The government has delivered tangible reforms that have led to rising GDP growth rates and allowed for economic liberalization. This trend continued in 2004 where the benefits of this policy could be seen in many forms while at the same time there were some areas in which concerns grew.
In December 2004 the IMF completed its ninth and final review under a three-year poverty reduction and growth facility (PRGF) arrangement. The review enables Pakistan to draw a tranche of US$262m. Pakistan has declined to take the money under a much-publicized move that states that the "shackles of the IMF" have been broken by the present government.
More significant, however, was that in completing the final review, the IMF stated that Pakistan has made a strong recovery since the economic crisis of the late 1990s. Sound macroeconomic policies and structural reforms had resulted in a stronger export and current account position, a lower debt burden, access to international capital markets and a revival in growth. The IMF also suggested that while external support had played a part in Pakistan's recovery, the improvement had reflected a government-led change of policies.
However, the IMF was worried that Pakistan faced rising inflation and that the social indicators remain weak. It also remained concerned about public expenditure management and the slow pace of reform in power generation.
This is an area in which successive governments under the leadership of General Musharraf have failed to deliver. Inflation seems to be climbing into double digits as the year comes to an end and the social sector remains a sore point despite the pronouncements of various government spokesmen.
A favourite tactic of Prime Minister Shaukat Aziz is to rubbish comments on the failure of the government to fight poverty. Aziz says that any such talk of failure is "drawing room gossip, as the facts on the ground speak otherwise". He is also quick to berate people on seeing the glass half empty when they should be seeing it half full.
Despite all this brave talk, poverty continues to grow in Pakistan. Economists have commented, like in the report released by the Social Policy and Development Centre in December, that high growth rate alone cannot lift Pakistanis out of the poverty cycle.
At end-2004 the Multi-Fibre Arrangement (MFA, a quota agreement governing the international trade in textiles) ends and textiles will compete on price and quality. This clearly presents an opportunity for Pakistan where cotton and cotton-based products account for over 60 per cent of total exports. However, there will be strong competition from larger producers such as China and India and also from within as exporters continue to complain of problems they face in producing items in Pakistan.
These problems range from high power rates, the absence of infrastructure facilities, harassment by government officials on issues like tax payment and labour levies, a rise in crime and the red tape involved in getting their goods cleared at points of exit.
The encouraging thing is that recent restructuring and modernization in the sector indicates that Pakistan will be able to compete effectively, and that the textile sector will expand.
On June 12, 2004, the government unveiled its budget plans for 2004-05. It was largely a growth-oriented budget. The government reduced taxes and the number of tax bands, as well as lowered import tariffs. It also increased expenditure on health, education and development by a substantial 31 per cent year on year, and launched a number of reform initiatives. In the first quarter (July-September) of 2004-05 tax collection rose by 18.5 per cent year on year, above target, as a result of improved revenue-collection methods.
But tax collection continues to remain a contentious issue. Partly to blame is the government's reluctance to give autonomous status to the Central Board of Revenue (CBR) and another problem is growing corruption within the ranks of the organization itself. So far, the government has done nothing in this regard but continues to promise to do so.
Pakistan has intentionally operated a loose monetary policy in recent years in order to stimulate economic growth. The low cost of funds available to the corporate sector has enabled companies to strengthen their balance sheets, improve profitability and invest. However, international interest rates and inflationary pressures began to edge up in 2004, forcing the SBP to act. In its July-December 2004 monetary policy statement, the SBP highlighted the threat of rising domestic prices and stated its intention of undertaking a measured tightening of monetary policy.
In March 2004 the average lending rate stood at 4.69 per cent; by September it stood at 5.84 per cent and by October it had risen to 6.01 per cent. In July the SBP raised the yield on six-month Treasury bills to 2.52 per cent, and by November this had risen further, to 3.73 per cent. The T-bill rate is expected to continue its rise in 2005 and 2006.
Real GDP growth (at factor cost) accelerated to an estimated 6.2 per cent in 2003-2004, led by strong manufacturing growth, solid export growth and moderately firm service-sector and agricultural growth. Low interest rates have also supported robust growth in investment and private consumption. The rapid industrial growth recorded in 2003-2004 stemmed in large part from higher export quotas for Pakistan's main export, textiles.
