Despite the improvement in the macroeconomic indications in the first half of the current fiscal year, the central bank has kept the policy rate unchanged at six per cent.
In its monetary policy statement, the State Bank of Pakistan (SBP) said the inflationary environment stayed benign, LSM gained traction, and fiscal consolidation remained on track.
In addition, successful completion of ninth review under IMF’s EFF and disbursements from multilateral and bilateral sources added on to the country’s external buffers. With the pickup in private sector credit, for fixed investment in particular, along with improving security situation reflected strengthening of investor and consumer confidence, it added.
Average CPI inflation has declined to 2.1 per cent between July and December 2015, with perishable food items and motor fuel leading the way. Meanwhile, the trend in YoY CPI inflation has reversed; it rose for the third consecutive month to 3.2 per cent in December 2015.
Keeping in view the benign outlook of global commodity prices, expectation of a moderate pickup in domestic demand and further ease in supply side constraints, the SBP expects the average inflation in fiscal year 2015-16 to remain in the range three to four per cent. However, global oil price trends and excess domestic food stocks (wheat, rice, and sugar) may exert downward pressures on inflation.
Large-scale manufacturing (LSM) grew by 4.4 per cent during July-November FY 2016 as compared to 3.1 per cent in the same period last year. LSM mainly benefitted from monetary easing, falling international prices of key inputs, better energy situation, increased domestic demand for consumer durables, and expansion of construction activities.
There are challenges to the overall economic performance from the declines in the production of cotton and rice. However, a part of these losses could be offset by better performance of other crops, especially from the upcoming wheat crop. In view of these developments, real GDP is set to maintain the previous year’s growth momentum. The uptick in economic activity appears to continue beyond FY16 on the back of energy and infrastructure projects under China-Pakistan Economic Corridor (CPEC).
Pakistan’s overall balance of payment position continued to strengthen in H1-FY16. The external current account deficit narrowed down to almost half of the last year’s level on account of persistent decline in international oil price and steady growth in workers’ remittances. In the capital and financial accounts, besides strong official inflows, there is some improvement in foreign direct investment.
Given depressed outlook of international commodity prices, the external current account deficit is expected to remain lower than last year. With continuation of the IMF EFF and expected disbursements from other official sources, the surplus in capital and financial accounts may increase in the second half of FY16. These are expected to have favourable impact on foreign exchange reserves.
Furthermore, expected increase in FDI from China may help maintain an upward trajectory in foreign exchange reserves. Reversing of trends in exports, however, is dependent on external demand and cotton prices in international market. In addition, easing of domestic constraints with the completion of ongoing energy projects could help in improving export competitiveness.
Fiscal deficit was contained to 1.1 per cent of GDP during the first quarter of fiscal year 2016, compared to 1.2 per cent in the same period last year. This reduction, despite substantial increase in development expenditures during Q1-FY16, was due to improvement in tax revenues and containment of current expenditures. The improvement in fiscal accounts may continue in the remaining months of FY16. While additional tax measures announced in October 2015 are expected to contribute to growth in FBR revenues, current spending is likely to remain within target.
The year-on-year growth in broad money (M2) accelerated largely due to a substantial increase in Net Foreign Assets (NFA) of the banking system. The growth in Net Domestic Assets (NDA) of the banking system decelerated despite a pickup in private sector credit. On the liability side, deceleration in growth of deposits and acceleration in currency in circulation are source of concern.
The credit to private sector increased by Rs339.8 billion during H1-FY16 as compared to the Rs 224.5 billion in same period last year. The impact of monetary easing, improved financial conditions of the major corporate sector and better business environment encouraged firms to avail credit not only for working capital requirements, but also for fixed investments. Going forward, the improvements in LSM, expansion plans announced by major industries and favourable monetary conditions are expected to provide continued momentum in the demand for credit.
Some stress in liquidity noticed in Q1-FY16 due to increased government borrowing from the scheduled banks steadily eased in Q2-FY16 owing to improved revenue collection and timely receipt of foreign flows. Besides this, pressures in foreign exchange market also induced volatility in interbank liquidity requirements. This is also evident from movements in overnight repo rate which mostly remained slightly above the SBP target rate.
