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ECONOMIC REVIEW
Glooming State Of Economy
(by SHABBIR H. KAZMI
)
Glooming State Of Economy
Reduction in discount rate by 200 basis points in the recent past enabled Large Scale Manufacturing (LSM) sector to grow by 1.5% during July-November FY12 as against an average contraction of 3.5% during the same period of the last three years. However, emerging challenge is how to finance the external account deficit on account of decline in direct and portfolio investments and shortfalls in official inflows. Missing of fiscal targets and lower external inflows have resulted in skewed composition of the monetary aggregates as Net Domestic Assets (NDA) have grown disproportionally, as against this Net Foreign Assets (NFA) have contracted. As a result NDA/NFA ratio has deteriorated and is likely to keep inflation rate in double digit.
Lack of diversified and sustainable financing sources has resulted in substantial borrowings from the banking system by the government and declining foreign exchange reserves. This has squeezed the availability of credit for the private sector and increased the pressure on rupee liquidity. The central bank has been injecting substantial liquidity on almost permanent basis, up to Rs230 billion till February 9 from commencement of the current financial year to ensure smooth functioning of the payment system and avoid financial instability.
The uncertain market liquidity flows have led to excess volatility in short term interest rates and increased the challenges of monetary management. The main reasons for this uncertainty include a sharper deterioration in the external current account deficit, a declining trend of foreign inflows, and a higher currency to deposit ratio. However, other market interest rates, such as KIBOR and Weighted Average Lending Rate, have largely followed the policy rate reductions.
A declining interest rate environment together with a relatively better growth in LSM is expected to help in improving private sector credit offtake. Credit to the private sector has expanded by Rs238 billion up to Glooming State Of EconomyFebruary 03 from the commencement of ongoing financial year. To come up with remedial steps it is necessary to probe a little deeper. The looming energy crisis, unfavorable law and order conditions, uncertain political environment, failure to boost investors remain the key concern.
During the current financial year performance of textile sector has remained subdued after outstanding performance during FY11 due to higher cotton prices. This facilitated the private sector to retire debt as well as keep fresh borrowing low during FY12. Due to looming energy crisis capacity utilisation has remained low and likely to come under pressure due to prolonged winter, which is also inhibiting credit demand for fixed investment. The fresh credit disbursement during first half was mainly utilized to meet working capital requirements and significant part of this credit will be retired in the second half.
The provisional estimates hint towards a deficit of Rs532 billion or 2.5% of GDP. Keeping in view that the fiscal deficit is always higher in the second half of a fiscal year, also substantiated by last ten year data that containing the FY12 fiscal deficit close to the government's revised target of 4.7% of GDP would be difficult. It is encouraging to note that the tax collection by the Federal Board of Revenue during the first half was Rs 840 billion, showing a strong growth of 27%. It is also expected that auction of 3G licenses can attract good response and help in containing possible fiscal slippages. However, achieving full year target of Rs1,952 billion still seems ambitious.
The risks to external position have also increased due to widening trade deficit, fragile global economic conditions and continued paucity of financial inflows. The added burden is payment of US$1.2 billion to the IMF during the current financial year. The situation looks real precarious because of declining foreign exchange reserves, already down to US$12.2 billion as on February 09, 2012 from US$14.8 billion at end June 2011. Similarly, rupee has depreciated by 5.2% against dollar during first seven months of current financial year.
A 33.7% growth in imports of petroleum products on the back of higher international oil prices, total imports have increased to US$19.7 billion at end December 2011.However, volume of imports remained muted, indicating moderation in domestic demand pressures. Given the rising tensions in the US-Iran relations and political uncertainty in the Middle East oil prices are unlikely to fall significantly in the near future and may even increase. Therefore, despite low volumes, imports are projected to grow by 15% during FY12. Similarly, the falling cotton prices played a key role keeping exports under pressure; in fact there has been a decline in export receipts to US$12 billion during the first half. The volume of export has also declined considerably. Assuming that these trends would continue in the second half export receipts may decline up to 5%.
Incorporating robust inflow of workers' remittances, the external current account deficit is expected to remain in the range of $3.5 billion to $5.5 billion or 1.5 to 2.4 percent of GDP. The possibility of limiting the deficit to the lower levels is mainly contingent upon realization of Coalition Support Fund, US$800 million, and the proceeds from the auction of 3G licenses, estimated to be around US$850 million. That said the real challenge would remain the current account deficit.
The circular debt issue will continue to affect GDP growth rate. Energy sector reforms can not only help in reducing government's reliance on banking system borrowings but also minimize the need to adjust the energy prices in a sporadic and unpredictable manner. Both these factors would help in improving the effectiveness of monetary policy and its contribution in keeping inflation low and stable.
Despite moderate aggregate demand, pressure on rupee is likely to continue due to uncertain foreign inflows and substantial government borrowings to finance the fiscal deficit. It must be kept in mind that sustainable economic recovery over the medium term call for a sizeable increase in both the domestic and foreign private investment in the economy. For this to happen, the business confidence needs to be revived by reducing uncertainties due to energy shortages.


 
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