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KARACHI, Oct 30: Following is the executive summary of the State Bank annual report 2003-04 released on Saturday:
Economic Growth, Savings & Investment
The robust 6.4 per cent FY04 growth is not only substantially higher than the 5.1 per cent increase recorded in FY03, it is also well above the 5.3 per cent GDP growth target for the year. However, despite the strong increase in real output and the positive outlook for the year ahead, the profile of FY04 real GDP growth highlights certain weaknesses in the economy. Unlike the broad-based growth in FY03, the much of value-added in FY04 is concentrated in just three sectors, namely LSM, wholesale & retail trade and electricity & gas distribution.
Also, contrary to common perception, data shows that during FY04 the acceleration in aggregate demand was mainly driven by investment activities rather than consumption alone as total real investment grew by 12.4 percent1 while real consumption demand grew by 5.5 per cent during this period.
Agriculture
The agriculture sector witnessed a deceleration in the growth rate from 4.1 per cent during FY03 to 2.6 per cent in FY04. Other than minor crops, which showed a small recovery, all other sub-sectors showed a substantial slowdown in the growth rate, for example, major crops witnessed a growth of 2.8 per cent during FY04 compared with 6.9 per cent growth in FY03. Livestock also registered a lower growth of 2.6 per cent in FY04 as against 2.8 per cent growth in the preceding year. However, higher prices in FY04 partially compensated the farmers for lower output growth. Another important development was that the actual disbursement of agri-credit exceeded the annual targets by 12.2 per cent during FY04, inducing higher input usage.
Industry
The industrial sector witnessed a robust 13.1 per cent growth during FY04. The major impetus to this rise came from electricity & gas distribution and large-scale manufacturing (LSM). The remarkable performance of industry pushed up its share in GDP from 23.1 per cent during FY03 to 24.5 per cent in FY04. Similarly, construction sector recorded the highest growth rate since FY87 due to increase in housing finance, supportive government policies and increase in government expenditures. A substantial growth in gas distribution was the main contributor for the strong growth of electricity & gas distribution in FY04. The broad-based growth of LSM pulled the annual growth rate for the sector to a remarkable 18.1 per cent2 which is the strongest growth recorded in the last three decades.
This remarkable LSM performance is principally derived from the accommodative monetary policy, global recovery that fuelled export growth, changes in government regulations and rising development spending. The direct impact of the monetary policy is most evident in sub-sectors such as automobiles, electronics and construction. The availability of cheap export finance, rising international demand and supportive government policies accounted for the growth in export-led industries such as textiles, leather, and pharmaceuticals. Government's regulation and tariff structure changes also helped the vegetable ghee & cooking oil and beverages industries. Public sector industries recorded a lower growth rate of 6.1 per cent against 9.5 per cent in FY03.
Services
The services sector experienced a slight slowdown as its sectoral growth rate fell to 5.2 per cent in FY04 compared to 5.3 per cent in FY03. This was the result of a deceleration in almost all sub-sectors except for wholesale & retail trade, which grew at an impressive 8 per cent due to increased volume of external trade. Transport, storage & communication witnessed a slight decline in growth from 4 per cent in the preceding year to 3.9 per cent in the current year, largely due to the poor performance of Pakistan Railways. Increased investment in this sector, especially in telecommunications, was encouraging as it was among the priority areas of government policies. Finance and insurance sector continued to perform poorly in FY04 as breakeven by SBP compared to large profits in FY03 overshadowed the profitability of domestic banks.
Saving and Investment
Contrary to a double-digit growth in national savings in the last 10 years, the rise in national savings decelerated to only 9 per cent during FY04, well below the nominal GDP growth. As a result, the ratio of national savings to GDP fell to 19.8 per cent from a record high of 20.6 per cent in FY03. The deceleration in the growth of national savings during FY04 is attributed to (1) a substantial decline of 12.7 per cent in the private savings; and (2) negative growth in net factor income from abroad.
The improvement in the economy is also visible in the strong revival in the investment activities during FY04. In nominal terms, total investment rose by an impressive 22.3 per cent during FY04 as against an average of 7 per cent in the preceding three years. As a result, the total investment to GDP ratio witnessed a trend reversal during FY04, to reach a remarkable 18.1 per cent compared with 16.7 per cent in the preceding year. The substantial rise in real investment reinforces the view that the present economic recovery is sustainable, at least in the medium term.
Prices
FY04 witnessed a sharp resurgence of inflationary pressures, with CPI inflation ending a seven-year downward trend. After bottoming out at all-time low of 1.4 per cent in July 2003, marginal (YoY) CPI inflation witnessed a steep rise through most of FY04 to close at 8.5 per cent, taking the average CPI inflation for the year to 4.6 per cent.
