The State Bank, at the very beginning of its annual report, says that “the FY18 ended with a mixed performance of the economy.” The growth momentum gained further strength as the economy achieved its 13-year highest real GDP growth of 5.8 percent in FY18 and inflation remained below the target for the fourth consecutive year. However, a sharp deceleration in revenue growth compared to expenditures and increased dependence on imports to meet growing domestic demand led to widening in the twin deficits to unsustainable levels. While the fiscal deficit was the highest during the last five years leading to faster accumulation in public debt, especially the external debt, the record current account deficit led to increased pressures on foreign exchange reserves and exchange rate.

The GDP growth in 2017-18 had some peculiar characteristics. It was broad-based in the sense that all the three major sectors showed robust performance and was supported by a host of factors, including low cost of financing, improved energy supplies, favourable business sentiments, fiscal incentives through subsidies and higher public spending and progress on CPEC-related projects. However, strong domestic demand also played a key role in pushing up growth. CPI inflation was below the annual target for the fourth consecutive year during FY18 and clocked in at its second lowest level since FY03. Prices were up by 3.9 percent in FY18 compared to 4.2 percent last year.

The SBP policy rate was increased by a cumulative 75 basis points during the year, after keeping it unchanged for the last two years. The main factors leading to this reversal in the policy rate included growing macroeconomic imbalances, impact of exchange rate depreciation on inflation, insufficient financial inflows, sharp increase in global oil prices and higher-than-expected fiscal gap. Budgetary borrowings from the banking system remained elevated during FY18. Not only did the government rely on SBP financing and borrowed about Rs 2.2 trillion in Q3-FY18 alone, it also breached the “zero quarterly borrowing” limit as prescribed under the SBP Act.

On the other hand, fiscal accounts continued to deteriorate for the second consecutive year. Fiscal deficit rose to 6.6 percent of GDP during FY18, surpassing both the 4.1 percent target for the year and 5.8 percent during the previous year. Compared to an 8.8 percent increase in FY17, public debt increased by 16.5 percent during FY18. The gross public debt also rose to 72.5 percent of GDP at the end of June 2018 from 67.0 percent at the close of FY17, remaining significantly higher than the 60 percent limit envisaged in the Fiscal Responsibility and Debt Limitation Act, 2005.

Despite an increase in exports and modest recovery in remittances, the current account (C/A) deficit rose to a historic high of dollar 18.1 billion during FY18. Financial inflows were insufficient to finance this deficit. As a result, foreign exchange reserves held by the SBP dropped by dollar 6.4 billion during the year, reaching dollar 9.8 billion by the end of June, 2018 and leading to depreciation of the rupee by 13.7 percent during the year.

SBP’s the outlook for FY19 is that some of the recent policy measures like monetary tightening, exchange rate depreciation, regulatory duties on imports and a cut in development spending are likely to dampen domestic demand and contain fiscal deficit. These developments would also have implications for inflation and growth going forward. According to the SBP, the GDP growth target of 6.2 percent for FY19 appears ambitious and it may fall in the range of 4.7 to 5.2 percent.

Keeping in view a variety of measures and developments, the C/A deficit was projected in the range of 5 to 6 percent of GDP as compared to 5.8 percent in FY18. The administrative revenue measures, increase in the regulatory and federal excise duties, a reduction in development spending and austerity measures are expected to contain the fiscal deficit in the range of 5 to 6 percent of GDP during FY19. The overall assessment suggests that underlying inflationary pressures may persist and average inflation may be expected in the range of 6.5 to 7.5 percent as against 3.9 percent last year and the target of 6.0 percent for the current year.

The tone and tenor of the SBP’s annual report show a touch of optimism. It states that the economy showed a mixed performance though almost all the indicators except real GDP growth rate had shown a deteriorating trend during the year. The GDP growth rate was also not induced by some government policies but largely came on the back of record contribution from crops and livestock sub-sectors due to favourable weather conditions, CPEC projects and a strong domestic demand which may prove to be temporary. Moreover, the growth spurt during FY18 was also consumption-driven and not investment-driven which suggests that this level of growth may not be sustainable.

Similarly, although the average inflation during the year was quite low, there were ample indications that inflation in the latter part of the year had shown a considerable increase. For instance, core inflation had reached a peak of 7.1 percent in June, 2018 – the highest level since 2014 and underlying inflationary pressures were worsening. Increase in gas tariffs, import duties and excise duties plus pass-through of higher international oil prices, exchange rate depreciation and the likely increase in electricity tariffs are some of the factors which are sure to raise the rate of inflation quite substantially.

The report states quite clearly that there is a need to increase saving and investment to sustain growth. The fiscal deficit was targeted at 4.9 percent of GDP but it was very hard to achieve. The current account deficit target of 4.0 percent, given the developments so far in the external sector during FY19, is not going to materialise. The developments on the external and domestic debts were simply shocking. Compared to an 8.8 percent increase in FY17, public debt grew by 16.5 percent during FY18. The gross public debt to GDP is now much higher than envisaged in the FRDL Act, 2005 which means that the government does not feel bound by the constraints of this law and it may take a number of years, even decades, if we want to observe the limitations of this Act in letter and spirit. More worrying was the fact that more than half the increase in public debt during FY18 was contributed by external debt and we are not in a position to retire this debt easily.