KARACHI-State Bank of Pakistan lowered on Thursday its Gross Domestic Product (GDP) growth forecast for the 2008-09 fiscal year to between 2.0 and 3.0 per cent from its previous estimate of 2.5-3.5 per cent. 'Major economic indicators show underlying weaknesses, which, if not addressed, could hamper economic recovery, the State Bank of Pakistan said. The Bank released its third quarterly report on the 'State of Economy for the year 2008-09. Pakistan achieved GDP growth of 5.8 per cent in the fiscal year 2007-08, and the govt had originally set a growth target of 5.5 per cent for the current year. SBP also raised its 2008-09 average inflation forecast to between 20.5 and 21.5 per cent from an earlier forecast of between 19.5 and 20.5 per cent. Inflation hit a peak of 25.3 per cent in August last year. The Bank also said that a reduction in the countrys development expenditures was undesirable, as it would hurt the countrys human and physical infrastructure. 'While the improvement in macroeconomic indicators is very encouraging, the economy is not out of the woods yet, the Bank said in the report. 'Major macro-economic indicators show underlying weaknesses which, if not addressed, could hamper economic recovery. The Bank cited 'stubbornly high inflation, massive deterioration in external accounts and declining industrial output, especially among big manufacturers, for the weaker growth forecast. Manufacturing output fell 7.7 per cent for the nine months through March from the same period a year earlier, according to the latest available data. In the year-earlier period manufacturing grew five per cent. It forecasts fiscal deficit will narrow to 4.0 per cent to 4.5 per cent of Gross Domestic Product this financial year from 7.4 per cent last financial year, though the Bank acknowledged its forecast might be tough to hit. 'The anticipated weaker performance of revenues and increase in expenditures both point to the risk of slippage in the fiscal-deficit target, and a contingent increase in financing requirements, it said. According to the report, average CPI inflation in the current fiscal year is expected to stay between 20.5 per cent and 21.5 per cent whereas the growth in fiscal deficit may hover between 4.0 and 4.5 per cent and current account deficit, however, is likely to be 5 per cent to 5.5 per cent of GDP. 'Exports are projected to stand at dollars 18.5 billion to 19.5 billion worth while imports would be in the range of $30.5 to $ 31.5 billion respectively in FY09. In terms of workers remittances, country is estimated to receive $7.5 billion worth in 2008-09, report added. The report said the economic performance of the country would remain weak in FY09. A moderation in economic growth was expected and embedded in a lower growth target for FY09, but developments during the first four months of the fiscal year made it obvious that even this lower growth target would be difficult to achieve. These developments included stubbornly high inflation, massive deterioration in external accounts, and declining industrial output. The report mentioned the record wheat and rice harvests together with the likelihood of good production in minor crops and of fodder, backs expectations that growth in the crops sub-sector of agriculture will exceed the FY09 annual target. However, the substantial negative growth in Large Scale Manufacturing (LSM), remains a major drag on prospects of improving real GDP growth. A reasonable performance from the livestock sector, supporting all this, will help take the overall agri-sector growth close to, or over, the annual target. Also, notwithstanding a slowdown in the trade, and the transportation & communication sub-sectors, the services sector is also expected to perform well, the report added. 'Inflation began to decline, the current account deficit narrowed substantially with a corresponding stability in the exchange rate, and fiscal discipline was maintained with the fiscal deficit being reported to be 3.1 per cent of GDP for July-March FY09, report said. However, the report noted with caution: 'while this improvement in macro-economic indicators is very encouraging, the economy is not out of the woods yet. Major macro-economic indicators show underlying weaknesses which, if not addressed, could hamper economic recovery. The report said that recent easing of inflationary pressures is indeed encouraging as the headline inflation - measured by consumer price index (CPI) - dropped to 17.2 per cent on year-on-year (YoY) basis in April 2009 from its peak of 25.3 per cent YoY in August 2008. 'In particular, a sharp downtrend in food inflation is a welcome development as this component of CPI affects low income groups the most. CPI food inflation fell from its peak of 34.1 per cent YoY during August 2008 to 17.0 per cent in April 2009', it added. It said the downtrend in inflation owes to both, favorable international and domestic developments, as well as a deceleration in domestic demand. The latter, in particular, reflects the monetary tightening by the State Bank , as well as the complementary improvement in fiscal discipline, especially after November 2008. It is worth noting that the acceleration in the fall of inflation is becoming visible only after the monetisation of the fiscal deficit was halted, the report added. The report said that in order to support industry and particularly the export-oriented sectors, which were pressured by the impact of the global recession, SBP introduced measures such as; easing access to concessional financing schemes, and lengthening maturities. The central bank also injected appropriate liquidity to meet banking systems increased demands for commodity operations and settlement of circular debt. However, by April 2009, broad money (M2) growth was still quite weak, at 1.9 per cent year-to-date, down sharply from 8.4 per cent in the corresponding period last year, reflecting continued deceleration in domestic demand. 