Economic Ac­tiv­ity Shows Growth

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Re­cent gains in con­fi­dence in the econ­omy, backed by im­prove­ment in key in­di­ca­tors, need to be nur­tured to en­sure their sus­tain­abil­ity. For in­stance, the av­er­age CPI in­fla­tion has re­mained in sin­gle digit dur­ing FY14 and pol­icy vig­i­lance is required for this trend to con­tinue. Economic ac­tiv­ity has im­proved and fur­ther re­forms, es­pe­cially in the en­ergy sec­tor, would help con­sol­i­date the mo­men­tum.

Sim­i­larly, im­prove­ment in pro­duc­tiv­ity and com­pet­i­tive­ness is a must to con­tinue to build for­eign ex­change re­serves in the medium term while meet­ing ex­ter­nal obli­ga­tions.

The year- on- year CPI in­fla­tion has re­mained volatile dur­ing FY14. It in­creased sharply till Novem­ber 2013 then de­clined for few months be­fore in­creas­ing again to 9.2 per­cent in April 2014. The av­er­age CPI in­fla­tion for July- April, FY14 is 8.7 per­cent; higher than the year’s tar­get of 8 per­cent. The main rea­son for this volatil­ity is un­ex­pected move­ments in food prices and changes in ad­min­is­tered prices. The core in­fla­tion, how­ever, has re­mained quite sta­ble at around 8 per­cent over the past 12 months. Im­por­tantly, from the point of view of mon­e­tary pol­icy, it is the out­look of in­fla­tion that mat­ters.

The SBP ex­pects av­er­age CPI in­fla­tion to re­main around 8 per­cent dur­ing FY15, bar­ring any ex­oge­nous shock. Ba­sic fac­tors sup­port­ing this as­sess­ment are: ( i) moder­ate ag­gre­gate de­mand; ( ii) de­cel­er­a­tion in broad money growth led by con­tained gov­ern­ment bud­getary bor­row­ings from the bank­ing sys­tem; ( iii) ex­pec­ta­tions of low in­fla­tion­ary pres­sures as in­di­cated by SBP- IBA con­sumer con­fi­dence sur­vey; and ( iv) sta­ble out­look of in­ter­na­tional com­mod­ity prices.

In­di­ca­tors of cur­rent economic ac­tiv­ity are look­ing bet­ter as well. Pro­vi­sional es­ti­mates of real GDP show a growth of 4.1 per­cent for FY14. En­cour­ag­ingly, this growth has been led by a 5.8 per­cent in­crease in the in­dus­trial sec­tor out­put. Ex­am­i­na­tion of pri­vate credit data also points in the di­rec­tion of im­proved economic ac­tiv­ity. For in­stance, the flow of net credit to pri­vate sec­tor was al­most two and a half times more dur­ing the first nine months of cur­rent fis­cal year com­pared to the cor­re­spond­ing pe­riod of last year. Sim­i­larly, the monthly av­er­age gross credit dis­burse­ments, ar­guably a bet­ter gauge of the nexus between credit and pro­duc­tion, dur­ing the same pe­riod are about Rs150 bil­lion higher this year.

Th­ese trends show that in­ter­est rate is only one fac­tor in af­fect­ing economic ac­tiv­ity. It is the im­prove­ment in sen­ti­ments, rel­a­tively bet­ter avail­abil­ity of en­ergy, and re­duc­tion in gov­ern­ment bor­row­ing from the bank­ing sys­tem that has en­cour­aged the pri­vate sec­tor. The con­tin­u­a­tion of th­ese trends, how­ever, would re­quire a sus­tained ef­fort to ease im­ped­i­ments to growth through im­ple­men­ta­tion of nec­es­sary re­forms. In par­tic­u­lar, re­forms in the en­ergy sec­tor can go a long way in in­creas­ing pro­duc­tiv­ity, eas­ing the fis­cal bur­den, and re­duc­ing the im­port bill.

Be­cause of the gap between im­ports and ex­ports, the trade deficit re­mains at an el­e­vated level of $ 12.2 bil­lion dur­ing July- March, FY14. Also, the Real Effective Ex­change Rate ( REER) has ap­pre­ci­ated by 8.0 per­cent in Q3- FY14 and its po­ten­tial im­pact on the trade bal­ance needs to be mon­i­tored care­fully go­ing for­ward. Nev­er­the­less, mainly due to ro­bust growth in worker’s re­mit­tances, the ex­ter­nal cur­rent ac­count deficit, at $ 2.3 bil­lion, seems quite man­age­able at this point in time. This is be­cause the cap­i­tal and fi­nan­cial ac­count net flows have also im­proved to $ 2.2 bil­lion, con­sid­er­ably eas­ing the pres­sure on the bal­ance of pay­ments po­si­tion. In fact, the SBP was able to meet the IMF’s ad­justed Net In­ter­na­tional

Af­ter in­clud­ing the bet­ter- thanpro­jected in­flows from the is­suance of Euro bonds of $ 2 bil­lion and other in­flows from mul­ti­lat­eral sources in April and early May 2014, the SBP’s for­eign ex­change re­serves have in­creased to $ 8.0 bil­lion by 9th May 2014 from $ 5.4 bil­lion at end- March 2014. This marked im­prove­ment in re­serves and the con­se­quent sta­bil­ity in the for­eign ex­change mar­ket is the main in­di­ca­tor of im­proved sen­ti­ments in and about the econ­omy. In turn, th­ese sen­ti­ments could help in at­tract­ing more fi­nan­cial in­flows and thus lead to fur­ther in­creases in re­serves. The SBP also re­mains com­mit­ted to play its role in en­sur­ing fur­ther ac­cu­mu­la­tion of re­serves to achieve ad­e­quate lev­els in the medium term.

De­spite a short­fall in tax col­lec­tion com­pared to the bud­geted tar­get, the gov­ern­ment has been able to con­tain the fis­cal deficit at 3.1 per­cent dur­ing July- March, FY14. Con­se­quently, gov­ern­ment bor­row­ing for bud­getary sup­port from the bank­ing sys­tem has come down to Rs276 bil­lion dur­ing 1st July – 2nd

May, FY14 com­pared to Rs1021 bil­lion dur­ing the cor­re­spond­ing pe­riod of last year. In par­tic­u­lar, gov­ern­ment bor­row­ing from SBP shows a net re­tire­ment of Rs287 bil­lion as com­pared to an in­crease of Rs393 bil­lion last year. More­over, the gov­ern­ment was also able to keep its bor­row­ings from SBP be­low the IMF tar­get for end- March 2014.

Based on a bal­anced as­sess­ment of th­ese con­sid­er­a­tions, the SBP’s Board of Di­rec­tors has de­cided to main­tain the pol­icy rate at 10 per­cent.

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