Last Three Quarterly Reports of SBP 2011-12

7/31/2019 Last Three Quarterly Reports of SBP 2011-12

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TOPIC:

SUBMITTED TO

SIR ASAD IJAZ SHIEKH

SUBMITTED BY

MEHWISH BATOOL M10MBA009

NAVEEN SABA M10MBA010

AROOSH MEHMOOD M10MBA026


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TABLE OF CONTENTS

Acknowledgement..

Overview of First Report

o Real Sector

o Inflation & Monetary Policy

o Money and Credit

o Fiscal Development..

o External Sector..

Overview of 2nd Report

o Real Sector

o Inflation And Monetary Policy.

o Fiscal Policy And Public Debt..

o External Sector.

Overview of 3rd Report

o Real Sector

o Inflation And Monetary Policy.

o Fiscal Policy And Public Debt..

o External Sector..

Looking Forward..

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ACKNOWLEDGEMENT

First and foremost, we thank to ALLAH ALMIGHTY for his countless

blessings and then we would like to thank to our professor SIR ASAD IJAZ

SHIEKH for the valuable guidance and advice. He inspired us greatly to work

in this project. His willingness to motivate us contributed tremendously to our

project.

Finally, an honorable mention goes to our families and friends for their

understandings and supports on us in completing this project. Without helps of

the particular that mentioned above, we would face many difficulties while

doing this assignment.


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The analysis in this report is confined to the last three quarterlyreports of SBP.

OVERVIEW OF LAST QUARTER OF 2011

Provisional estimates put forward by the National Income Accounts Committee show GDP

growth at 2.4 percent for FY11, lower than the growth of 3.8 percent in the previous year. In

the context of the prevailing security concerns, the exogenous shock from rising oil prices

and the impact of the unprecedented floods, this decline is broadly in line with SBPs

expectations.On a positive note, the post flood recovery in wheat, sugarcane and minor crops helpedagricultural growth surpass previous years level. However, rural incomes may not riseproportionately due to lower market prices of wheat and rising input costs (e.g. diesel andfertilizer). In the manufacturing sector, demand for products, particularly textiles, autos;fertilizer, cement, and POL remained strong. Nevertheless, despite this strong demand,supply constraints particularly the shortfall in energy created production bottlenecks,which led to a significant slowdown in industrial growth.In our view, the growth outlook will be shaped by policy responses to several key domesticchallenges:

i. energy shortages, which are restricting growth;ii. The high fiscal deficit thats financing has become difficult partly owing to the

backlog arising from the non-recognition of power sector subsidies of earlieryears as reflected in the circular debt;

iii. Build-up of domestic debt, raising concerns for macro stability;iv. Inflationary pressures which are not receding readily. The subsequent discussion will

elaborate these challenges.

i. The growing energy shortages:

In the energy sector, gas supply constraints have become more binding and this Shortage isaffecting broader economic growth. For example, textile units Generally rely on natural gasnot only for power generation but also for Production. Fertilizer output and power generationhave been affected by gas-load Management in particular and the resulting power shortageshave created Production constraints in several industries.

ii. A rising fiscal deficit:

The government is facing difficulties in containing the fiscal deficit. Information available uptoMarch 2011 puts the budget deficit at 4.5 percent of GDP, slightly higher than the deficit of4.3 % in the corresponding period of the previous year. The sectors experiencing growth stillremain either outside the tax net or are lightly taxed (e.g. agriculture and services).Althoughrevenue growth has been weak for most of the year, additional measures were introduced inthe fourth quarter. The government has also managed to contain spending showing itscommitment to pursue prudent macroeconomic policies, although much of the burden has

been borne by development expenditures. In addition, a reduction in power sector subsidieshas been pledged in an effort to resolve problems in the energy sector. Furthermore, FBR ismaking efforts to improve tax compliance.


