TOPIC:

OVERVIEW OF PREVIOUS 3 QUARTERLY REPORTS ON ECONOMY ISSUED BY SBP

SUBMITTED TO SIR ASAD IJAZ SHIEKH SUBMITTED BY MEHWISH BATOOL NAVEEN SABA AROOSH MEHMOOD M10MBA009 M10MBA010 M10MBA026

HAILEY COLLEGE OF BANKING & FINANCE

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TABLE OF CONTENTS
Acknowledgement.. Overview of First Report o o o o o Real Sector Inflation & Monetary Policy Money and Credit Fiscal Development.. External Sector..
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7 8
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Overview of 2nd Report o o o o Real Sector Inflation And Monetary Policy. Fiscal Policy And Public Debt.. External Sector.
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Overview of 3rd Report o o o o Real Sector Inflation And Monetary Policy. Fiscal Policy And Public Debt.. External Sector..
13 14 15 15 16

Looking Forward..

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ACKNOWLEDGEMENT
First and foremost, we thank to ALLAH ALMIGHTY for his countless blessings and then we would like to thank to our professor SIR ASAD IJAZ SHIEKH for the valuable guidance and advice. He inspired us greatly to work in this project. His willingness to motivate us contributed tremendously to our project. Finally, an honorable mention goes to our families and friends for their understandings and supports on us in completing this project. Without helps of the particular that mentioned above, we would face many difficulties while doing this assignment.

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The analysis in this report is confined to the last three quarterly reports of SBP. OVERVIEW OF LAST QUARTER OF 2011
Provisional estimates put forward by the National Income Accounts Committee show GDP growth at 2.4 percent for FY11, lower than the growth of 3.8 percent in the previous year. In the context of the prevailing security concerns, the exogenous shock from rising oil prices and the impact of the unprecedented floods, this decline is broadly in line with SBPs expectations. On a positive note, the post flood recovery in wheat, sugarcane and minor crops helped agricultural growth surpass previous years level. However, rural incomes may not rise proportionately due to lower market prices of wheat and rising input costs (e.g. diesel and fertilizer). In the manufacturing sector, demand for products, particularly textiles, autos; fertilizer, cement, and POL remained strong. Nevertheless, despite this strong demand, supply constraints particularly the shortfall in energy created production bottlenecks, which led to a significant slowdown in industrial growth. In our view, the growth outlook will be shaped by policy responses to several key domestic challenges: i. energy shortages, which are restricting growth; ii. The high fiscal deficit thats financing has become difficult partly owing to the backlog arising from the non- recognition of power sector subsidies of earlier years as reflected in the circular debt; iii. Build-up of domestic debt, raising concerns for macro stability; iv. Inflationary pressures which are not receding readily. The subsequent discussion will elaborate these challenges. i. The growing energy shortages:

In the energy sector, gas supply constraints have become more binding and this Shortage is affecting broader economic growth. For example, textile units Generally rely on natural gas not only for power generation but also for Production. Fertilizer output and power generation have been affected by gas-load Management in particular and the resulting power shortages have created Production constraints in several industries. ii. A rising fiscal deficit:

The government is facing difficulties in containing the fiscal deficit. Information available upto March 2011 puts the budget deficit at 4.5 percent of GDP, slightly higher than the deficit of 4.3 % in the corresponding period of the previous year. The sectors experiencing growth still remain either outside the tax net or are lightly taxed (e.g. agriculture and services).Although revenue growth has been weak for most of the year, additional measures were introduced in the fourth quarter. The government has also managed to contain spending showing its commitment to pursue prudent macroeconomic policies, although much of the burden has been borne by development expenditures. In addition, a reduction in power sector subsidies has been pledged in an effort to resolve problems in the energy sector. Furthermore, FBR is making efforts to improve tax compliance.

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iii.

