ISLAMABAD

The Asian Development Bank (ADB) in its recent report has said that economic reforms initiated by the Pakistan government in the past year contributed to improved economic conditions, growth edged up, budget deficit shrank, foreign exchange reserves strengthened and a sovereign bond issue enhanced policy credibility.

The Bank in its Asian Development Outlook Update 2014 released by the Bank said that Pakistan in recent years has endured low growth, chronic power deficits and large fiscal and external imbalances.

However, several years of concerted national commitment will be required to eliminate electricity shortages and effect the structural reforms necessary to achieve high and inclusive growth.

Preliminary estimates place GDP growth at 4.1% in FY2014 (ended 30 June 2014), up from 3.7% in FY2013 and higher than the 3.4% projected in ADO 2014.

The ADB said that upturn came from improved industrial performance: a pickup in construction by 11.3%, continued growth in large-scale manufacturing at 4.0%, and electricity supply improved by 3.7% owing largely to the government’s clearance of intra-industry debt.

Growth in large-scale manufacturing reflected higher production of fertilizer, electronics, chemicals, and leather, while textile production marginally declined.

More proactive policies on energy allocation and management adopted during the year helped industry grow.

However, electricity and gas shortages will continue to limit growth and drain public finances for several more years, until further governance reform and new investment take effect.

Growth in services slipped to 4.3% in FY2014 from 4.9% a year earlier largely because growth in the finance and insurance sub sector and in general government services markedly slowed. Consumption expenditure picked up, however, boosting wholesale and retail trade.

Agriculture growth slipped to 2.1% from 2.9%, reflecting bad weather in areas that produce such minor crops as pulses and potatoes, as well as weaker growth in livestock, the latter of which accounts for 56% of agricultural production.

These developments outweighed strong expansion of 3.7% in major crops underlined by bumper harvests of rice, sugarcane, wheat, and maize-but not cotton, which suffered a small decline.

Private consumption remained the largest contributor to growth in FY2014 at 4.6 percentage points, helped by stronger remittances and improved rural incomes from major crops. The contribution of investment was a low 0.2 percentage points. A 0.5% increase in gross fixed capital formation came from a 17.3% expansion in general government investment, as private and public enterprise investment fell by 2.6%.

The ratio of fixed investment to GDP continued to decline, 3.7.1 Supply-side contributions to growth Percentage points Agriculture Services Industry Gross domestic product.

Economic trends and prospects in developing Asia: South Asia Pakistan 147 falling to 12.4% from 12.6% in FY2013 (Figure 3.7.2). Private and public enterprise investment in the various production sectors slipped to 9.9% of GDP.

Net exports turned negative, subtracting 0.7 percentage points from GDP as import growth outpaced export.

Consumer price inflation accelerated to an average of 8.6% in FY2014 from 7.4% in the previous year. Year-on-year inflation was volatile, rising to 10.9% in November 2013, falling to 7.9% in January 2014, picking up again to 9.2% in April, and then falling again to 8.2% in June (Figure 3.7.3).

This largely tracked food inflation made volatile by short supplies of perishable items. Food inflation averaged 9.0% in FY2014 but ended the year at 7.4%. Following the increase in electricity tariffs in October 2013, nonfood inflation stabilized at around 9%, averaging 8.3% for the full year.

The ADB report said that consolidated government budget deficit was contained at 5.5% of GDP in FY 2014, down from an average of 8.0% over the past 3 years. The improvement was mainly from a significant increase in nontax revenues and a provincial cash surplus of 0.3% of GDP as provinces spent less on development-a measure for fiscal consolidation along with reduced power subsidies.

Total expenditure declined to 19.8% of GDP in FY2014 from 21.4% in FY2013.

Current expenditure was 0.5% above the budgetary target for the year, reflecting overruns on subsidies and interest payments.

Subsidies were lower than in the previous year, by 0.3% of GDP, but surpassed the budgetary target by 0.4% of GDP notwithstanding significant power tariff increases during the year to bring income closer to cost recovery.

Savings from tariff increases were partly offset by larger power supplies that necessitated commensurate subsidy increases, turning a plus for the economy into a minus for the budget.

Interest payments increased by a marginal 0.1pc of GDP to 4.5pc, as interest rates on short-term domestic debt were higher than estimated.

The consolidated public sector development program was compressed to

PRs 865 billion (3.4% of GDP) from the budgeted Rs 1,155 billion, and provincial development spending was reduced to nearly 30% below budget, or by 0.7% of GDP. Tax revenues fell short of their FY2014 target by 4.0pc.

Federal Board of Revenue tax collection continued to be lower than targeted for another year because planned tax measures could not be fully implemented.

Non-tax revenues were 4.3pc over the budgeted amount, reflecting the one-time receipt of $1.5 billion from Saudi Arabia for project development and $1.1 billion from the auction of the 3G/4G mobile telecommunications spectrum in the last quarter, as well as a large profit remittance from the State Bank of Pakistan (the central bank).

Responding to inflation and pressures on the exchange rate in the first half of FY2014, the central bank increased its main policy rate in September and November by a cumulative 100 basis points to 10pc (Figure 3.7.4). It kept the policy rate unchanged in the second half of FY2014, even as inflationary expectations eased and the currency appreciated. Large foreign inflows during this period allowed the government to reduce budgetary borrowing from the central bank, which dropped to PRs197 billion in FY2014 from Rs 507 billion in 3.7.5 Budget borrowing from banks.