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iii. Implications for domestic debt:

The impact of the widening fiscal deficit is clearly visible in the sharply rising domestic debt.Outstanding government domestic debt reached Rs 5,594 billion(31.8 percent of estimatedGDP) which is more than double the stock at end-June 2007. This sharp growth in debtstock is fueling concerns about macro stability and monetary management.In addition, thematurity profile of domestic debt reveals that the government has to rollover the entire stockof Rs 2,854 billion of short term debt at least once a year. Any surge in credit demand fromother sectors of the economy could elevate rollover risk,3 and could also expose thegovernment to interest rate risk.

iv. Stubborn inflationary pressures:

Fiscal discipline and restrictions on government borrowing from SBP are necessary to

contain inflationary expectations, which we believe have become ingrained in recent months.In overall terms, although the post-flood hike in CPI inflation has largely dissipated, inflationis stubborn, in excess of 13 percent.Possible reasons could include: (a) the lagged impact ofgovernment borrowings from SBP during Jul-Sep 2010; (b) frequent upward adjustments inutility and POL prices;5 (c) increase in commodity prices; and (d) the rising trend in the houserent index (HRI).

Outlook

For agriculture, we are optimistic about the next cotton crop for several reasons:

a) higher cotton prices during FY10 encouraged farmers to increase acreage for thenext crop;b) there is a shift towards more productive (and disease resistive) BT cotton seeds; andc) water availability is expected to improve over last year.

Rising fertilizer prices are the key downside risk at the moment.

1)Real Sector Real GDP Growth

FY11 proved to be another difficult year for Pakistans economy. Against the target of 4.5percent, the country could post a growth of 2.4 percent this was even weaker than the 3.9percent achieved in FY10.A slowdown in growth was anticipated since the country hadsuffered severe losses due to the devastation caused by the unprecedented floods in August2010.In addition to major kharif crops, the allied industries, trading services, and exportsectors were adversely affected. Furthermore, logistics, power infrastructure, and manyindustrial units were also damaged.

Agriculture Sector

The agriculture sector posted a strong recovery after the devastating impact of the floods inearly FY11. This recovery was mainly led by the livestock sub-sector,followed by minor

crops and some major crops (sugarcane and wheat).Notwithstanding the significant lossescaused by the floods, growth in the livestock subsector was sufficient to provide much need


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edimpetus to agriculture growth. In the case of minor crops, some recovery was expectedafter the flood as farmers focused more on minor crops (vegetable, pulses etc.)instead ofestablished major crops.

Large-Scale Manufacturing

The overall LSM posted a growth of only 1.6 percent during Jul-Mar 2011,substantially lowerthan 4.4percent in the corresponding period of FY10. However, quarterly data reveals somesigns of recovery as LSM growth improved to 2.4 percent on a YoY basis in Q3-FY11,afterrising by 1.2 percent during H1-FY11This gradual recovery can be traced to a number offactors. First, despite facing losses in August2010 due to the floods, industries based on agriraw material thrived during the quarter due to better crops. Second, favorable movements inglobal commodity prices helped improve margins of domestic producers. Lastly, exportdemand remained strong. This gradual recovery can be traced to a number of factors. First,despite facing losses in August 2010 due to the floods, industries based on agri raw materialthrived during the quarter due to better crops. Second, favorable movements in globalcommodity prices helped improve margins of domestic producers. Lastly, export demandremained strong.

.

2)Inflation and monetary policyRecent trends in CPI inflation suggest that the impact of floods on prices has clearly worn-off, but in overall terms, inflationary pressures remain quite strong:

i. Jul-May FY11 CPI inflation of 14.0 percent is considerably higher than 11.7 percentin the corresponding period of FY10. Nevertheless, we expect CPI inflation for FY11to remain close to 14.0 percent an improvement over SBPs earlier projections.Although high inflation is always a major source of concern for the central bank,some recent trends are disconcerting. Firstly, inflation remains stubborn.

ii. Inflationary pressures are broad-based, suggesting that inflation has permeated tomost sectors and will therefore be difficult to curtail in the short run.

iii. Although food inflation may decline in the coming months, overall inflation may notsubside in the near future.

Inflation Trends

Year-on-year CPI inflation came down from a peak of around 15.5 percent in December2010 to 13.23 percent in May 2011. Notably, this level of inflation was very close to its pre-flood level, indicating that the impact of the August 2010 floods on inflation has played out.Disappointingly, this downtrend could not be sustained beyond February due to increases inthe prices of non-perishable food items (e.g. cooking oil; dairy products ;tea; and gramwhole).Furthermore, rising prices of the apparel & textile and cleaning & laundry sub groups,diagram A key concern for SBP is the extent to which inflationary pressures have spreadacross the economy. Specifically, the share of items in the CPI basket displaying double digitinflation has remained over 50percent in May 2011. To put this in perspective, in May2010,only around 39 percent of commodities in the CPI basket were showing double digit inflation.