Implications for domestic debt:

The impact of the widening fiscal deficit is clearly visible in the sharply rising domestic debt. Outstanding government domestic debt reached Rs 5,594 billion(31.8 percent of estimated GDP) which is more than double the stock at end-June 2007. This sharp growth in debt stock is fueling concerns about macro stability and monetary management.In addition, the maturity profile of domestic debt reveals that the government has to rollover the entire stock of Rs 2,854 billion of short term debt at least once a year. Any surge in credit demand from other sectors of the economy could elevate rollover risk,3 and could also expose the government to interest rate risk. iv. Stubborn inflationary pressures:

Fiscal discipline and restrictions on government borrowing from SBP are necessary to contain inflationary expectations, which we believe have become ingrained in recent months. In overall terms, although the post-flood hike in CPI inflation has largely dissipated, inflation is stubborn, in excess of 13 percent.Possible reasons could include: (a) the lagged impact of government borrowings from SBP during Jul-Sep 2010; (b) frequent upward adjustments in utility and POL prices;5 (c) increase in commodity prices; and (d) the rising trend in the house rent index (HRI). Outlook For agriculture, we are optimistic about the next cotton crop for several reasons: a) higher cotton prices during FY10 encouraged farmers to increase acreage for the next crop; b) there is a shift towards more productive (and disease resistive) BT cotton seeds; and c) water availability is expected to improve over last year. Rising fertilizer prices are the key downside risk at the moment.

1) Real Sector
Real GDP Growth
FY11 proved to be another difficult year for Pakistans economy. Against the target of 4.5 percent, the country could post a growth of 2.4 percent this was even weaker than the 3.9 percent achieved in FY10.A slowdown in growth was anticipated since the country had suffered severe losses due to the devastation caused by the unprecedented floods in August 2010.In addition to major kharif crops, the allied industries, trading services, and export sectors were adversely affected. Furthermore, logistics, power infrastructure, and many industrial units were also damaged.

Agriculture Sector
The agriculture sector posted a strong recovery after the devastating impact of the floods in early FY11. This recovery was mainly led by the livestock sub-sector,followed by minor crops and some major crops (sugarcane and wheat).Notwithstanding the significant losses caused by the floods, growth in the livestock subsector was sufficient to provide much need

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edimpetus to agriculture growth. In the case of minor crops, some recovery was expected after the flood as farmers focused more on minor crops (vegetable, pulses etc.)instead of established major crops.

Large-Scale Manufacturing
The overall LSM posted a growth of only 1.6 percent during Jul-Mar 2011,substantially lower than 4.4percent in the corresponding period of FY10. However, quarterly data reveals some signs of recovery as LSM growth improved to 2.4 percent on a YoY basis in Q3-FY11,after rising by 1.2 percent during H1-FY11This gradual recovery can be traced to a number of factors. First, despite facing losses in August2010 due to the floods, industries based on agri raw material thrived during the quarter due to better crops. Second, favorable movements in global commodity prices helped improve margins of domestic producers. Lastly, export demand remained strong. This gradual recovery can be traced to a number of factors. First, despite facing losses in August 2010 due to the floods, industries based on agri raw material thrived during the quarter due to better crops. Second, favorable movements in global commodity prices helped improve margins of domestic producers. Lastly, export demand remained strong. .

2) Inflation and monetary policy

Recent trends in CPI inflation suggest that the impact of floods on prices has clearly wornoff, but in overall terms, inflationary pressures remain quite strong: i. Jul-May FY11 CPI inflation of 14.0 percent is considerably higher than 11.7 percent in the corresponding period of FY10. Nevertheless, we expect CPI inflation for FY11 to remain close to 14.0 percent an improvement over SBPs earlier projections. Although high inflation is always a major source of concern for the central bank, some recent trends are disconcerting. Firstly, inflation remains stubborn. Inflationary pressures are broad-based, suggesting that inflation has permeated to most sectors and will therefore be difficult to curtail in the short run. Although food inflation may decline in the coming months, overall inflation may not subside in the near future.

ii. iii.