While the rise in domestic CPI inflation was indeed influenced by international prices, the impact of these was mitigated, to an extent, through fiscal measures.3 As a result, in contrast to trends in most regional economies, the rise in Pakistan's CPI inflation during FY04 largely stemmed from domestic sources, reflected principally in the leading roles of the food and house rent sub-groups respectively.
The CPI food inflation witnessed a sharp rise of 13.4 per cent (YoY) in June 2004 as compared to a quite subdued 0.9 per cent in June 2003, taking annualized food inflation to 6 per cent for FY04. The acceleration in CPI food inflation, October 2003 onwards, was largely attributed to artificial supply shortages of wheat that were probably due to the realization that Government's capacity to intervene was hampered by depleted wheat reserves.
On the other hand, CPI non-food sub-group witnessed a YoY increase of 5.3 per cent in June 2004, while annualized non-food inflation recorded a rise of 3.6 per cent in FY04. CPI non-food inflation was quite benign before setting for an upward trend in March 2004 onward. The rising pressures mainly stemmed from sub-group of house rent index (HRI). The role of HRI was critical in accelerating the overall CPI inflation, as this component has a 23.43 per cent weight in the CPI basket. Specifically, HRI rose by 8.2 per cent on year-on-year basis in June 2004 compared with only 1.2 per cent in June 2003.
The concentration of inflation in food and other essentials also raises concerns over the impact on low-income groups. People in the low income group (Rs3000 per month or less) suffered at 10.4 per cent YoY inflation in June 2004 against the average CPI inflation of 8.5 per cent for the period.
Public Finance and Fiscal Policy
In FY04, the fiscal consolidation drive of the government produced a second successive reduction in the budgetary deficit. It not only managed higher revenue collection but was also able to contain expenditures to bring down the fiscal deficit to 3.9 per cent of GDP from 4.5 per cent in FY03.
The consolidated revenue receipts in FY04 stood at Rs798.8 billion, showing an increase of Rs81.5 billion over FY03 largely due to higher tax collections and larger non-tax receipts. The consolidated expenditures, however, increased at a slower pace compared to FY03 and rose by Rs70.8 billion in FY04.
Developmental expenditures again showed under utilization of Rs5.6 billion during FY04. Since development expenditures are important for generating future economic growth and employment, it is imperative that their full utilization must be ensured. It is expected that these expenditures for FY05 will overtake defence expenditure after a long time. Even assuming that the entire allocation of Rs202 billion is not fully utilized, the overall growth over the previous year's actual outlay is likely to be above 25 per cent.
A significant shift was witnessed in the financing profile during FY04. External financing (net) and borrowing from non-bank sources declined during the year while borrowing from the banking sector surged as compared to the net retirement in recent years.
Money and Banking
FY04 witnessed the evident impact of the accommodative monetary stance pursued by the central bank since last few years. On the one hand this easy monetary stance was instrumental in instigating a massive increase in aggregate demand, which drove the real GDP growth to over 6 per cent for the first time since FY96, but on the other hand it also contributed to rising inflationary pressures in the economy.
Although, SBP was confronted with a number of conflicting objectives in FY04, it consistently indicated its desire to use monetary policy to stimulate economic activity in the country, and its willingness to accept some modest rise in inflationary pressures as a cost for accelerating economic growth.
This policy stance proved extremely helpful in achieving a broad-based recovery of the economy led by the manufacturing sector. The private sector fully exploited the low interest rates as is evident from a record growth in the private sector credit of Rs325.2 billion. Increasing share of personal loans in this credit expansion also suggests that, hitherto inaccessible bank credit is now within the reach of the small borrowers, thus making the banking system much more effective in terms of its benefits to the common man.
The banking sector on its part consolidated the tremendous improvements it made during FY03. Bank deposits and credit in FY04 recorded strong increases on the back of robust economic recovery. This performance was helped by both, the falling burden of outstanding non-performing loans as well as by stemming inflows of fresh NPLs.
Keeping in view the developments of FY04, the central bank is likely to continue balancing between the objectives of sustaining the growth momentum, managing the pressures on the exchange rate and containing inflation through FY05, but the FY05 monetary policy is unlikely to be as accommodative as in FY04. This is implicit in the SBP's monetary policy statement, which clearly indicates the SBP's concerns over the monetary overhang in the economy, and states that the SBP would only seek to avoid a "significant" weakening of the economy.
Domestic and External Debt
The country's debt profile improves further for the third successive year during FY04. Not only did the debt bearing capacity of the economy increase but the growth in outstanding debt stock was insignificant.
