Pressure on reserve position, external balance to persist in ’12

Economic experts believe the country’s reserve position and external balance will be key determining factors going into ’12 as fiscal and monetary policies failed to stimulate the economy out of stagflation in the outgoing year. “Considering the rate of rupee decline, we expect a further 6-7 per cent depreciation in ’12, closing the year around the 95-96 level against the dollar,” according to Syed Sayem Ali, country economist for Pakistan and Middle East at Standard Chartered Bank. That, combined with the $4.5 billion debt repayment due this year, will pressure the reserve position, he adds.

Inflationary tendencies
A weakening rupee will feed into inflation. And even though CPI has just surprised market watchers by sneaking under 10 per cent presently, the decline will be temporary at best if the rupee fall is not controlled. Another critical factor is energy reliance on imported oil. “If oil prices rise, reserves will come under overwhelming pressure,” says Sayem. Sakina Husain, research analyst at Pakistan credit rating agency (pacra) and financial journalist, expects oil prices to remain stable. “Global demand is slow, and even the US was a net exporter last season, so I don’t expect price fluctuations,” she says. Weak recovery in the US, sovereign debt drama in Europe and slowdown in China are likely to keep oil price muted. But with increasing Iran-specific tension around the Straits of Hormuz, the possibility of an erratic oil price movement cannot be ruled out, even if it has not yet been priced in by currency and commodity markets. There is a notable element with regard to food inflation, though, notes Sakina. “Wheat shortage will push up prices to an extent, but otherwise the outlook seems stable enough”.

Money printing
The government has drawn considerable criticism due to unprecedented borrowing from central and scheduled banks. “One of the few bright spots in ’11 was an initial declining trend in government borrowing. It actually retired some borrowing to the central bank, hence the slight drop in inflation,” says Sayem. But it seems the borrowing binge is on again. According to mid-Dec data, central bank presses printed another Rs220 billion, risking subsequent rise in inflation. There is also news of political motivation to reduce the policy rate by another 100bps. “With foreign investment absent, government borrowing will put pressure on domestic liquidity,” according to Sakina.

Energy crisis
The energy sector is actually plagued by a financial crisis in the supply chain. The problem owes more to financial resources than energy availability. But with the government’s fiscal space constrained, there is little likelihood of sorting out the energy problem in ’12. Energy shortfall is blamed for lacklusture private sector performance in ’11. Yet with heavy government borrowing consistently crowding out the private sector from credit markets, chronic energy shortage only intensified the private sector dilemma. Banks, for their part, have had few problems with risk-free advances to the government. “Energy tariffs have increased more than 100 per cent in the fours years of the present government,” says Sayem, adding that the government’s projection of additional 30 per cent tariffs will mean reduced growth and output, lower exports, higher unemployment and declining real wages.

Security situation
While the security situation improved in the last year – fewer terrorist attacks and bomb blasts – rollback in military aid means security expenses will remain a big drain on the national exchequer. And considering intense pressure on the reserve situation, observers expect the government to revisit dynamics of the army operation in the tribal area. “There is a big question mark on continued military presence in the north,” notes Sayem. Realistically speaking, there are few viable alternatives. The government will need to keep spending, especially on social uplift and development projects in conflict zones like Swat, to keep violence from erupting again in future, he adds.
This means the practice of diverting development funds to non-development heads will continue.

Low earning/fiscal story
The government’s fiscal position will almost definitely remain unenviable. Tax reforms have not materialised, foreign aid has receded, the debt burden is mounting and Rs300-400 billion in annual PSE loss is going nowhere in election year. In absence of meaningful tax revenue generation, the other main earner, exports, is not much to write home about either.
“International cotton price is at its lowest in two years. With more than 50 per cent of the export basked comprising cotton and related products, export competitiveness is sure to suffer in ’12,” says Sakina.
Failing a game-changer, the ’12 narrative is unlikely to be much different from the preceding year. With earning low and expenditure rising, even minus exogenous shocks, swelling deficits will occupy minds of policy-makers and observers alike.