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Inflation Outlook

Following a good rabi season,wheat and sugar prices have come down which should

contain, and perhaps ease, food inflation in the coming months.

3)Money and CreditThe improvement in the external account, and some let-up in government borrowing fromSBP, allowed SBP to keep its policy rate unchanged at 14.0 percent in the last three policyannouncements (January, March and May 2011).These decisions reveal a shift in monetarypolicy when compared to a cumulative increase of 150 bps in the policy rate during H1-FY11. The key challenges for monetary policy included weak domestic economic activity,double-digit inflation, risks of reversal in the external account and a large fiscal deficit thatrequires on-going domestic financing. Although the impact of the floods on domestic priceshas clearly dissipated, inflationary pressures remain more disturbingly , the outlook forinflation is not encouraging.

4)Fiscal DevelopmentsThe overall fiscal position continued to be under stress during the first three quarters ofFY11. The consolidated deficit during Jul-Mar 2011 reached 4.5 percent of GDP, slightlyhigher than the 4.3 percent for the same period last year. On a positive note, the governmenthas managed to control its spending.

5)External SectorAfter remaining in deficit for six consecutive years, Pakistans current account posted asurplus of US$ 0.7 billion in Jul-Apr 2011. This improvement overshadowed the deteriorationin the financial account during this period, resulting in an overall surplus of US$ 1.2 billionduring Jul-Apr 2011,compared to US$ 0.7 billion in corresponding period of the previousyear.

OVERVIEW OF 1st QUARTER2012

Policy makers were hopeful that the country would put up a better economic performance inFY12 after last year, which was a difficult one for the economy, not only due to thedevastating floods that hit the country early in the fiscal year, but also due to the lack ofexternal financing and energy shortages.Unfortunately, as in FY11, the country was hit once again by floods in the early months ofFY12.On a positive note, the floods in FY12 were not as severe as those in FY11..

the government has been making some headway towards improving its finances.

Moreover, the federal government has budgeted a surplus of Rs 125.0 billion on part ofprovinces, however, due to 52.8 percent increase in their expenditures, provinces managedonly Rs 11.6 billion surplus up to Q1-FY12, which was 85.7 percent lower than the


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corresponding period last year. Any short fall in the contribution by the provinces wouldmake achievement of the fiscal deficit target more challenging.Lack of external funding has put the burden of financing the deficit disproportionately on the

banking system, which has led to crowding out of private sector and is acting as adisincentive for banks to perform their role of financial intermediation. Government borrowingfrom the banking system up to end-Nov 2011 was Rs 736.8 billion, against Rs 336.1 billionin the corresponding period last year. This amount includes Rs 391.0 billion borrowed fromthe banks to retire PSE(public sector enterprises) debt, which has now been transferred onto the governments books. Unfortunately, PSEs continue to hemorrhage as a crediblerestructuring plan has not been put into action. As a result circular debt issue is likely topersist.

The governments efforts to keep its borrowing from SBP in check during the initialmonths of FY12, helped in keeping demand-driven inflationary pressures at bay, which wassupplemented by the easing of food prices. As a result, YoY CPI inflation declined to single

digits (9.7 percent) in Dec 2011 after remaining in double digits for the last two years. Whilethe increase in energy prices, recent weakening of the Pak Rupee and the base effect mayincrease inflation in the coming months, the end-year average inflation is likely to fall close to12.0 percent as projected earlier.While SBP has shown its willingness to relax its policy to support the private sector as it didin Jul and Oct 2011, it cannot add to the stress on the economy arising from weaknesses inother sectors. The most recent policy decision to keep the policy rate unchanged wasinfluenced among others, by the weakness in external accounts during Q1-FY12.

Pakistan was fortunate in FY11 that its current account ended up in a surplus and,despite the drying up of FDI and other foreign investments; there was a net increase in itsFX reserves. Given the rigidities in the trade account and the vulnerability of the financialaccount, sustaining this performance in FY12 was always going to be difficult. Nevertheless,the pace at which the current account deteriorated during the first quarter of FY12 took manyby surprise. Specifically, the current account deficit for Sep 2011 alone was over US$ 1.0billion.