Inflation Trends
Year-on-year CPI inflation came down from a peak of around 15.5 percent in December 2010 to 13.23 percent in May 2011. Notably, this level of inflation was very close to its preflood level, indicating that the impact of the August 2010 floods on inflation has played out. Disappointingly, this downtrend could not be sustained beyond February due to increases in the prices of non-perishable food items (e.g. cooking oil; dairy products ;tea; and gram whole).Furthermore, rising prices of the apparel & textile and cleaning & laundry sub groups, diagram A key concern for SBP is the extent to which inflationary pressures have spread across the economy. Specifically, the share of items in the CPI basket displaying double digit inflation has remained over 50percent in May 2011. To put this in perspective, in May2010, only around 39 percent of commodities in the CPI basket were showing double digit inflation.

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 Inflation Outlook
Following a good rabi season,wheat and sugar prices have come down which should contain, and perhaps ease, food inflation in the coming months.

3) Money and Credit

The improvement in the external account, and some let-up in government borrowing from SBP, allowed SBP to keep its policy rate unchanged at 14.0 percent in the last three policy announcements (January, March and May 2011).These decisions reveal a shift in monetary policy when compared to a cumulative increase of 150 bps in the policy rate during H1FY11. The key challenges for monetary policy included weak domestic economic activity, double-digit inflation, risks of reversal in the external account and a large fiscal deficit that requires on-going domestic financing. Although the impact of the floods on domestic prices has clearly dissipated, inflationary pressures remain more disturbingly , the outlook for inflation is not encouraging.

4) Fiscal Developments
The overall fiscal position continued to be under stress during the first three quarters of FY11. The consolidated deficit during Jul-Mar 2011 reached 4.5 percent of GDP, slightly higher than the 4.3 percent for the same period last year. On a positive note, the government has managed to control its spending.

5) External Sector
After remaining in deficit for six consecutive years, Pakistans current account posted a surplus of US$ 0.7 billion in Jul-Apr 2011. This improvement overshadowed the deterioration in the financial account during this period, resulting in an overall surplus of US$ 1.2 billion during Jul-Apr 2011,compared to US$ 0.7 billion in corresponding period of the previous year.

OVERVIEW OF 1st QUARTER 2012

Policy makers were hopeful that the country would put up a better economic performance in FY12 after last year, which was a difficult one for the economy, not only due to the devastating floods that hit the country early in the fiscal year, but also due to the lack of external financing and energy shortages. Unfortunately, as in FY11, the country was hit once again by floods in the early months of FY12. On a positive note, the floods in FY12 were not as severe as those in FY11. . the government has been making some headway towards improving its finances. Moreover, the federal government has budgeted a surplus of Rs 125.0 billion on part of provinces, however, due to 52.8 percent increase in their expenditures, provinces managed only Rs 11.6 billion surplus up to Q1-FY12, which was 85.7 percent lower than the

