ISLAMABAD, Jan 10: Risks to Pakistan’s economy are rising due to unstable politics which might impact the prospects for foreign investments, says Merrill Lynch.
“We believe, however, that the outcome of elections will prove decisive for the future course of policy framework, as the next government will need to take tough decisions in both the political and economic fronts,” it said in its latest country review.
Meanwhile, it said it expected structural foreign inflows into Pakistan will sustain, thanks to a strong domestic economy that should be driven by sustained medium term flows through remittances, and private/public investments.
Merrill Lynch believes that there will be 6.8 per cent GDP growth during 2007-08. “The downside risk to our call clearly hinges on political stability and the looming power crisis, especially if it lingers.”
Talking about the State Bank’s quarterly report released earlier, Merrill Lynch said, “negative news sells relatively well compared to positive in the media. SBP also highlighted several positives.”
Outlook for the services sector remain positive, backed by acceleration in retail and wholesale trade, and better performance by the financial sector and community services.
Although the expected deceleration in LSM growth (6.9 per cent) indicates a broad-based slowdown in aggregate demand, disaggregated data suggested for electronics appears strong at 8.0 per cent additionally, SBP expects a revival in LSM driven by infrastructure industries, which grew 8.3 per cent on year on year basis (YoY) in the first quarter of 2007-08 vs 3.7 per cent in the preceding year.
Although the fiscal indicators seem weaker, they are associated primarily with development expenditure which rose 89.5 per cent on year to year basis in the first quarter of the current financial year.”
In our view, this highlights an upside risk to domestic economy”, Merrill Lynch said.
On the revenue side, total revenue collections have risen to 14.4 per cent YoY during July-Oct 2007, driven by sales tax collection (up 17 per cent) and Federal Excise Duty (up 19.7 percent). “This highlights the strength in the domestic economy, in our view.”
Overall, export growth rose 11.3 per cent YoY during July- October 2007, thanks to the strong 23.1 per cent growth in non- textile exports. Last but not the least, growth in next credit to the private sector appears to be stabilising at 15 per cent YoY. “To us, this data point also signifies that the pace of growth in the domestic economy is broadly intact.”
Inflation is in the limelight again, it said, adding despite economic successes, the government has largely failed to control inflation since financial year 2004-05 due to volatile food and international oil prices and overheated economy.
Food inflation is dominating the inflation scene, and oil prices seem set to take over.
In recent statements, caretaker finance minister had indicated at higher oil, gas and power prices to avoid significant subsidies and pressure on current expenditure.
“Our crude estimate suggests that a 10 per cent increase in domestic inflation will add 1.5 per cent to CPI over and above the implicit price pressures on other components of CPI.”
“We believe the risk of a pronounced second round of inflation is very much on the cards, given the significant rise in food and oil inflation recently. This can also be validated from SBP’s September inflation monitor.
“As per SBP, wage inflation for September 2007 was 14.2 per cent, marginally lower than 14.5 per cent in September 2006. At the same time, pressure on underlying inflation is on the rise at 6.5 per cent YoY (SBP estimates) in October, vs 5.2 per cent in May 2007, in line with the increase in 20 per cent trimmed mean inflation trend.
About the twin deficits, Merrill Lynch calculations point at current account deficit of $7.7 billion in 2007-08. Every 10 per cent rise in oil prices would add $700 million to the import bill and the current account deficit.
“So we expect the oil import bill and current account deficit to rise by another $1.4 billion, if we raise our average oil price assumption to $75 bbl for the full 2007-08 financial year. Our estimates for 2007-08 foreign investment is $5.1 billion (vs $8.4 billion in 2006-07).
Hence, the remaining $4 billion of current account deficit could be funded through mix of reserve withdrawals and external debts.
The obvious question is whether Pakistan’s credit rating could hurt if it accumulates another $4.0 billion in external debts.
“We believe Pakistan can easily raise $4 billion while keeping the external debt-to-GDP ratio consistent at 27.5 per cent in 2007-08, (or $44 billion, vs the current debt level of $40 billion). This should help it maintain its credit rating of B plus by Standard and Poors and B1 by Moody’s International in our view.”