ALTHOUGH our economy has been growing at over six per cent per annum since 2003, much of this has been possible because of the consumer binge that came from a decline in savings and the funding available from banks to finance consumption. The manufacturing sector has been able to service this buoyant growth in consumption demand through high-capacity utilization rates and sizable profits.

However, despite growing business confidence, investment demand has not gone up as sharply as one would have expected. In fact, the rate of investment has fallen below the level of 1999/2000. Also, there has been little diversification; project funds sanctioned by banks and financial institutions for expanding and modernizing existing capacities outweigh those meant for new projects.

Moreover, this growth has been narrowly based in both agriculture and industry. In agriculture, the entire growth has been in cotton and wheat, thanks largely to good weather conditions. However, the prospects for the agricultural sector this year certainly do not look as bright as that of last year, considering that the size of the cotton crop then was the highest in living memory.

In the industrial sector, much of the production expansion has been in automobiles, sugar, chemicals, in none of which Pakistan has, or likely to have, in the foreseeable future, any comparative advantage. These generally inefficient sectors have been thriving simply at the expense of hapless consumers. Two sub-sectors of industry — textiles and leather — in which we have greater ability to compete internationally have done well largely because of the local availability of the key ingredient, the raw material. However, a segment of the textile industry producing knitted garments is now experiencing a painful death, unable to save itself from the tsunami of more competitive Chinese products.

The prospects for 2006/07 require more pro-active government monitoring and surveillance. The two most worrying aspects are the high rate of inflation — highest among comparative economies — and the widening gap between the import bill and export earnings, likely to (based on figures for the first six months of the year) touch, if not cross, an alarming $10 billion in the negative. Part of this chasm in the external trade account can be filled by annual remittances of overseas Pakistanis of around four billion dollars. But this will still leave a gap of six billion dollars, which will require bridging through a combination of the following:

a) capital inflows from donors for funding earthquake relief rehabilitation and reconstruction activities (considering that four billion dollars out of the pledged six billion dollars will be in the form of loans to be made available over the next three years or so; some of these funds could be expected to pour into the foreign exchange reserve);

b) annual contributions of one to 1.5 billion dollars from donors like the World Bank and Asian Development Bank for regular programmes and projects (some of this money will go into meeting obligations to service external debts); and

c) foreign investment either into new projects of sectors like telecommunications, oil and gas and mineral exploration or to buy stocks in corporate entities in which the government is divesting its holdings, such as Sui Southern, Sui Northern, Steel Mills, the KESC and one or two electricity distribution companies.

The remaining hole which, despite the foreign exchange inflows referred to above, could be a sizable amount that will require a combination of measures ranging from a rundown of foreign exchange reserves, a downward adjustment in the value of the rupee (which is required in any case because our inflation rate is distinctly higher than that of most of our competitors and trading partners) to maintain profitability of exports versus sales in domestic markets and further raising of interest rates by pursuing a more contractionary monetary policy, which will have implications for economic growth and real incomes of people.

To check the sharp rise in trade deficit, decision-makers could be tempted to raise the levels of import duties or slap trade controls which would violate our commitments under the WTO rules or, even if permissible within the WTO framework, would clearly be a regressive step that would penalize consumers as well as provide a stimulus for smuggling.

Moreover, thanks to the analysis of trade data conducted by Abn-Amro, we discover that contrary to official explanations that the trade deficit was widening on account of imports of plant and machinery, a large proportion of what is classified as capital goods/equipment is essentially motor cars and other consumer durables like refrigerators, airconditioners. This partly reflects on the quality of the information generated by government systems.

In other words, the rising import bill is not simply because of high oil prices and imports of plant and machinery for investment that will create more production capacity, thereby enhancing the country’s export capability resulting in narrowing future trade deficits. Much of the imports are being soaked in by the surging consumer demand.

The other matter of concern is the sharp increase in income and wealth disparities and inequalities between the haves and have-nots, as those with little skills, the majority of the population, find that despite economic growth their wage levels and living standards have, at best, remained stagnant, if not worsened.

Furthermore, the economic outlook could be adversely affected by another factor, a slowing down of consumer demand in the US. The relatively high growth rate of the US and the UK economies have sustained high levels of consumption that has been fuelling demand for goods and services stimulating industrial and service sector growth in the rest of the world, particularly the economies of countries like China, India and Pakistan.

The key question is to what extent these heightened levels of demand are sustainable. All kinds of doubts are being expressed about the longevity of a process whereby the US continues to borrow at a mind-boggling rate of two billion dollars a day, having already outdone all laws of economics, and having defied all predictions of sceptics that such a state of affairs could not persist. Laws of gravity must eventually prevail. Fiscal rectitude is required in the US, and soon, as hard choices cannot be deferred indefinitely by a country living on borrowed money and borrowed time. This likely correction raises the risks in 2006 for economies like ours, given our high level of dependence on exports to the US — 26 per cent of our total exports in 2005 and 32 per cent of total exports to the UK.

There is, therefore, a need to exercise greater caution while forecasting the economic landscape for 2006. This is not to suggest that the future looks bleak but that the fallout of a weakening in consumer demand in the US and UK, by hitting exports, could dampen our economic performance. Considering that export growth during the first six months of this financial year has already been much more subdued than the feverish pace at which imports have been rising. Such a development will hurt investor sentiment and the economy’s growth prospects as well.

The writer is a former finance minister of Punjab