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corresponding period last year. Any short fall in the contribution by the provinces would make achievement of the fiscal deficit target more challenging. Lack of external funding has put the burden of financing the deficit disproportionately on the banking system, which has led to crowding out of private sector and is acting as a disincentive for banks to perform their role of financial intermediation. Government borrowing from the banking system up to end-Nov 2011 was Rs 736.8 billion, against Rs 336.1 billion in the corresponding period last year. This amount includes Rs 391.0 billion borrowed from the banks to retire PSE(public sector enterprises) debt, which has now been transferred on to the governments books. Unfortunately, PSEs continue to hemorrhage as a credible restructuring plan has not been put into action. As a result circular debt issue is likely to persist. The governments efforts to keep its borrowing from SBP in check during the initial months of FY12, helped in keeping demand-driven inflationary pressures at bay, which was supplemented by the easing of food prices. As a result, YoY CPI inflation declined to single digits (9.7 percent) in Dec 2011 after remaining in double digits for the last two years. While the increase in energy prices, recent weakening of the Pak Rupee and the base effect may increase inflation in the coming months, the end-year average inflation is likely to fall close to 12.0 percent as projected earlier. While SBP has shown its willingness to relax its policy to support the private sector as it did in Jul and Oct 2011, it cannot add to the stress on the economy arising from weaknesses in other sectors. The most recent policy decision to keep the policy rate unchanged was influenced among others, by the weakness in external accounts during Q1-FY12. Pakistan was fortunate in FY11 that its current account ended up in a surplus and, despite the drying up of FDI and other foreign investments; there was a net increase in its FX reserves. Given the rigidities in the trade account and the vulnerability of the financial account, sustaining this performance in FY12 was always going to be difficult. Nevertheless, the pace at which the current account deteriorated during the first quarter of FY12 took many by surprise. Specifically, the current account deficit for Sep 2011 alone was over US$ 1.0 billion. In the past, Pakistan has sustained larger current account deficits without losing its foreign reserves due to healthy inflows in the financial account. Unfortunately, owing to both domestic weaknesses and the international financial upheaval, financial flows have almost dried up, adding to the countrys economic vulnerability. While some financial inflows are expected, a part of the current account deficit is likely to be financed through reserves as was the case during Jul-Oct FY12. This has important implications for monetary management and price stability. The government is, however, optimistic that the 3G telecom license fee will be realized. In addition, due to recent developments, there is still optimism that parts of the CSF, bilateral assistance from the US, and the privatization proceeds of PTCL will be received. Furthermore, currency swap arrangements, which were recently formalized with the central banks of Turkey and China, will also facilitate bilateral trade and investment, easing the stress on the countrys reserves. Nevertheless, SBP remains vigilant that pressure on the Rupee is not translated into market speculation, which could become self-fulfilling. Striking a balance in managing a flexible exchange rate driven by economic fundamentals and by market speculation (within

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the context of sharp currency movements in the global economy) is challenging. SBP will continue to monitor the forex market closely to remove any excessive volatility in the Rupee.

1) Real Sector
The initial months of FY12challenged the key assumptions on which this years growth target rested: continuation of post-flood revival, firm global commodity prices, and back-up electricity supply arrangements by industries. Firstly, 2010 flood recovery was interrupted by another flood in Q1-FY12, which caused considerable damage to cotton crop in Sindh.

Agriculture Sector Performance

The initial assessment indicates major losses to cotton due to floods in Central and Southern Sindh. However, improved water availability, introduction of better yielding variety of rice, and the increase in wheat support price, are likely to help agriculture sector achieve its target for FY12.

Large-Scale Manufacturing
The LSM recorded a growth of 2.1 percent during Jul-Oct FY12 in contrast to 2.9 percent decline recorded in the corresponding period last year.

2) Inflation and Monetary Policy

Monetary Policy SBP ease its monetary policy stance in Jul and Oct 2011 was influenced by a combination of gradual decline in headline inflation, comfort in the current account balance, and the government efforts to contain its inflationary borrowing. SBP policy rate was reduced by a cumulative 200 bps to 12.0 percent. While this monetary easing was expected to help stimulate economic activities in the economy, risks emerging from external sector were acknowledged; resultantly policy rate was kept on hold in Nov 2011.

Developments in Monetary Aggregates

Changes in monetary aggregates during Jul-Nov FY12 are primarily driven by the deteriorating external accounts. Specifically, Net Foreign Assets (NFA) witnessed a contraction of 18.0 percent so far this year, against an expansion of 11.2 percent in the previous year. This sharp reversal led to deceleration in broad money (M2) growth as the expansion in net demotic assets (NDA) remained almost the same as in the last year.

Inflation
Headline inflation number has been edging down consistently and core inflation, encouragingly, is following suit Food inflation has receded considerably recently and been the major contributor towards the slowdown in inflation. However, commodities displaying double digit inflation have been above 50 percent since Feb 2011 an indication of the broadbased nature of inflation in the country.

