KARACHI, March 30: The second quarterly report of the State Bank says Pakistan economy may grow 5.5-5.8 per cent during this fiscal year ending in June. Initially the growth target was set at 5.3 per cent.

The central bank released the report here on Tuesday. "SBP staff forecasts put the FY04 real GDP growth within the 5.5 to 5.8 per cent range," says the report.

It attributes the improvement in the economic performance to record high exports; a sharp rise in imports of machinery and inputs; the continuing surge in capacity utilization; a strong growth in taxes and above all "the record growth in net private sector credit.

But the report warns that "some evident weaknesses cloud the signal improvements in most areas of the macro economy." "Anecdotal evidence suggests that unemployment, though falling gradually, remains significant; and realistically speaking, with the economy still performing below the 6 per cent long-term growth trajectory, the likelihood of immediate relief is low."

"Another, more recent, concerns the spectre of rising inflation," the report further warns. "While overall CPI inflation (or inflation measured by consumer price index) is still low relative to that in past years, there is a clear evidence of a gradual up trend."

The report also points out that with inflationary pressures particularly evident in food staples, driving food inflation to a 6-year high in December 2003, "the incidence of inflation falls disproportionately on the most vulnerable (low income groups who are the least prepared to absorb the burden)."

"The upsurge in food inflation that appears driven by supply shocks as well as less-than-adroit management, clearly points to the considerable scope for improvement in managing the agri-product supply chain."

The report also remarks that the "benefits of the low cost of credit have not been without a price; the resulting fall in carrying costs have reduced an important constraint on speculative activities."

"The recent wheat shortages clearly illustrate the dangers to public welfare from unfettered private sector initiated in the absence of the discipline of a competitive market or government regulation," the report notes.

"Illegal and immoral speculative activities need to be reined in through implementation of anti-trust legislation in letter and spirit...Otherwise such activities would undermine the public support for market liberalization thereby threatening to lock the economy into a less efficient over-regulated paradigm."

In the short-term SBP forecast indicates that CPI inflation (or inflation measured by consumer price index) will remain in the range of 3.8-4.2 per cent. (Annualized CPI inflation has already risen to 3.49 per cent in eight months of this fiscal year. Independent economists say at the end of the fiscal year it may settle somewhere between 4.2-4.5 per cent).

Commenting on the rising marginal inflation the SBP report says that it was the increase in food prices that dominated the profile of inflation. But since food inflation is less sensitive to interest rates and since the external sector account surplus continued (though at a lower pace) the State Bank kept its easy monetary policy stance unchanged.

But "SBP continues to closely monitor price trends and stands ready to respond aggressively to contain any surge in inflation beyond tolerable limits." The report says that low interest rates have contributed to the growth and development of consumer credit market and increased access of relatively cheap credit to agriculture.

The report further says that during the last two years the easy availability of consumer credit has catalyzed a huge surge in demand for automobiles, especially cars and motorcycles. Production of cars shot up to 44,433 units in the first half of this fiscal year which is around 70 per cent of car production in the entire FY03.

"While the sharp increase in production certainly helped reduce delivery lags as well as the premiums for immediate availability (delivery) these problems have not yet been eliminated."

This may be a case of market collusion. The report says that "the presence of market collusion and the effective absence of regulatory bodies has contributed significantly to price pressures in many segments of the economy such as cement, automobiles, wheat, etc."

"The relatively steep head-turning hikes in prices of more visible commodities play an important role in raising the otherwise more modest inflationary expectations; this has probably been the case in the recent past as well."

The report says that the public case for the removal/reduction in protections for the auto industry is simply based on the belief that domestic manufacturers were taking undue advantage of the privilege market access to reap windfall gains with little benefit to the country in terms of transfers of technology, increased investments and job creation.

"Moreover, there is seemingly little point in protecting a domestic market that is apparently uncompetitive internationally, given that Pakistan is soon expected to accede to a WTO-mandated reduction in tariff and non-tariff barriers."

"However, as often is the case, the argument for the retention or removal of protections for the auto industry is not quite as simple as it appears." "A closer look at the issues suggest that the government has to strike a very delicate balance between consumer welfare and the need to develop engineering industry and foster investor confidence by avoiding abrupt policy shifts."

"Another major theme visible from the Q2-FY04 developments is the fiscal space that is finally emerging as a result of past reforms and the growth in the economy," says the SBP report.

"The economy has now suffered many years to low investment in health, education, infrastructure, etc. in the attempt to correct the burden of historic macroeconomic imbalances, and these inevitably have curtailed the economy's ability to accelerate growth."

"Thus, the increasing fiscal space must now be focussed on redressing the social sector shortfalls expeditiously," warns the report. One constraint often cited to support the inability to accelerate development expenditures is the lack of implementation capacity. But the report counters: "This need not be a binding constraint, as the government could seek to take advantage of the managerial capacity available with reputable established private sector social service providers."

Finally, "a combination of good fortune and the sound policy have placed Pakistan's macro-economy on a sound footing, and the country stands on the verge of graduating successfully (hopefully permanently) from an IMF programme."

"However, this should not imply a relaxation in macroeconomic discipline. Quite to the contrary, the continued progress of the country on a stable and sustainable high growth trajectory will depend crucially on sound policies."

"If anything, the government policies are likely to come under greater scrutiny as investors critically evaluate the government's commitment to consolidate and deepen the gains already made."