As in the previous year, the State Bank says that the growth was led principally by industry and in particular large scale manufacturing (LSM), which benefited from a further acceleration in aggregate domestic demand as well as strong external demand.
However, contrary to conventional wisdom, the acceleration in aggregate demand in 2004 (as in 2003) stemmed mainly from a strong rise in investment activities with a much smaller contribution of credit-led consumption demand.
The investment growth rate has jumped to a record 22.3 per cent - the highest ever in the recent history of Pakistan, pushing the investment-GDP ratio to 18.1 per cent. This acceleration in investment, together with the sustained consumption growth, underpins expectations of a continuation in the industrial growth momentum in the years ahead.
Inflationary pressures have continued to pick up. According to the SBP, year-on-year consumer price inflation averaged 6.6 per cent in the first 11 months of 2004. It rose to average 9.1 per cent year on year in July-November 2004; the rise was largely the result of a strong increase in food prices. Rising wholesale price inflation and high oil, gas and electricity prices (as utilities are privatized and subsidies reduced) will further boost consumer price inflation in coming months.
In early 2004 the Pakistan rupee remained steady, but it began to depreciate in June. It reached a low of Rs 61.3 to $1 in October, but then recovered in November and December to stand at Rs 59.7 to the dollar on December 15. By the end of December, the Karachi Stock Exchange's KSE-100 index crossed 6,000 points for the first time ever.
However, the year's economic performance also highlighted the vulnerability of the economy to shocks; contrary to initial expectations the agriculture sector growth proved disappointing as key crops suffered heavily from natural vagaries.
Similarly, other than wholesale and retail trade, growth in the services sector decelerated. Therefore, the quality of the year's growth is poorer compared to the previous year, being quite concentrated in only a few sectors (large-scale manufacturing, electricity and gas distribution, wholesale and retail trade and construction).As a result of the larger contribution of LSM in overall GDP growth, industrial output pulled ahead of agricultural output. This is the culmination of a medium-term trend, which if sustained, carries very significant implications for Pakistan's economy. In particular, it suggests an increasingly important role of monetary policy (especially given the increased sensitivity to interest rates movement implied in credit-driven growth), as well as the greater impact of external shocks (as industry is more dependent on imported inputs as well as on external demand).
The government's higher public sector development expenditure has also contributed to higher investment demand. The greater dependence on LSM to sustain the growth momentum, as well as the perceived vulnerability of the sector to interest rate increases were key determinants of the SBP decision to only gradually increase interest rates in the face of rising inflationary pressures.
In this background, despite a gradual decline in net foreign exchange inflows, and a relative increase in government borrowing for budgetary support, the SBP largely maintained its easy monetary stance during 2004. This, in turn, underpinned the record credit expansion in 2004; to put this in perspective, the Rs325 billion growth in net credit to the private sector was more than twice the cumulative net credit expansion in the preceding three years.
However, the easy monetary policy also had some negative effects that need to be monitored closely. The most obvious of these was the increase in speculative activities in the economy, as borrowers sought to take advantage of soft credit terms and rising inflationary pressures. This was evident in a variety of markets, including wheat, automobiles, real estate, etc.
There is clearly a need for increased regulatory intervention as well as consumer resistance to unwarranted price hikes. An important development in credit regulation during the year was the amendment in the SBP prudential regulations introduced to enable bank lending to the SMEs.
This is not only expected to be a key driver of future credit growth, it could also significantly help improve employment generation and output in the economy. A positive side effect of the resulting increase in lending to the informal sector would be improved incentives for documenting economic activities, since the credit access to the SME sector will depend on demonstrable cash flows.
It should be noted that a strong fiscal position goes hand in hand with the ability of the central bank to prudently sustain low interest rates. The strong growth in government revenues and containment of fiscal deficit made important contributions to the SBP's ability to sustain low interest rates in the impact of high oil prices to consumers in the months ahead.
The government has delivered tangible reforms that have led to rising GDP growth rates and allowed for economic liberalization. This trend continued in 2004 where the benefits of this policy could be seen in many forms while at the same time there were some areas in which concerns grew.
