Economy showing signs of modest improvement: SBP

[Salman]

Economy showing signs of modest improvement: SBP


KARACHI: The economy is showing signs of modest improvement as preliminary data indicates that the commodity producing sector, especially agriculture, is doing better-than-expected whereas services sector seems well-placed to gain from robust retail trade transportation activities and increased profitability of the banking sector, says State Bank’s second quarterly report for the fiscal year 2011-12 on the State of the Economy released on Tuesday.

The report said the ample availability of key staple crops and less than anticipated supply disruptions due to floods, played a key role in containing inflationary pressures during the period from July to December of current financial year 2011-12.

However, it pointed out that despite these positive developments, risks to macro-economic stability have, nevertheless, increased. Specifically, the position of the external sector weakened at a rate faster than expected; and the fall in financial and capital inflows exerted pressure both on SBP’s foreign exchange reserves and on the rupee, it said, adding that this, along with the pickup in government borrowing from SBP, complicated liquidity management. Finally, energy shortages continued to plague production activities, especially in the industrial sector, it added.

The developments during H1FY12 indicate that risks to macroeconomic stability are stemming from the external sector and the continued weaknesses on the fiscal side, it said and added in terms of the real sector, there has been some improvement since the publication of SBP’s Annual Report in December 2011.

The economy is still expected to grow in the range of 3.0 to 4.0 percent. Inflationary outlook has improved slightly on account of supply side factors (food). It is expected that FY12 inflation will fall within the range of 11 to 12 percent, with a bias towards the lower boundary, the report added.

It said that in spite the lower fiscal deficit during H1FY12, containing the overall fiscal deficit to its revised target of 4.7 percent of gross domestic product (GDP) seems to be challenging. Quarterly data for previous years has shown that the deficit remains relatively higher in the second half of the year, it said, adding that the achievement of the revised fiscal deficit is dependent on the realisation of the envisaged surpluses from provincial governments, which are likely to be lower-than-expected; the non-tax revenues, which depend on inflows into the Coalition Support Fund (CSF), and the auction of 3G licences; and strict control over expenditures.

According to the report, the burden of financing this deficit will fall on the banking system, specifically on commercial banks. Other than growing concerns about the supply of loanable funds for the private sector, renewed government borrowing from SBP entails rising inflationary expectations in the economy, it said, adding that on external front, although the current account deficit is expected to be in the range of 1.5 to 2.5 percent of GDP, there is an upward bias to this prediction. Given the fall in financial and capital inflows, funding this modest current account deficit could be challenging. Market players are increasingly concerned about whether the envisaged foreign inflows will materialise in time. This, together with the scheduled repayment of International Monetary Fund (IMF) loans ($1.1 billion) during H2FY12, may draw down SBP’s foreign exchange reserves, the report added.

However, the declining trend in headline inflation may not persist. The core inflation (non-food, non-energy) has shown no signs of receding, and more than half of the commodities in the consumer price index basket are still posting double-digit inflation, it said and added that this stubbornness is attributed to a host of factors including the periodic upward revision in administered prices, especially that of petroleum products; depreciation of the domestic currency, particularly during the second quarter of the year; and the revival of inflationary expectations with the government borrowing from SBP since November 2011.

It said that the greater concern is the composition of government borrowing, which has tilted towards inflationary financing. Data for Q2FY12 indicates that the government was unable to meet its self-imposed quarterly limit of zero net budgetary borrowing from SBP, the report said and added that high frequency data shows that government borrowing from SBP picked up from November onwards, and reached Rs 219.2 billion during Q2FY12. This dependence on SBP financing was because of the difficulties encountered in rolling over maturing treasury-bills in the month of December 2011 – a risk highlighted in SBP’s monetary policy statements and annual and quarterly reports, it added.

It said that the data for consolidated fiscal operations indicates a deficit of 2.5 percent of GDP for H1FY12. This deficit was slightly lower as compared to the H1FY11. The good news is that this came primarily from the revenue side; the Federal Board of Revenue (FBR) tax collections reached Rs 840.1 billion during H1FY12, showing a yearly growth of 27.1 percent, it said, and added that moreover, SBP profits of Rs 104 billion contributed significantly to non-tax revenues.

Nevertheless, it is important to note that financing this contained fiscal deficit in H1FY12 was challenging as compared to H1FY11, it said, adding that as mentioned earlier, the burden of financing fell squarely on domestic sources, since the expected external inflows did not materialise. Specifically, uncertainty about inflows from the CSF and the Eurobond issuances still prevails, the report added.