'As a result of this, SBP projections suggest that deceleration in inflation will be much sharper in the next few months. This is also evident from the successive fall in the core inflation during March and April 2009', it added. However, it noted with concern that growth in Large Scale Manufacturing (LSM) has been negative for the 10th consecutive month in March 2009, the longest period in which production continued to shrink. LSM growth dropped by 7.6 per cent during July-Mar FY09 compared with a 5.0 per cent rise in the corresponding period of FY08. This is the major drag on the prospects of improving real GDP growth, it added. The report pointed out that anticipated weaker performance of revenues, and increase in expenditures both point to the risk of slippage in the fiscal deficit target, and a contingent increase in financing requirements. Similarly, resurgence in international commodity prices poses risks to the assessment of a continued sharp deceleration in inflation in the months ahead. In particular, a rise in international oil prices would have adverse consequences for domestic inflation as well as the external account balance, it added. In addition, the report said the international inflows under financial and capital accounts are relatively lower compared with the preceding years, causing a rise in overall external account deficit. A fall in financial inflows is the result of combined impact of both external and domestic factors, the report added. 'While, Pakistans ability to access international financial market is constrained, any shortfall in external inflows would add to pressures on monetary policy, the report added. 'In short, the limited gains in key macro-economic indicators should not lead to complacency as the quality of these improvement and challenges to economy are some factors of disquiet, it pointed out. SBP report suggested that reduction in development expenditure is not desirable, as it would have detrimental impacts on countrys human and physical infrastructure. 'In the medium term, the only viable way to achieve sustainable improvements in fiscal accounts is to raise the tax-to-GDP ratio through increasing the tax net, it said ,adding, this is because a substantial reduction in current expenditures is not possible without significant reduction in the size of government machinery, due to inflexible interest payments and expenses under defence and civil administration. The report also stressed upon increasing exports by product and market diversification with gains in productivity. It underscored the need to implement second generation reforms to improve governance, strengthening institutions and reforming legal as well as regulatory system. The pertinent point here is that the lower demand for private sector credit and increased risk averseness of banks during the year so far, allowed the govt to increase borrowings from commercial banks without putting upward pressure on interest rates, it said. 'Similarly, resurgence in international commodity prices poses risks to the assessment of a continued sharp deceleration in inflation in the months ahead. In particular, a rise in international oil prices would have adverse consequences for domestic inflation as well as the external account balance. However, flows under financial and capital accounts are relatively lower compared with the preceding years, causing a rise in overall external account deficit. A fall in financial inflows is the result of combined impact of both external and domestic factors. On the domestic front, poor law & order and security situation, and political noise have led to net outflows of portfolio investment. While, Pakistans ability to access international financial market is constrained, any shortfall in external inflows would add to pressures on monetary policy, it added. The report further said that in the medium term, the only viable way to achieve sustainable improvements in fiscal accounts is to raise the tax-to-GDP ratio through increasing the tax net. 'This is because a substantial reduction in current expenditures is not possible without significant reduction in the size of govt machinery, due to inflexible interest payments and expenses under defence and civil administration. 'Another area of concern is the gradual improvement in current account deficit, which is principally driven by a decline in import growth. In addition, country would also have higher debt servicing in coming years. These two factors reinforce the common view that sustainable improvement can be achieved only through increasing exports by product and market diversification with gains in productivity. These are not easy tasks, it said. Increase in market diversification requires quality products with a good name of the country and congenial environment to buyers of Pakistani products to visit production venues and observe the processes. A large number of buyers required to do this to satisfy their developed countries clients about safety standards and environmental as well as social issues. Similarly, product diversification needs investment, expertise, spending in research and development, it added.