In the past, Pakistan has sustained larger current account deficits without losing itsforeign reserves due to healthy inflows in the financial account. Unfortunately, owing to bothdomestic weaknesses and the international financial upheaval, financial flows have almostdried up, adding to the countrys economic vulnerability. While some financial inflows areexpected, a part of the current account deficit is likely to be financed through reserves aswas the case during Jul-Oct FY12. This has important implications for monetary

management and price stability.

The government is, however, optimistic that the 3G telecom license fee will berealized. In addition, due to recent developments, there is still optimism that parts of theCSF, bilateral assistance from the US, and the privatization proceeds of PTCL will bereceived. Furthermore, currency swap arrangements, which were recently formalized withthe central banks of Turkey and China, will also facilitate bilateral trade and investment,easing the stress on the countrys reserves.

Nevertheless, SBP remains vigilant that pressure on the Rupee is not translated intomarket speculation, which could become self-fulfilling. Striking a balance in managing a

flexible exchange rate driven by economic fundamentals andby market speculation (within


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the context of sharp currency movements in the global economy) is challenging. SBP willcontinue to monitor the forex market closely to remove any excessive volatility in the Rupee.

1)Real SectorThe initial months of FY12challenged the key assumptions on which this years growth targetrested: continuation of post-flood revival, firm global commodity prices, and back-upelectricity supply arrangements by industries. Firstly, 2010 flood recovery was interruptedby another flood in Q1-FY12, which caused considerable damage to cotton crop in Sindh.

Agriculture Sector Performance

The initial assessment indicates major losses to cotton due to floods in Central and Southern

Sindh. However, improved water availability, introduction of better yielding variety of rice,and the increase in wheat support price, are likely to help agriculture sector achieve its targetfor FY12.

Large-Scale Manufacturing

The LSM recorded a growth of 2.1 percent during Jul-Oct FY12 in contrast to 2.9percent decline recorded in the corresponding period last year.

2)Inflation and Monetary Policy

Monetary Policy

SBP ease its monetary policy stance in Jul and Oct 2011 was influenced by a combination ofgradual decline in headline inflation, comfort in the current account balance, and thegovernment efforts to contain its inflationary borrowing. SBP policy rate was reduced by acumulative 200 bps to 12.0 percent. While this monetary easing was expected to helpstimulate economic activities in the economy, risks emerging from external sector were

acknowledged; resultantly policy rate was kept on hold in Nov 2011.

Developments in Monetary Aggregates

Changes in monetary aggregates during Jul-Nov FY12 are primarily driven by thedeteriorating external accounts. Specifically, Net Foreign Assets (NFA) witnessed acontraction of 18.0 percent so far this year, against an expansion of 11.2 percent in theprevious year. This sharp reversal led to deceleration in broad money (M2) growth as theexpansion in net demotic assets (NDA) remained almost the same as in the last year.

Inflation

Headline inflation number has been edging down consistently and core inflation,encouragingly, is following suit Food inflation has receded considerably recently and beenthe major contributor towards the slowdown in inflation. However, commodities displayingdouble digit inflation have been above 50 percent since Feb 2011 an indication of the broad-

based nature of inflation in the country.


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3)Fiscal Policy and Public Debt Fiscal Situation

The budget deficit in the first quarter of FY12 was 1.2 percent of GDP, compared with 1.5percent during the same quarter of the last year.The reduction in the budget deficit wascaused primarily by sharp rise in tax collection on the back of increased tax collection effortsas well as high growth in taxes on imports. While expenditures also showed higher growththan the last year, the upside is that some of this growth was tilted towards developmentexpenditures

Total Debt & Liabilities

The settlement of circular debt of power sector PSEs and public procurement agenciesresulted in a substantial Rs 572.2 billion increase in the stock of total debt & liabilities (TDL),during the first five months of FY12, that reached Rs 12.7 trillion (Table 4.6). However, afteradjusting for this one-off factor, the increment in TDL stock shows a lesser magnitude duringJul-Nov FY12 as compared to the same period last year.

4)External SectorThe first five months of FY12 saw a sharp deterioration in the external account positioncompared to the previous year. Specifically, external account posted a deficit of US$ 1.7billion during Jul-Nov FY12 compared to a surplus of US$100.0 million in the correspondingperiod of the previous year. The deficit in overall external account is attributed to thedeteriorations recorded in both, the current and financial accounts during the period underreview

OVERVIEW OF 2ND QUARTER2012.

