In its third quarterly report for FY18, the State Bank has undertaken a comprehensive review of Pakistan’s economy, focusing particularly on challenges now facing the country. The SBP report presents a mixed picture of the economy at the end of March, 2018. The real GDP growth was estimated at a 13 year high of 5.8 percent in FY18, along with a benign inflationary environment.

However, according to the report, continued deterioration in the external balance and high fiscal deficit remains a source of concern. A higher GDP growth was achieved on the back of strong performances by the agriculture and services sectors, both of which grew at, or above, their targets. Rising global commodity prices and strong domestic demand played a key role in determining the trend of domestic prices during July-March, FY18. However, their impact was more than offset by a decline in food prices and the headline inflation remained somewhat lower at 3.8 percent compared to 4.0 percent in the corresponding period of last year.

A sharp increase in expenditures and a slower growth in revenues resulted in the fiscal deficit rising to 4. 3 percent of GDP during July-March, FY18, compared to 3.9 percent in the corresponding period of last year. The slowdown in revenue collection was primarily due to direct taxes while acceleration in growth of expenditures was led by provincial spending, with both current and development expenditures rising sharply.

The report has underlined the fact that higher fiscal deficit was largely financed through borrowings from SBP and external sources. In case of external finance, the government relied heavily on commercial loans and sovereign bonds. The revaluation losses caused by the depreciation of the rupee also added significantly to the external debt. With these developments, gross public debt rose by Rs.2.7 trillion during July-March, FY18, to reach Rs.24.1 trillion by the end of March, 2018. Within gross public debt, government debt increased by Rs.2.4 trillion to reach Rs.22.0 trillion as of end-March, 2018. External sector remained under pressure despite some recovery in exports and home remittances. Increase in global oil prices, together with higher machinery and transport imports, exacerbated the trade balance. This led to the highest current account deficit of dollar 12.1 billion the country has seen during July-March of a fiscal year.

In the larger economic context, it is relevant to note here that the government has set a 6.2 percent real GDP growth target for FY19 but the ongoing dry spell and water shortages may adversely impact the value addition potential of the agriculture sector. The growing external vulnerability and high fiscal deficit will continue to pose major risks to the achievement of this target. Several factors may help keep inflation around the target of 6 percent set for FY19. The government has set fiscal deficit target at 4.9 percent of GDP but this target appears challenging. On the external side, a higher C/A deficit together with limited financial flows would continue to keep the balance of payments (BoP) under pressure.

While highlighting the risks and challenges faced by the economy, the State Bank report has pointed out that the most welcome developments during July-March, 2018 were the real GDP growth estimated at a 13 year high of 5.8 percent and low inflationary environment largely owing to a decline in food component. These achievements would not only increase employment opportunities but would also help raise the standard of living of ordinary people who spend a large part of their incomes on food.

However, it is doubtful whether the targets fixed for FY19 are likely to be achieved. While CPEC spending and improvement in power supply are reassuring factors for accelerating growth, water shortages and political uncertainty could adversely impact the agriculture sector which has close linkages with other sectors. On the other hand, price pressures have remained largely under control but high domestic demand, lagged impact of adjustment in energy prices and a substantial depreciation of the rupee may contribute to higher inflation in the near future.

A matter of serious concern in this regard is the rising fiscal deficit and the widening CA deficit. The fiscal deficit has already risen to 4.3 percent of GDP till the end of March, 2018, as against the full year target of 4.1 percent. The improvement in primary balance could not be sustained further, signifying that the non-interest expenditures grew at a fast rate. The disturbing aspect is that provincial governments, as usual, could not generate budget surpluses to reduce the overall budget deficit. Instead, they revved up the pace of development expenditures to fast track completion of the ongoing projects for political mileage before the term of the current assemblies came to an end.

The severest challenge to the economy continues to be the massive deficit in the external sector of the economy. Foreign exchange reserves of the country have dwindled to barely finance two months of imports. The prospects for FY19 are also not bright. Although exports are expected to pick up pace, the import bill is likely to stay high owing to a notable increase in international commodity prices, especially of oil.

The projection is that FDI inflows are expected to remain lower in FY19 while the situation in the Middle East and the substitution of domestic labour in place of expatriates may tend to affect the overall level of home remittances. A large fiscal deficit and excessive widening of CA deficit are leading to a considerable accumulation of public debt. Such a state of affairs, if continued over a long term period, would increase the debt servicing cost sharply, reduce the available resources for development spending and mortgage the future of coming generations.