December 11, 2006	Monday	Ziqa'ad 19, 1427

THERE is little in the State Bank of Pakistan (SBP) annual report 2006 that may ring alarm bells for the economic policy makers in Islamabad.. The key economic indicators do not indicate any sign of a looming crisis in the short- term.

This does not mean the economy does not face any challenges or the government has found a recipe for a sustainable high level of economic growth.

Persistently high inflation, current account deficit, and fiscal situation do pose considerable risks to the economy but a benign international environment, strong services sector growth, growing remittances, recovery in agriculture, high level of domestic liquidity and increasing government spending appear to have combined to give the government some breathing space to address the longer-term challenges.

What distinguishes the present military government from most of the past military and civil rulers is that this time the GHQ has outsourced, for most practical purposes, the management of the economy to the technocrats and allowed them to operate within the boundaries of the existing power structures. These technocrats, led by the prime minister, were not only quick to take advantage of the ‘9/11 windfall’ but also have managed to stabilise the macro economic environment resulting in an average GDP growth of 6.6 per cent per annum during the last four years.

The SBP is forecasting a GDP growth of 6.8 to 7.2 per cent during the fiscal 2006-07.

That brings us to another point: while the economic managers have brought relatively more discipline to policy formulation and implementation, they have also been lucky.

The following table illustrates this point:

Real GDP growth average

(per cent per annum)

1999-2002 2003-2006

World 3.6 4.9

Emerging

Markets 4.9 7.3

Developing

Asia only 6.6 8.7

Pakistan 4.1 6.6

(Source: IMF)

The world economy experienced a slow down during 2001-2002 after the United States stock market bubble burst in 2001. However, the recovery was in full swing by 2003.

The above data highlights the fact the Pakistan’s growth during the last four years although higher relative to the 1990s mirrored just the global economic boom led by Asia. As the world economy expanded faster during 2003-2006, so did Pakistan’s.

It is no secret that the developing Asia, driven by China and India, has recorded the highest growth rate in the world. However, what is indeed noticeable that during both 1999-2002 and 2003-2006 periods, Pakistan’s growth rate was lower than the average of not just Asia but also that of the entire emerging markets. This relative underperformance needs closer examination and deeper study by the policy makers and the private sector.

Given the hard numbers, the statements about becoming another Asian tiger and having the best performing stock market in the world need a reality check. The stock market may be anticipating or pricing in a slow down. Karachi’s stock market, measured by the performance of KSE100 Index, is the worst performing in Asia during 2006.

While stock markets race ahead or overshoot in anticipation of economic growth, they tend to discount slowdown ahead of the actual developments. No doubt, the stock market has been under pressure due to other factors, but those are not new. The objective fact remains that Pakistan’s bull market that set records during 2002-2005 ended in 2006 and is the worst performing market among major Asian stock markets so far this year. Is the market if not through the statements of brokers on the electronic media but speaking through its actual performance predicting a decelerating growth?

It would seem that any global slowdown, particularly in the United States and Pakistan’s major trading partners, could reverse the already faltering exports growth. This would lead to additional pressure on a widening current account deficit and the Pakistan rupee exchange rate, which has apparently held its value against a weak dollar during 2006.

The US currency has lost 12 per cent against euro, 14.6 per cent against British pound and 2.6 per cent against Japanese yen during 2006. Pakistani rupee is overvalued on a trade-weighted exchange rate basis and is rather vulnerable to any external shock.

While a 3-5 per cent depreciation may not be surprising to the markets, any significant deterioration in the external account, be it due to higher oil prices or a slowdown in the economies of Pakistan’s major of trading partners, is likely to put pressure on the rupee, which though theoretically free, is de facto pegged to the US dollar.

Any significant depreciation may not be necessarily good for the economy as it will increase cost of imports and inputs, push up inflation and undermine foreign investors’ confidence. Hence, the State Bank would be well advised to focus solely on targeting the inflation rate through a tight monetary policy rather than worry about other variables.

The State Bank Governor Dr Shamshad Akhtar has warned that the SBP will intervene for providing higher returns to the depositors if the banks fail to reduce the banking spread and provide better yield on deposits. Unless the governor is planning to introduce some structural and regulatory changes, such a well meaning wish is unlikely to be achieved through moral suasion. On the other hand, a failure to control inflation, a core function of any central bank, is a risk that can derail the macro stabilisation progress made so far.