In terms of GDP, the burden of debt and its servicing has significantly declined in FY04. Specifically, overall debt to GDP ratio has dipped to 72.3 percent by end-FY04 from 79.3 percent in the FY03 and 85.9 percent in FY02. Similar improvement is witnessed in respect of debt servicing to GDP and revenues ratios.
Another noteworthy feature of debt situation is that the substitution of expensive debt with cheaper borrowings is changing its profile, i.e., the average cost of holing debt stock is declining. This was visible for both: external debt (e.g. the pre-payment of expensive ADB loans were partly substituted by soft loans), and domestic debt (e.g. lower flows into the expensive NSS instruments were compensated by higher borrowings from relatively cheaper PIBs).
These favourable changes in debt profile in the recent few years are largely attributable to: (1) increased repayment capacity of the country due to strong economic recovery, (2) subdued growth in debt resulting from prudent debt management and improving fiscal discipline, and (3) low domestic interest rates.
Balance of Payments
The overall balance though still in surplus at $887 million, experienced a sharp fall of 80 per cent YoY over the preceding year, resulting from a deterioration in both, the current account and capital account. The deterioration under capital account is mainly due to a one-off large pre-payment of expensive external debt. Excluding this one-off pre-payment the overall balance recorded a $2,424 million surplus in FY04.
The current account surplus at $1.8 billion was substantially lower than $4.2 billion witnessed in the preceding year. Interestingly, adjusting for conversion of foreign currency deposits, it is clear that the FY04 remittances are very close to FY03 remittances.
The sharp jump in trade deficit is clearly caused by the strong 27.6 per cent growth in imports, which overshadowed the robust 10.3 per cent jump in exports during FY04. Although the rising international prices of major imports especially oil was a major concern during FY04, petroleum import bill rose by $100.1 million YoY basis in FY04. This relatively low increase is deceptive. Had the average FY03 oil prices been sustained, Pakistan's oil bill would have been significantly reduced during FY04.
The export volume reached $12.3 billion during FY04, recording a 10.3 per cent rise over preceding year, and also surpassing the annual export target by 1.7 per cent. This high export growth was mainly textile driven as earnings from the four major categories namely: cotton fabrics, knitwear, bed wear and cotton yarn crossed $1 billion each.
The changes in the current account have significant impact on the exchange rate. The rupee strengthened through most of H1-FY04 when the YoY decline in the current account surplus was low, and when SBP was also lowering its net purchases from the inter-bank forex market. However, the rupee posted depreciation during H2-FY04 as the monthly current account surpluses diminished sharply and then turned into deficit by May 2004. In fact, the depreciation in the rupee would have been even steeper had the central bank not defended the rupee aggressively, so as to allow the economy to adjust gradually to the changing exchange rate environment.
Pakistan's total liquid reserves rose to $12,328 million at end-June FY04 compared with $10,719 million last year. However, the increment of $1,609 million in FY04 was lower than $4,287 million in FY03. This slowdown was not unexpected given the SBP continued focus on liberalization of the exchange regime, the recovering economy (and attendant expectations of a rise in imports) as well as the anticipated pre-payment of expensive external debt.
In overall terms, the erosion in the external account in FY04 is primarily driven by exceptional outflows and less from weakness in foreign exchange inflows; overall inflows, at $25.6 billion during FY04 were higher than the $25.2 billion experienced last year.
Socioeconomic
With an estimated population of around 148.7 million in 2004, Pakistan is the sixth most populous country in the world and faces a daunting challenge of poverty reduction and human development. The high proportion of working-age population through their additional productivity can produce a "demographic dividend" in the form of faster economic growth, higher employment generation and thus poverty reduction. This demographic change can be an asset, if the large pool of labour is transformed into productive human capital. It offers an opportunity for faster economic growth rate, which can only be possible if an adequate investment in human capital is made. Notably, a better educated workforce will be better equipped to compete in this age of competition and globalization. Thus, the increased fiscal space resulting from the higher economic growth in FY04 should be utilized for enhancing spending on education and health further in FY05 accompanied by improved governance and better management in the delivery of these services at the grassroot level.
1 Nominal total investment witnessed a sharp rise of 22.3 percent during FY03.
2 Source: Federal Bureau of Statistics. LSM production index data pertains to July-June FY04.
3 For example, the impact of strong international steel prices was partially offset by the reduction in import taxes. Similarly the rising cost of some petroleum product imports was mitigated by the government's decision to absorb the higher cost through lowering implicit taxes. However, it is important to note that this was mainly affected the fuels prices; the increase in the cost of other petroleum derivatives such as lubricants, greases, etc. did impact the domestic economy.
