase in FY2002. The ongoing upsurge in imports of machinery, as well as credit to the private sector, in the first 7 months of FY2004 indicates that growth in investment is continuing. This sustained rise in private sector investment, particularly in textiles, augurs well for manufacturing’s medium-term prospects. The LSM sector is expected to expand by 8-9% annually over the next 2 years. The Government’s active debt management policy and tax reforms are expected to lead, respectively, to further reduction in debt servicing and to increases in revenues. The resulting fiscal leeway will allow it to spend more on development and operation and maintenance in the public sector. This will in turn improve physical infrastructure, which along with continuing low interest rates, is likely to further encourage investment, as various industries approach their capacity limits. Investment and industrial production will also be facilitated by the expected reduction in electricity tariffs, resulting from the approximately 28% increase in hydropower generation capacity upon the upcoming completion of the Ghazi Barotha Hydropower Project, with a total installed capacity of 1,425 megawatts. A significantly strengthened economic base now exists, and if the Government continues to pursue sound macroeconomic policies and to implement its planned economic and governance reforms, the economy should be able to grow by 5.8% in FY2005 and by 6.0% in FY2006. This higher rate should help reverse the rising poverty trend of the 1990s and achieve the PRSP poverty reduction target of 4 percentage points by FY2006.
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ss capacity in most industries, and appreciation of the Pakistan rupee. In an environment of stable prices, the State Bank of Pakistan (SBP) continued to pursue an easy monetary stance to stimulate investment and growth. The 6-month treasury bill rate and the bank lending rate maintained a steep downward trend throughout FY2003 (Figure 2.19). SBP only partially sterilized the additional foreign exchange reserves, and money supply (M2) growth accelerated to 18.0% from 15.4% in FY2002. Private sector demand for credit picked up by PRs167.7 billion, or more than three times as fast as in FY2002, reflecting the further strengthening of the economic recovery.
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