Oil takes steam out of economy in Pakistan
Pakistan Times Federal Bureau Report

ISLAMABAD: Biting fuel oil prices are threatening to take steam out of the growth momentum of Pakistan, with forecasts suggesting bitter inflation and current account levels.

After posting much better than expected growth last fiscal year at 8.4 percent, Pakistan's economy is projected to grow by 6.5 percent in 2005-2006, says Asian Development Outlook 2005 Update release.

The steeper than projected increases in oil prices, shortages of essential food items, and strong domestic demand would push inflation at higher levels of 8.5 percent than the earlier forecast of 5 percent.

This Update trims the GDP growth forecast for FY2006, and raises significantly the projections for inflation and the current account deficit as it takes into account much higher baseline oil prices. International oil prices hit $70 a barrel in August 2005.

"Sustained, high oil prices above the baseline would pose a serious risk for the FY2006 forecasts of GDP growth, inflation, the balance of payments, and the fiscal deficit." The report points out that high oil prices may negatively affect Pakistan's economy.

Lower Growth of Exports

"If [international oil prices] remain at current levels, or go higher, projections for imports, the fiscal deficit, and inflation may have to be revised upward, while any negative impact on the global economy could lead to lower growth of exports," the Update cautions.

High oil prices are likely to have a negative fiscal impact of about Rs 30 billion (0.4 percent of GDP) in the form of revenue loss due to lower petroleum surcharges and additional subsidies to oil marketing companies and refineries.

"This is likely to be more or less offset by higher than budgeted receipts from the US for logistics support for its operations in Afghanistan," the ADO added. Increases in defense expenditures are also projected to be limited.

However, large rises projected in development expenditures and in government servants' salaries and pensions will contribute to a higher fiscal deficit in 2005-06, though it will remain below 4 of GDP.

Debt servicing will remain on target because of efforts in recent years that have significantly improved the debt structure.

The ADO hopes that sound macroeconomic fundamentals, enhanced private investment, and a significant expansion in the public sector development programme will bolster the economy in FY2006, though their positive impact is now expected to be diminished by the increase in global oil prices.

The net result is that the economy is now projected to grow by 6.5 percent, 0.5 percentage point lower than the pervious forecast. Having peaked in FY2005, inflation is expected to decline somewhat during FY2006. The balance of payments is likely to come under further pressure as high economic growth and oil prices push up imports.

After powering forward over the last 2 years, large-scale manufacturing is expected to settle to a more sustainable, but still robust, growth rate of about 11 percent in FY2006.

Production Capacity

Substantial production capacity built in the last 2 years will come on line during the year. Exemption of major export industries from the general sales tax and withdrawal of import duty on raw materials and other supplies in the FY2006 budget will also boost production.

Agricultural growth is likely to decline in FY2006, mainly because of the high-base effect. It will also be difficult to sustain last year's record-high cotton output because of already heavier monsoon rains and greater moisture than last year, which increase crop vulnerability to pests.

Further, the damage caused by recent floods to standing crops will depress agricultural production. Conversely, the greater availability of water will benefit water-intensive crops such as rice and sugarcane, while the prospect of greater water reserves than last year will also help winter crops.

The lower import duty rates on tractors and fiscal incentives for the livestock sector, announced in the FY2006 budget, will also support agriculture by encouraging investment. Given these factors, growth of agriculture is projected at 3 in FY2006.

In the services sector, the recent surge in telecoms is likely to be sustained in FY2006, based on substantial investments made last year by private telecoms service providers, and on the introduction of wireless local loop services that will open up rural areas. The banking sector is also expected to register robust growth once more.

Forecast on Imports

Imports are forecast to grow at about 18 percent in FY2006 because of continuing fast economic growth, a larger oil bill, and the planned import of wheat and other essential food items.

For their part, exports are expected to benefit from liberal incentives for export industries announced in the FY2006 budget, continuation of the textile industry's restructuring and modernization of the past several years, and the ending of quotas under the Multifibre Arrangement in January 2005.

Although the expected deceleration of the global economy relative to FY2005 will weigh on exports, they are still likely to show brisk growth of about 15%. The deficit on the trade and services accounts is expected to widen.

As a result, the current account deficit will expand to about $3.5 billion, or 2.8 percent of GDP, though its financing is not expected to present a problem because of anticipated substantially larger privatization-related FDI in FY2006.

Further tightening of monetary policy and the opening up of imports of essential food items, particularly from India, will damp inflationary pressures in FY2006. However, expansionary fiscal policy, high oil prices, and the large monetary overhang may make it difficult to contain inflation, which is therefore projected to decline only marginally to 8.5 percent in FY2006.

GDP Growth

With fast GDP growth and even stronger import expansion, as well as ongoing improvements in tax administration, taxes collected by the Central Board of Revenue are projected to grow by 17 percent in FY2006.

Improved relations with India and a possible upturn in bilateral trade will also boost growth in the medium term. Easing of external security concerns is also likely to promote foreign investment.

Accordingly, it is projected that the high economic growth will be sustained in FY2007, inflation will be brought down a little, the fiscal deficit will be kept below 4 percent of GDP, and the current account deficit will be maintained at 2.5-3 percent of GDP.

The deficit in the current account of the balance of payments represents a return to more normal circumstances for a developing country like Pakistan that needs net foreign borrowing to accelerate development. The projected deficit can be easily financed through FDI (including privatization proceeds) and soft loans.

Two risks to these economic projections need to be mentioned. First, international oil prices are continuing to rise and have been very volatile.

If they remain at their current levels, or go higher, projections for imports, the fiscal deficit, and inflation may have to be revised upward, while any negative impact on the global economy could lead to lower growth of exports.

Second, the security situation remains uncertain. Any deterioration could harm both domestic and foreign investment.●