Half way into FY12, the economy is showing signs of a modest improvement. Preliminary

data indicates that the commodity producing sector, especially agriculture, is doing betterthan expected. Services also seem well-placed to gain from robust retail trade activities;transportation; and increased profitability of the banking sector. The ample availability of keystaple crops and less than anticipated supply disruptions due to floods, played a key role incontaining inflationary pressures during the period under review.

Despite these positive developments, risks to macro-economic stability have,nevertheless, increased. Specifically, the position of the external sector weakened at a ratefaster than expected; and the fall in financial and capital inflows exerted pressure both onSBPs foreign exchange reserves and on the Pak Rupee. This, along with the pickup ingovernment borrowing from SBP, complicated liquidity management. Finally, energyshortages continued to plague production activities, especially in the industrial sector. Within

the commodity producing sectors, major kharifcrops are likely to achieve their target growthfor FY12.1


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Fortunately, flood-related damages to the cotton crop in Sindh have been more thanoffset by gains in Punjab. The use of high quality cotton seeds; improved availability of

water; and the increase in area under cultivation due to higher crop prices last year were themain reasons here.However, the benefits of productivity gains to farmers are being eroded by the dwindlingprice of their produce.2 This, along with the increased cost of inputs (especially that offertilizer), has squeezed margins for farmers. Accordingly, farm income is expected to belower than last year.

The improvement in the production of minor crops and the ample availability of keystaple crops has eased inflationary pressures in the food group during H1-FY12.3 This wasprimarily responsible for bringing YoY CPI inflation down to single digits (9.7 percent) inDecember 2011 at that level for the first time since October 2009. However, the decliningtrend in headline inflation may not persist. Core inflation (non-food, non-energy) has shown

no signs of receding, and more than half of the commodities in the CPI basket are stillposting double-digit inflation.4 This stubbornness is attributed to a host of factors including:(1) the periodic upward revision in administered prices, especially that of petroleumproducts;(2) depreciation of the domestic currency, particularly during the second quarter of the year;

(3) the revival of inflationary expectations with the government borrowing from SBP sinceNovember 2011.

Within aggregate demand, there has been almost no improvement in the investmentcomponent, despite the reduction in the cost of borrowing, following the cut in SBPs policyrate. Loans to private sector businesses saw an expansion of only 3.5 percent in H1-FY12,compared with 8.4 percent during the first half of FY11. More importantly, fixed investmentloans during H1-FY12 saw a net retirement of Rs 8.5 billion, against an expansion of Rs 8.1billion last year. The low demand for fixed investment loans is largely due to persistentenergy shortages, the unfavorable law and order situation, and excess capacity in theindustrial sector.

Demand for working capital loans has also been low; these loans saw an expansionof Rs 99.5 billion during H1-FY12 compared to Rs 131.3 in H1-FY11. This was primarilydriven by: (1) the textile sector, which required less working capital as cotton prices fell, andthese units still carried forward healthy profits from FY11; and (2) the inability of sugar millsto offload their stocks from last year, which constricted seasonal demand for fresh loans. It ispertinent to note that the government had to intervene in the sugar market by purchasing

378,000 tons of sugar through TCP. This helped sugar mills retire some of their bankborrowings.While demand for credit was understandably low, significant government borrowing fromcommercial banks also ate into the supply of loan-able funds for the private sector. H1-FY12data indicates that government borrowing for budgetary support more than doubled,compared to the same period last year. Although the bulk of this borrowing (Rs 391.0 billion)was needed to partially settle the inter-agency receivables of PSEs in the energy sector, andthe payment of subsidies to procurement agencies (popularly known as circular debt), directborrowing for deficit financing was Rs 365.0 billion, which was higher than last yearsborrowing of Rs 308.5 billion.

Of greater concern is the composition of government borrowing, which has tilted

towards inflationary financing. Q2-FY12 data indicates that the government was unable tomeet its self-imposed quarterly limit of zero net budgetary borrowing from SBP. High


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frequency data shows that government borrowing from SBP picked up from Novemberonwards, and reached Rs 219.2 billion during Q2-FY12. This dependence on SBP financingwas because of the difficulties encountered in rolling over maturing T-bills in the month of

December 2011 a risk highlighted in SBPs Monetary Policy Statements and Annual andQuarterly Reports.