On gross disbursements, the amounts disbursed by banks either in Pakistan rupees or in foreign currency against loans during the month. It includes loans reprised, renewed, or rolled over during the month. In case of running finance, the disbursed amount means the maximum amount received by the borrower at any point during the month.

The current account deficit equaled 1.2% of GDP in FY 2014, marginally up from 1.1% in FY 2013 despite strong 13.7% growth in remittances from workers overseas (Figure 3.7.6).

The trade deficit widened by 7.7% as imports grew by 3.8%, reversing a decline of 0.5pc in FY 2013, and export growth remained modest at 1.5%. It is too early to gauge the benefits from preferential access to the European Union under Generalized System of Preferences Plus status, effective from 1st January 2014.

Exports of textiles, which account for somewhat over half of exports, grew by 6.4pc, reversing declines of 1.8pc and 0.6pc in the previous 2 years. 

However, textiles appear to be the only export category to post a significant gain.

The services account deficit widened, as inflows from the Coalition Support Fund were lower than in FY 2013.

The ADB report said that capital and financial inflows were very strong in the second half of FY 2014 with two notably successful eurobond placements, the one-off receipt of $1.5 billion from Saudi Arabia, and disbursements of program loans from multilateral agencies.

After 7 years without access to international capital markets, the government placed $2 billion in dollar-denominated eurobonds, half maturing in 5 years and the other half in 10 years, in offers that were substantially oversubscribed.

Reflecting the large capital inflows, net liquid official reserves swelled to $9.1 billion at the end of June 2014 from a low of $3.2 billion the previous January.

Nevertheless, reserves remained low at the end of the fiscal year, cover for only 2.2 months of imports of goods and services.

Along with the increase in reserves, the Pakistan rupee appreciated to PRs 97.5 to the dollar in March 2014 and broadly stabilized at this rate to the end of FY2014. This followed depreciation of about 6% in the first 7 months of the year-and preceded a fall to Rs 102.6 in early September 2014 in response to demonstrations that began in August.

In real effective exchange rate terms, the rupee appreciated by 5.6p in FY2014, with possible adverse implications for export competitiveness.

Projections for FY2015 assume that the government will make satisfactory progress on its economic agenda to reform the energy sector and state-owned enterprises, rationalize import tariffs, and improve the business climate. Energy reforms include moving toward market-based pricing and improving system governance, efficiency, and sustainability. A major power tariff revision was made in October 2013, and a further increase is planned for FY2015. The government has developed a plan to sell shares of some listed public sector enterprises in capital markets and is prioritizing others for restructuring before privatization.

The projected decline in the deficit assumes a provincial cash surplus equal to 0.9pc of GDP. The budget envisages current expenditures increasing by only 1.6pc from the estimated out turn in FY2014. While most major categories of spending increase by double digits,

including a 10pc increase in salaries and pensions and a 15% increase in interest payments, large savings are expected from a 37% drop in subsidies, equal to 0.6pc of GDP, achieved mainly by cutting untargeted power subsidies.

Containing subsidies will be a challenge given overruns in recent years, and success will depend on implementing power sector reforms to raise tariffs enough to meet costs, improve collection, reduce leakage, and invest in generation, transmission, and distribution systems.

Power tariff increases in FY2014 helped reduce subsidies, but savings were partly offset by subsidies to cover improved supply. The Public Sector Development Program is slated to increase by 36%. The budget plan makes more resources available for public investment and, in particular, social protection, for which allocations have been increased by 38% to Rs 97.1 billion from Rs 70.0 billion in FY2014.

Total expenditure is budgeted to increase by only 1.1% in absolute terms, bringing it down to 19.5% of GDP from 19.8% in FY2014.

On the revenue side, the FY2015 budget includes measures to expand the tax base by removing exemptions and concessions, penalizing non-filers, rationalizing tax rates, and reducing tax leakage through better administration.

These measures are expected to generate additional revenue equal to 0.8pc of GDP. Federal Board of Revenue tax collection is projected to increase to 9.7% of GDP from 9.0% in FY2014.

However, tax increases will be offset by a 24.0% drop in nontax revenue, which was buoyed in FY2014 by the one-off receipt of $1.5 billion from Saudi Arabia and large proceeds from the auction of the 3G/4G spectrum.

As a result, budget revenues are expected to increase only marginally in FY2015 to equal 14.5% of GDP, up from 14.3% in FY2014.

Consumer price inflation is expected to average 8.2% in FY2015,slightly down from 8.6% in FY2014.

The ADB report said that business and consumer sentiment survey in May 2014 found inflationary expectations had steadied, apparently reflecting improved exchange rate stability and much lower domestic borrowing for budgetary support as development partners help finance the government’s economic program.

While the increase in public sector salaries and some increase in electricity tariffs will exert upward pressure on prices, declining international commodity prices and a relatively stable exchange rate should help contain inflation.

On the supply side, food prices will remain a key determinant of inflation as in recent years. The central bank intends to stay vigilant on monetary policy and keep inflation in a range of 7.5%-8.5%.

Continued strong inflows of remittances are expected to help limit the current account deficit to 1.3% of GDP in FY 2015.

Manufacturing should benefit from better electricity supply, allowing a boost in textile production. With access to the European Union under the Generalized System of Preferences Plus, exports are projected to increase by 4.0%.

Imports are projected to advance by 5.0%, a rate essentially unchanged from FY2014, reflecting a marginal increase in growth, easing prices for oil and other commodities, and continued stagnation in private investment.

The current account deficit is expected to be financed by continued modest flows of private direct and portfolio investment, sustained multilateral and bilateral lending to support the government’s economic reform program, and planned government borrowing from international capital markets.