RIDING on what our economic manager’s call, “the strong economic fundamentals” during the last three years, the economy is now on the higher growth trajectory.

Acceleration in growth including a sharp pick up in industrial production, a strong upsurge in investment and strengthening of the external sector have been the hallmarks of the performance.

However, critics say that though overall economic conditions have somewhat improved, they are unlikely to lead to a growth rate strong enough to sharply reduce unemployment rates and poverty incidence.

Political uncertainty remains high because of the elections next year. And structural problems persist. Investment in creation of new capacity is negligible— especially in high-tech industries. The twin fiscal and current account deficits are rising with lingering high rate of inflation. And these are some of the major challenges confronting the government.

The government has set an ambitious GDP growth target of seven per cent for the next 3-5 years. With fiscal and monetary stimulus vanishing, progress on structural reforms such as governance has become crucially important.

In addition to further bolstering investor confidence, the government has to improve enabling environment including supply of skilled people through aggressive skill development programme.

Now, when the economy is experiencing some reversal in positive indicators, the task of budget- making has become somewhat formidable. The budget 2006-07 is expected to continue the focus on public sector development, particularly water and power projects as well as infrastructure development.

The major challenges include rehabilitation and reconstruction of the earthquake affected areas and soaring crude oil prices.

The growth is sure to fall below the targeted seven per cent for current year. The target was based on the assumption of four per cent growth in agriculture and 12 per cent in the large-scale manufacturing. Both sectors are expected to perform below expectations.

The anticipated growth in agriculture sector was consistent with 22 million tons of wheat and over 13 million bales in cotton. But the wheat production is now estimated at 20.5 million tons and cotton at 12 million bales. Three out of four major crops with over 40 per cent weight in agricultural output are likely to record negative growth.

In the large-scale manufacturing sector, major industries like cotton and sugar have faced raw material shortages owing to crop failures. Automobile sector may loose its esteem because of ill-directed policies to encourage import of reconditioned and new cars, reduction in duties etc. The rising interest rates have impacted on cost of production. This is likely to put some pressure on investment decisions in setting new industries.

Import liberalisation has contributed to deterioration of current account balance. The budget should focus on curbing imports of luxury items through duty and tariff and by restricted bank lending. The current account may be sustainable for the short-term. But if the current trend persists, managing the balance of payments would become very difficult.

The current composition of imports is not very healthy. What is all the more alarming that mobile phones and road motor vehicles have been put into the category of machinery, justifying imports as inevitable for a growing economy. The expected current account deficit of 4.7 per cent of GDP is huge and demands some corrective measures in the budget.

A high inflation rate has made the task of poverty reduction harder. It was a norm in the past that whenever inflation picked up on the back of oil prices, stringent measures were taken to ensure smooth supply of essential items. It is the first time that when pressure mounted from import side, the supply side response was very haphazard.

The domestic industry exploited absence of an updated anti-cartel legislation for its benefit. Sugar, cement and steel industries indulged in market abuse. And the government appeared to be a silent spectator. The helpless consumers were left to fend for themselves with obvious outcomes.

In the last six years, the national budgets have offered very little to the poor farmers or the agricultural sector. The whole policy support is biased in favour of big land holders, middle man and fertilizer industry. The food and agriculture ministry and its scores of subsidiaries have failed to develop any effective support and extension policy for the agriculture sector.

The support price mechanism is the only policy of the government but it failed to set farming patterns. The poor farmers with less education, inadequate access to formal credit stream and holding capacity are bound to sell their products to middle man on the prices which are far less than the support price.

The government should take into consideration the necessary policy support for productivity enhancement and promote mechanization for higher yields. The growth in agriculture sector is key to the long-term goal of higher growth and poverty reduction.

Fiscal consolidation has undoubtedly contributed to a sharp recovery in economic growth accompanied by macroeconomic stability during the last three years. But now fiscal balance is under pressure. Revenue performance, on the other hand, is better than the target and will help ease some pressure on the earthquake-related spending.

However, the revenue performance is also the result of higher prices of essential items like sugar and other commodities. The current pace of revenue generation, lower than the nominal GDP growth, is not enough to support the thrust towards a higher growth trajectory.

Pakistan will have to allocate substantially large resources for strengthening the country’s depleted physical and human infrastructure to sustain the growth momentum in the long-run.

With current the narrow tax base, it will be difficult to generate enough resources to finance infrastructure development. The government has to make efforts to broaden the tax base i.e. to hitherto untaxed or under- taxed sectors. It will enable the government to reduce marginal tax rates which will help further stimulate investment and production, and will promote voluntary tax compliance.

Broadening of tax base will also ensure a fair distribution of the tax burden among various sectors of the economy. The services sector including wholesale and retail trade as well as agriculture are potential areas. The next year’s budget should create more fiscal space for investment by realising the tax revenue potential of a growing economy.