‘Half way into FY12, the economy is showing signs of a modest improvement. Preliminary data indicates that the commodity producing sector, especially agriculture, is doing better than expected. Services also seem well-placed to gain from robust retail trade activities; transportation; and increased profitability of the banking sector,’ says State Bank’s Second Quarterly Report for the fiscal year 2011-12 on the State of the Economy released here on Tuesday.
The report, which covers the period from July to December FY12, said the ample availability of key staple crops and less than anticipated supply disruptions due to floods, played a key role in containing inflationary pressures during the period under review.
However, it pointed out that despite these positive developments, risks to macro-economic stability have, nevertheless, increased. ‘Specifically, the position of the external sector weakened at a rate faster than expected; and the fall in financial and capital inflows exerted pressure both on SBP’s foreign exchange reserves and on the Pak Rupee,’ it said, adding that this, along with the pickup in government borrowing from SBP, complicated liquidity management. Finally, energy shortages continued to plague production activities, especially in the industrial sector, it added.
‘Developments during H1-FY12 indicate that risks to macroeconomic stability are stemming from the external sector and the continued weaknesses on the fiscal side,’ it said and added that in terms of the real sector, there has been some improvement since the publication of SBP’s Annual Report in December 2011.
‘The economy is still expected to grow in the range of 3 to 4 percent. Inflationary outlook has improved slightly on account of supply side factors (food). It is expected that FY12 inflation will fall within the range of 11.0 to 12.0 percent, with a bias towards the lower boundary,’ the report added.
According to the report, the burden of financing this deficit will fall on the banking system, specifically on commercial banks. Other than growing concerns about the supply of loan-able funds for the private sector, renewed government borrowing from SBP entails rising inflationary expectations in the economy, it said, adding that on external front, although the current account deficit is expected to be in the range of 1.5 to 2.5 percent of GDP, there is an upward bias to this prediction.
‘Given the fall in financial and capital inflows, funding this modest current account deficit could be challenging. Market players are increasingly concerned about whether the envisaged foreign inflows will materialise in time. This, together with the scheduled repayment of IMF loans (US$ 1.1 billion) during H2-FY12, may draw down SBP’s foreign exchange reserves,’ the report added.
It said that within the commodity producing sectors, major kharif crops are likely to achieve their target growth for FY12.
The improvement in the production of minor crops and the ample availability of key staple crops has eased inflationary pressures in the food group during H1-FY12, it said, adding that this was primarily responsible for bringing YoY CPI inflation down to single digit (9.7 percent) in December 2011 – at that level for the first time since October 2009.
The report said that within aggregate demand, there has been almost no improvement in the investment component, despite the reduction in the cost of borrowing, following the cut in SBP’s policy rate. ‘Loans to private sector businesses saw an expansion of only 3.5 percent in H1-FY12, compared with 8.4 percent during the first half of FY11.
More importantly, fixed investment loans during H1-FY12 saw a net retirement of Rs 8.5 billion, against an expansion of Rs 8.1 billion last year,’ it said, adding that the low demand for fixed investment loans is largely due to persistent energy shortages, the unfavorable law and order situation, and excess capacity in the industrial sector.
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