31 October 2004	Sunday	16 Ramazan 1425

KARACHI, Oct 30: The State Bank says that the outlook for economic growth of over 6 per cent looks quite promising without making it clear if the target of 6.6 per cent set for the current fiscal year can be achieved. But it warns that inflation will rise beyond the target of 5 per cent.

In its annual report for July-June 2003-04, released here on Saturday, the central bank says that risks to this fiscal's prospects emanate mainly from exceptionally high international oil prices. The report says that higher oil prices "can adversely affect the current account and fiscal balance, putting pressure on exchange and interest rates."

It fears that water shortages can amplify this external shock by reducing wheat output and other Rabi crops and by raising demand for imported fuel oil to generate electricity.

"These risks can be mitigated if exports and remittances (or money sent back home by overseas Pakistanis) continue to show better than assumed results, government revenues exceed their target, wheat supply is augmented through timely imports, development expenditure is not curtailed and gas and coal are increasingly used for power," the report maintains.

According to the State Bank, the concentration of inflation in food and other essential items has raised concern about its impact on the low income group. It says that inflation for poor people i.e. families with a monthly income of Rs3000 or less was 10.4 per cent in June 2004 against the average consumer inflation of 8.5 per cent.

The report says if the shortfalls in supply of commodities persist it will push up inflation beyond the targeted level of 5 per cent during the current fiscal year.

It also links the current fall in the rupee value to higher international oil prices and makes it clear that any move to stabilize the currency will create pressure for increasing interest rates sharply. The report identifies water shortages and increase in oil prices as the two main threats to the projected economic growth of over 6 per cent.

The report says initial indications are that the growth momentum of the economy will continue during this fiscal year. "This is expected to be led principally by the continued strong performance of industry...as well as a reasonable showing by agriculture, both of which are likely to support real GDP growth of over 6 per cent."

The services sector too is expected to grow strongly on the back of the rise in the real sector as well as increased investment in key sub-sectors such as telecommunication.

"However, there are a number of factors that pose a significant threat to these expectations, chief amongst which is the anticipated water shortages that is likely to hit many major crops."

In fact, the hopes of even a reasonable performance of the agricultural sector in this fiscal year "hinge on the anticipated exceptional cotton harvest, and good performance of minor crops," says the report.

Similarly, sustained increase in international oil prices has multiple negative dimensions. "First, there is a threat of a slowdown of the global economy, which could, in turn, hit Pakistan's export growth (hurting the textile industry in particular). Second, as the country's oil import bill expands, it will turn the current account surplus into deficit and put pressure on the rupee. Third, the economy is also likely to face increased inflationary pressure, particularly as the government may not be able to buffer local fuel prices for long."

"The resulting pressure on the exchange rate would also be hard to mitigate because of the increased integration of the domestic financial markets, with interest rate movements affecting the currency markets and vice versa."

It further says that although the SBP monetary policy will remain geared to containing inflation, "the initial momentum built up in the first quarter of FY05 will resist the reversal to the target."

Cleared of jargons, it means that since inflation was at 9.18 per cent in July-September 2004, it may not fall to the targeted level of 5 per cent for this full fiscal year, despite SBP efforts to contain it.

The report says that the government's steps will also determine the SBP's ability to meet its monetary targets. It underlines "the necessity of holding to fiscal discipline" not only to avert the direct negative long-term consequences but also to avoid "losing the hard-won credibility of Pakistan's economic managers in the eyes of the international investment community."

"However, in addition to containing the rise in the (fiscal) deficit to the FY05 target levels, it is important that the government continues to protect development spending."

It appreciates the government's desire to substantially increase investment in the infrastructure and the social sector but "it is imperative that the budgetary allocations are indeed materialized."

The report also warns that while foreign direct investment inflows improved in the last fiscal year, the country's share in FDI to the emerging market remains quite low. "It will take both, sustained macroeconomic discipline as well as the availability of a skilled workforce in order to change this picture for the better."

FYO4 Developments: The report says that the economy grew by 6.4 per cent in FY04 (July-June 2003-04), substantially higher than 5.1 per cent and above the target of 5.3 per cent.

"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," notes the report. "Unlike the broad-based growth in FY03, the much of value-added growth in FY04 is concentrated in just three sectors," namely large-scale manufacturing, wholesale and retail trade and electricity and gas distribution."

"Also, contrary to common perception, data show 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 per cent while real consumption demand grew by 5.5 per cent during this period."