Country Report: Pakistan

Economist Intelligence Unit: June 2008

 

 

Executive Summary

 

High Lights

 

Outlook for 2008-09

 

Political Outlook

 

  • Political stability is likely to worsen in 2008 as cracks in governing coalition deepen and as elements of civil society become more involved in political battles.
  • The Government remains focused for the moment on political problems despite a rapidly worsening economy. It has promise to restore the Supreme Court Judges last November by the President, Pervez Musharraf.
  • The increase in political and security risk may begin to have a strongly negative effect on foreign investment inflows. The economy is also likely to suffer from a lack of effective policymaking, owing to political strife.
  • PML (N) repeatedly called for Mr Musharraf to resign as President.
  • PPP has adopted a more flexible approach and may be open to work with the party PML-Q that supports President Musharraf.
  • ANP looking to have Pashtun identity and working to reduce feelings of alienation with in the tribal areas through non-military means.

 

International Relations:

 

  • US Missile attack on Pak Afghan border could lead to an outright escalation of violence. It was termed as naked aggression.

 

Economic Out look

 

  • The fiscal 2008/09 (July/June) budget, released on June 11th, seeks to reduce the growing fiscal deficit by raising taxes and easing subsidies on food and fuel. The latter move will aggravate inflationary pressures, however.
  • The Economist Intelligence Unit has raised its forecast for consumer price inflation. The inflation to average 11.8% a year in 2008-09 up from 9.3% previously is expected.
  • The real GDP growth (by expenditure) in 2007/08 will rise from 3.6% to 4.6%. Accelerating price rises will depress real wages and thus consumer spending.
  • Government consumption will reduce to 5.3% in 2008-09
  • Budget deficit to fall to 4.7% of GDP.
  • Inflation in 2008 will go to 15.6% and 8.1% in 2009.
  • Inflows of foreign investment and remittances from Pakistanis working overseas will mitigate the currency’s weaknesses.

 

 

 

 

 

Monthly Review

 

  • In mid-May the Pakistan Muslim League (Nawaz) withdrew its ministers from the cabinet because of a disagreement with the other major party in the coalition government, the Pakistan’s Peoples Party.
  • The government unveiled a package of proposed constitutional changes in late May. The amendments seek to clip the powers of the President but need a minimum two-thirds majority in parliament to be adopted.
  • The government signed a peace deal with a militant Islamic group operating in FATA in late May. But terrorist attacks continued in early June, when a bomb exploded in the capital, Islamabad.
  • The support price for wheat rose from PRs 510 (US$8.40) per 40 kg rose to Rs 625. Government has also allocated PRs 75bn to improve access to water by constructing dams and rehabilitating irrigation channels.
  • Economic growth slows to an estimated 5.8% in 2007/08.
  • Inflation shows no sign of slowing.
  • Real GDP growth (at factor cost) slowed to an estimated 5.8% in 2007/08, down from 7% in 2006/07 and well short of the target of 7.2%. The agricultural and manufacturing sectors contributed heavily to the slow down.
  • Consumer price inflation accelerated to 17.2% year on year in April, driven by food price rises of 25.5%. In addition to high global commodities prices, domestic production problems are stoking food price inflation.

Deutsche Bank “Asia Economic Special”

Pakistan Trip Notes

By Dr. Taimur Baig

1st July 2008

  • Reserves remain under sever pressure as import demand is yet to taper off, while inflows are not sufficient to prevent further depletion. Some FDI and official inflows have materialized in recent weeks, and some more are likely in the coming months. The timing and magnitude of these flows however is uncertain. Taking into account forward liabilities, usable reserves are below three months of imports or six months of balance of payments support. This is clearly worrisome.
  • Inflation shows no sign of letting up, and would go well over 20% yoy in the coming months as the fuel price hikes work through the economy. Monetary policy needs to be tightened substantially more.
  • In order to reduce the subsidy bill, between March 1 and June 30, petroleum and diesel prices have been raised by 37% and 51% respectively.
  • Gas and electricity tariffs have been increased too. However, diesel prices, accounting for the vast majority of the subsidy bill, need to rise by another 40% to reach a level consistent with the budget, a very difficult proposition. The budget is therefore subject to implementation risk of this measure. Also, with economy weakening due to an environment of policy tightening, the goal of increasing tax revenue collection by 25% this FY seems tenuous at best.
  • The central scenario remains one of muddle though, with partial fuel price adjustment, accelerated disbursement of official flows, and some additional monetary tightening combining to avert an outright crisis. But the chance of a worse, disorderly outcome is non-trivial and rising.

 

Present Situation

  • Inflation reached close to 20% yoy in May, with food price inflation at 28.5% yoy.
  • Weekly price indicator suggests no sign of food prices moderating.
  • With recently implemented fuel, energy and gas prices increases, inflation would exceed 20% in June and could head towards 25% in the coming months.
  • There is a strong likelihood of a wage-price spiral, exacerbated by the fact there is hardly any slack left in the economy.
  • The SB has raised its policy rate by 200bps this year, but the real interest rate is around negative 8%.
  • The govt aims to reduce the subsidy bill sharply bill sharply in FY09 through price adjustments. It is estimated that about 40% increase in diesel prices would be required at the beginning of the FY09 to achieve this goal.
  • There are more upside risks to the spending side, due to generous wage hikes and development projects program in the budget.
  • The current account deficit is likely to exceed 8% of GDP in FY08. This is being driven by a persistently wide trade deficit, exceeding USD 1bn a month.
  • Reserve have declined by USD5.5bn since October 2007.
  • Now Net reserve are below USD8bn.
  • The exchange rate depreciated sharply in April/May as ceased intervening.
  • The credit default spread on Pakistan’ s sovereign debt is now at over 600bps, higher than the level reached in the aftermath of the Bhutto assassination in December.
  • There are a number of stress point: the external borrowing environment will likely be unfavorable during the course of the year, putting the burden of external financing on official flows; tighter monetary conditions may lead to a pickup in loan defaults and affect bank performance demand.
  • Corporate portfolios could be adversely impacted by the sharp decline in equity markets.
  • The probability that adequate measures are taken to ensure sustainability is no more than 20%. While there is general recognition of the severity of the ongoing situation among the government officials, the political leadership remains preoccupied with intra-coalition struggle and worsening security situation.