THE Asian Development Bank’s Pakistan economic update released last week forecasts that high economic growth will be sustained this fiscal year as a result of improved fundamentals, rising investment and growing development spending.

But the report also flags some important economic concerns, primarily the impact on inflation of high world oil prices, a widening trade deficit and slower growth in agriculture.

The report, which reviews economic performance in 2004-05 and presents an outlook for 2005-06 points out that while last year saw the highest growth in two decades, inflationary pressures were fuelled by shortages in essential commodities, high oil prices and strong demand while the fiscal and current account deficits also slipped into deficits for the first time in three years.

Growth to slow: The ADB expects GDP growth of 6.5 per cent in 2005-06 against government forecasts of seven per cent. This lower estimate is based on a levelling off of manufacturing growth to about 11 per cent and agriculture growth of just three per cent compared to last year’s 7.5 per cent and government forecasts of 4.8 per cent for 2005-06.

Growth is expected to be led by the services sector, primarily through telecom and banking services.While GDP growth topping six per cent is considered robust, the ADB’s analysis raises some serious worries. The buoyancy of the services sector, a result of telecom deregulation and banking sector reform, is a welcome development.

Even the slowing growth in manufacturing is not unexpected since major industries have enhanced capacity utilization over the last two years and with most now operating at capacity, growth is bound to drop off slightly. What is of major concern, however, is the unpredictability of the agriculture sector.

In 2004-05, a record cotton crop led to the highest level of agriculture growth in nine years and gave GDP growth a significant boost as well. This year, the heavy monsoons are expected to leave the cotton crop vulnerable to pest attacks and therefore result in a lower yield.

While agriculture growth has averaged four per cent a year over the last several years, it is clear that not enough has been done to create and ensure sustainable growth in agriculture and therefore reduce the volatility this sector causes in GDP growth.

Over the last five years, there has been repeated discussion on increasing investment in agriculture to promote modernization and ensure higher yields per acre but other than the greater use of tractors, no real movement has been seen on this front. Indeed, in the Public Sector Development Programme which lays out development spending plans for the year, little attention is paid to allocations for agriculture.

In fact on the whole, the planning, allocation and monitoring of development spending is a continuing worry. Allocations have been rising every year but since little is known by the planners of the realities on the ground, planning is inadequate and post-allocation monitoring is poor, leading to poor results. It is therefore unlikely that in the current form of development spending, the ADB’s analysis that expanding figures on this front will lead to higher growth will come true.

Inflation still a worry: Another issue of concern to the ADB is of growing inflationary pressures in the economy. The bank expects the rate of inflation to drop only slightly to 8.5 per cent from 9.3 per cent last year against a government target of eight per cent.

While the ADB expects the tightening of monetary policy and the opening up of imports of essential commodities to help dampen inflationary pressures, the bank says expansionary fiscal policy, high world oil prices and the monetary overhang will make it difficult to reduce the rate of inflation significantly.

Another problem not addressed by the ADB is the government’s inefficient management of food supplies and poor oversight on the now-deregulated private sector. Several crises in the recent past—in the flour and sugar trades for example—have shown how exploitation by powerful cartels through manipulation of supplies has led to uncontrolled price increases. And there is still no progress on improving anti-cartel regulatory oversight.

At present, however, high oil prices could have an even worse impact on inflation. Towards the end of last week, global oil prices had eased to a two-month low when a US energy official suggested that Washington may release emergency heating oil for the winter. US crude was selling for $61.36 last week, down from a high in late August of $70.85, but still near to levels unseen in 25 years. These pressures have caused economies the world over to amend their economic forecasts.

The European Commission, for example, forecast recently that growth in the Euro zone may slow as a result of high energy prices. Pakistan is already fighting inflationary pressures and the government even recently raised interest rates to control price problems. This effort could now be thwarted by forecasts that temporary short-term lows in oil prices will be overshadowed by a generally rising trend in oil prices over the long term.

In September, Abn Amro Bank forecast that in the worst case, a new record could be set for oil prices in the next 12 to 24 months. In this context, the bank revised downwards its GDP growth forecast for the year to 6.3 to 6.7 per cent from seven per cent earlier based on the expectation that at an average of $60 to $65 per barrel.

Oil prices can shave up to 0.7 per cent off growth, the final outcome, of course, being contingent on the extent of the absorption by the government of the oil price rise in the budget. The bank also said that each dollar’s increase in international oil prices translates into, on average, a 0.29 per cent increase in the rate of inflation. As a result, they revised upwards their forecast for CPI inflation to nine to ten per cent from eight percent forecast previously.

Twin deficits to rise: The ADB forecasts that the fiscal will rise based on large increases in development spending and salaries and pensions of government employees but that tax revenues will rise by 17 per cent as a result of high GDP growth, double-digit import growth and ongoing improvements in the tax administration.

However, worries persist that the tax target of Rs690 billion may not be met since import tariffs continue to decline and the tax base continues to be narrow. No real improvements have yet been seen in the tax administration either and that means the tax collection target will depend almost entirely on strong GDP growth which may not be as rapid as a result of a slower agriculture sector and the impact of high oil prices.

The ADB also expects the current account deficit to widen to 2.8 per cent of GDP as a result of a growing trade deficit of $5.8 billion and an increase in the services account deficit as well. The trade deficit will rise as export growth decelerates to 15 per cent as a result of a slower global economy although import growth will remain high at 18 per cent, largely on account of high oil prices.

However, machinery imports will begin to trail off this year and could lead to a slower growth in the trade deficit as import growth slows. Abn Amro’s September report pegs the trade deficit for 2005-06 even higher at $8.7 billion to $9 billion and the current account deficit at nearly four per cent of GDP.

In conclusion, the ADB predicts that in the medium term, high economic growth will continue, inflation will come down and the twin deficits will remain in control. That is probably true. But what would be reassuring at this time would be a realistic reassessment by the government itself of the impact of high oil prices on major economic indicators and a discussion of how performance might be affected in the short term.

While revised forecasts from the government—virtually unheard of by tradition—could rattle investors temporarily, in the medium term this would create far greater confidence in the professionalism and competence of the government’s economic team.