Pakistan achieves high growth rate of 5.8 pc in FY18

KARACHI: State Bank of Pakistan has decided to increase the policy rate by 100 bps to 7.50 percent effective from 16 July 2018. The decision was made to curb aggregate demand and ensure near-term stability, said Governor State Bank of Pakistan (SBP) Tariq Bajwa announcing Monetary Policy here on Saturday.

Pakistan has achieved a 13- year high growth rate of 5.8 percent in FY18 and the average CPI inflation was well below the 6.0 percent target, he said.

However, moving forward, the challenges to Pakistan''s economy have further accentuated, First, the provisional SBP estimate for fiscal deficit in FY18 is 6.8 percent as opposed to 5.5 percent estimated in May 2018. The current account deficit has also increased to $ 16.0 billion during Jul-May FY18 as opposed to $ 11.1 billion in the corresponding period last year.

This means that aggregate demand has proved to be higher than previously thought, he said.

Second, June (YoY) inflation clocked in at 5.2 percent, and the average headline inflation for FY19 is expected to cross the 6.0 percent annual target.

Core inflation numbers and their one-year ahead projections ataround 7.0 percent also reflect demand pressures.

Third, on the external front, though both exports and workers''remittances are performing better, the sheer size of imports continues to pressurize FX reserves.

The real economic activity repeated its strong FY17 performance.

However, towards the end of FY18, some challenges cast shadows onthe capacity of the real sector to continue treading this high growthpath.

In the agriculture sector, the most important concern is shortageof water, which is likely to constrain agriculture production belowthe target in FY19. The manufacturing sector is also poised to show a mixed pictureowing to high base-effect, the on-going monetary tightening and somesector specific issues whereas construction allied industries arelikely to perform at par.

Taking stock of these developments and the spillover on theservices sector, SBP projects FY19 GDP growth to be around 5.5 percentas compared to the annual target of 6.2 percent.

Turning to CPI, the average headline inflation for FY18 stands at3.9 percent.

However, this picture is changing rapidly as is visible fromrising (YoY) headline and core inflation for June 2018 at 5.2 and 7.1percent, respectively.

Based on these recent estimates, SBP’s model-based range for average CPI inflation is 6.0–7.0 percent for FY19. This assessment relies on: (i) higher fiscal deficit; (ii) food inflation reverting to its normal behavior; (iii) unfavorable trend in international oil prices; (iv) lagged pass-through of rupee depreciation; and (v) high survey-based measures of inflation expectations captured by July 2018 edition of IBA-SBP''s Consumer Confidence Survey.

Monetary expansion in FY18 has been driven by government borrowing for budgetary support and healthy growth in credit to the private sector.

Despite some slowdown in fixed investment and particular issuesof the sugar and fertilizer sectors, stock of private sector borrowingincreased by Rs.

768 billion in FY18 which translates into a growth of14.8 percent.

In FY19, private sector credit is expected to increase by almostthe same amount at a growth rate of about 13.0 percent.

This will be driven primarily by the rise in need for workingcapital at the back of gestation of lagged fixed investment intoproduction and rising exports.

The expansionary impact of net domestic assets (NDA) on broadmoney supply has been partially neutralized by net contraction inforeign assets of the banking sector.

NFA saw a net contraction of Rs. 793 billion i.e.a negative impact of 5.4 percentage points on broad money growth during FY18. As a result, broad money supply saw a net expansion of 10.6 percent during FY18 as compared to 13.7 percent during FY17. Going forward the opposing direction of NFA from its NDA counterpart can keep broad money growth low in FY19. The current account deficit deteriorated to $ 16.0 billion during the first eleven months of FY18, which is 1.4 times over the same period last year.

A favorable impact of a strong recovery in exports (YoY growth of13.2 percent in Jul-May FY18) and increase in workers'' remittances(3.0 percent in Jul-May FY18) was more than offset by growing imports.

Specifically, strong demand for productive imports (metal,transport, machinery and petroleum) to support higher economicactivity and a sharp increase in international oil prices have pushedthe current account deficit to levels not sustainable beyond the shortterm.

In the absence of matching financial flows, a notable portion ofthis higher current account deficit was financed by using thecountry''s own resources.

As a result, SBP’s liquid FX reserveswitnessed a net reduction of US$ 6.7 billion to reach US$ 9.5 billionas of July 6, 2018. These developments suggest that the near-termmanagement of the country’s external accounts is of criticalimportance.

Debating at length, the Monetary Policy Committee noted that the following factors are contributing to evolving economic challenges:(i) the multiplier-effect of a strong fiscal expansion during the second half of FY18 is likely to offset the contractionary impact of monetary tightening in the recent months on domestic demand; (ii)higher international oil prices have continued to inflate the import bill; (iii) rising inflation projections and the ensuing fall in real interest rates; and (iv) a notable reduction in PKR and US interest rate differential.