Data for consolidated fiscal operations indicates a deficit of 2.5 percent of GDP forH1-FY12 This deficit was slightly lower compared to the first half of FY11. The good news isthat this came primarily from the revenue side; FBR tax collections reached Rs 840.1 billionduring H1-FY12, showing a YoY growth of 27.1 percent. Moreover, SBP profits of Rs 104.0billion contributed significantly non-tax revenues. Nevertheless, it is important to note thatfinancing this contained fiscal deficit in H1-FY12 was challenging as compared to H1-FY11.As mentioned earlier, the burden of financing fell squarely on domestic sources, since theexpected external inflows did not materialize. Specifically, uncertainty about inflows from theCoalition Support Fund (CSF) and the Eurobond issuances still prevails.

The slowdown in foreign exchange inflows has also raised concerns about countrysbalance of payments. Specifically, Q2-FY12 data shows that the overall external accountdeficit has increased to US$ 1.0 billion compared to US$ 0.8 billion in the first quarter of theyear; this takes the H1-FY12 external deficit to US$ 1.8 billion. The composition of the BoPreveals that the current account deficit has widened to US$ 2.2 billion, against an almost nilbalance during H1-FY11.Within the current account, a positive was the growth in worker remittances, which reachedUS$ 6.3 billion during the first half of the year. Excluding remittances, all other componentsof the current account deteriorated during the period under review. The import bill increasedon account of higher international oil prices and the import of fertilizer. These two itemsalone accounted for 60 percent of the increase in imports during H1-FY12. On the otherhand, export growth has slowed to 3.9 percent compared to 18.9 percent during the first halfof the previous year.6 The deceleration was largely concentrated in Q2-FY12, as exportsactually fell on a YoY basis for all three months of that quarter. The fall was driven primarilyby a decline in quantum; this is an indication of domestic structural weaknesses, as unitvalues (prices) actually increased for most of the textile items.

Despite these weaknesses, the size of the current account deficit should not be amajor source of concern, given Pakistans history. The real challenge is financing the currentaccount deficit, as both debt and non-debt inflows have declined. Quarterly numbers indicatethat financial/capital accounts posted a deficit of US$ 0.4 billion during Q2-FY12, whichimplies that the overallexternal deficit had to be financed by drawing down foreign exchange

reserves. Hence, SBPs foreign exchange reserves saw a reduction of US$ 1.9 billion duringH1-FY12 to US$ 12.9 billion. This decline in reserves was accompanied by a depreciatingPak Rupee, which lost 4.4 percent of its value during the first half of the year.

1)Real SectorShaped by real sector developments, the export and import baskets also underwent somechanges. For instance, while manufactured goods exports declined (mainly led by textiles),agri-based food exports remained strong. Similarly, a decline in agriculture product importswas offset by higher demand for intermediate goods and machinery, particularly in Q2-FY12.Services trade balance also deteriorated in H1-FY12. Overall, net exports had a downwardpull on aggregate demand in H1-FY12.


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Agriculture Sector

Most of the major kharif crops (cotton, rice, sugarcane) have already been harvested andpreliminary estimates show strong performance by these crops.This improved performanceis commendable given that farmers faced multiple challenges during the crop season,including floods in the summer, sharp fall in prices of agri produce and increase in inputcosts.

Industry

Half-way into FY12, the industrial sector has been showing some improvement over theprevious year However, this performance must be qualified, as part of the growth in Q1-FY12 reflects the effect of a low base. As this base effect fadeout, large-scale manufacturingwith a share of 52.3 percent in overall industry) posted decline in October and November2011 before finally picking up in December.

Large-scale manufacturing

Large-scale manufacturing growth decelerated during the quarter, from 2.8percent YoY inQ1-FY12 to negative 1.0 percent in Q2-FY12. It was anticipated that the drivers of Q1growth export demand and favorable post-flood base effect would not help. However,further deterioration occurred on account of continuing gas shortages during the peak wintermonths, which constrained production in fertilizer, cotton weaving, and steel re-rolling. As aresult, only 46 percent of LSM subsectors showed positive YoY growth in Q2-FY12compared to 57 percent in Q1.On a cumulative basis, H1-FY12 growth stands at 0.8 percent

2)Inflation and Monetary PolicyThe government announcement of zero quarterly limits on its borrowing from SBP,projections of a relatively small current account deficit and the likelihood of average CPIinflation to remain close to the 12 percent target for FY12 at the beginning of the year,allowed the central bank to adopt an accommodative monetary policy during H1-FY12.

Developments in Monetary Aggregates

Changes in broad money supply and its major components during H1-FY12 were driven

primarily by the developments in the external accounts, government borrowing, and a one-off settlement of circular debt. Moreover, quarterly data indicates that the monetaryexpansion witnessed during H1-FY12 is entirely concentrated in the second quarter of theyear due to seasonal credit off-take and a revival in government borrowing from the SBP.

Inflation

Headline inflation fell to single digits in Dec-11 after almost two years This was undoubtedlypositive news for the economy. However, our analysis indicates that inflation fundamentalshave not changed much.


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3)Fiscal Policy and Public Debt Fiscal Policy

Although some degree of fiscal restraint was observed in the first half of the current fiscalyear with a budget deficit of 2.5 percent of GDP lower than that in H1-FY11, tougher fiscaldiscipline will still be needed in the second half to achieve the full year target. The target forFY12 budget deficit has been revised upward to 4.7 percent; however, it will be challengingto achieve.

Domestic & external debt

Pakistan public debt stock recorded a sharp increase in Q2-FY12, reaching Rs 12.0 trillion

by end December 2011 (Table 4.4). The surge in debt burden, during the second quarter,was the outcome of a one-off settlement of circular debt of power sector PSEs and publicprocurement agencies by the government.

4)External SectorQ2-FY12 data indicates further deterioration in external accounts with overall deficitwidening to US$ 1.0 billion compared to US$ 0.8 billion in Q1-FY12. It may be recalled thatagainst the deficit of US$ 1.8 billion in H1-FY12, the country had posted a surplus of almost

US$ 1.0 billion in H1-FY11.

Economys review of last three quarters

Economic Indicators Q4 2011 Q1 2012 Q2 2012

Growth rate (percent)

GDP (at factor cost) 2.4 - -

Agriculture 1.2 - -

Major crops -4.0 - -

Minor crops 4.8 - -

Live stock 3.7 - -

Industry -0.1 - -

LSM 1.0 2.1 0.8


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Services 4.1 - -

Export(fob) 28.1 7.6 3.9

Import(CIF) 14.7 20.2 18.9

Tax revenue (FBR) 12.2 29.7 27.1

CPI (12 months) 13.9 12.0 10.9

Private sector credit 3.3 2.5 6.2

Money supplyM2 13.7 2.3 5.7

Billion US dollar

Total liquid reserves 17.2 16.9 17.0

Home remittances 9.0 5.2 6.3

Net foreign

investment

1.4 0.3 0.4

Percent of GDP

Fiscal deficit 4.5 1.2 2.5

Trade deficit 5.8 2.7 3.3

Current account

deficit

0.3 0.9 0.9

Looking Forward

Developments during H1-FY12 indicate that risks to macroeconomic stability are stemmingfrom the external sector and the continued weaknesses on the fiscal side. In terms of thereal sector, there has been some improvement since the publication of SBPs AnnualReport in December 2011. The economy is still expected to grow in the range of 3 to 4percent. Inflationary outlook has improved slightly on account of supply side factors (food). Itis expected that FY12 inflation will fall within the range of 11.0 to 12.0 percent, with a biastowards the lower boundary.In spite the lower fiscal deficit during H1-FY12, containing the overall fiscal deficit to itsrevised target of 4.7 percent of GDP seems to be challenging. Quarterly data for previousyears has shown that the deficit remains relatively higher in the second half of the year. Theachievement of the revised fiscal deficit is dependent on the realization of: (1) the envisagedsurpluses from provincial governments, which are likely to be lower than expected;7 (2) the

non-tax revenues, which depends on inflows into the Coalition Support Fund, and theauction of 3G licenses;8 and (3) strict control over expenditures.


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The burden of financing this deficit will fall on the banking system, specifically on commercialbanks. Other than growing concerns about the supply of loan-able funds for the privatesector, renewed government borrowing from SBP entails rising inflationary expectations in

the economy.

On external front, although the current account deficit is expected to be in the range of 1.5 to2.5 percent of GDP, there is an upward bias to this prediction. Given the fall in financial andcapital inflows, funding this modest current account deficit could be challenging. Marketplayers are increasingly concerned about whether the envisaged foreign inflows willmaterialize in time. This, together with the scheduled repayment of IMF loans (US$ 1.1billion) during H2-FY12, may draw down SBPs foreign exchange reserves.

Documents

Last Three Quarterly Reports of SBP 2011-12