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3) Fiscal Policy and Public Debt

Fiscal Situation
The budget deficit in the first quarter of FY12 was 1.2 percent of GDP, compared with 1.5 percent during the same quarter of the last year.The reduction in the budget deficit was caused primarily by sharp rise in tax collection on the back of increased tax collection efforts as well as high growth in taxes on imports. While expenditures also showed higher growth than the last year, the upside is that some of this growth was tilted towards development expenditures

Total Debt & Liabilities

The settlement of circular debt of power sector PSEs and public procurement agencies resulted in a substantial Rs 572.2 billion increase in the stock of total debt & liabilities (TDL), during the first five months of FY12, that reached Rs 12.7 trillion (Table 4.6). However, after adjusting for this one-off factor, the increment in TDL stock shows a lesser magnitude during Jul-Nov FY12 as compared to the same period last year.

4) External Sector
The first five months of FY12 saw a sharp deterioration in the external account position compared to the previous year. Specifically, external account posted a deficit of US$ 1.7 billion during Jul-Nov FY12 compared to a surplus of US$100.0 million in the corresponding period of the previous year. The deficit in overall external account is attributed to the deteriorations recorded in both, the current and financial accounts during the period under review

OVERVIEW OF 2ND QUARTER 2012

. 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. 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. 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 SBPs foreign exchange reserves and on the Pak Rupee. 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. Within the commodity producing sectors, major kharif crops are likely to achieve their target growth for FY12.1

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Fortunately, flood-related damages to the cotton crop in Sindh have been more than offset by gains in Punjab. The use of high quality cotton seeds; improved availability of water; and the increase in area under cultivation due to higher crop prices last year were the main reasons here. However, the benefits of productivity gains to farmers are being eroded by the dwindling price of their produce.2 This, along with the increased cost of inputs (especially that of fertilizer), has squeezed margins for farmers. Accordingly, farm income is expected to be lower than last year. 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-FY12.3 This was primarily responsible for bringing YoY CPI inflation down to single digits (9.7 percent) in December 2011 at that level for the first time since October 2009. However, the declining trend in headline inflation may not persist. Core inflation (non-food, non-energy) has shown no signs of receding, and more than half of the commodities in the CPI basket are still posting double-digit inflation.4 This stubbornness is attributed to a host of factors including: (1) the periodic upward revision in administered prices, especially that of petroleum products; (2) depreciation of the domestic currency, particularly during the second quarter of the year; (3) the revival of inflationary expectations with the government borrowing from SBP since November 2011. 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 SBPs 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. 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. Demand for working capital loans has also been low; these loans saw an expansion of Rs 99.5 billion during H1-FY12 compared to Rs 131.3 in H1-FY11. This was primarily driven by: (1) the textile sector, which required less working capital as cotton prices fell, and these units still carried forward healthy profits from FY11; and (2) the inability of sugar mills to offload their stocks from last year, which constricted seasonal demand for fresh loans. It is pertinent to note that the government had to intervene in the sugar market by purchasing 378,000 tons of sugar through TCP. This helped sugar mills retire some of their bank borrowings. While demand for credit was understandably low, significant government borrowing from commercial banks also ate into the supply of loan-able funds for the private sector. H1-FY12 data indicates that government borrowing for budgetary support more than doubled, compared to the same period last year. Although the bulk of this borrowing (Rs 391.0 billion) was needed to partially settle the inter-agency receivables of PSEs in the energy sector, and the payment of subsidies to procurement agencies (popularly known as circular debt), direct borrowing for deficit financing was Rs 365.0 billion, which was higher than last years borrowing of Rs 308.5 billion. Of greater concern is the composition of government borrowing, which has tilted towards inflationary financing. Q2-FY12 data indicates that the government was unable to meet its self-imposed quarterly limit of zero net budgetary borrowing from SBP. High

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frequency data shows that government borrowing from SBP picked up from November onwards, and reached Rs 219.2 billion during Q2-FY12. This dependence on SBP financing was because of the difficulties encountered in rolling over maturing T-bills in the month of December 2011 a risk highlighted in SBPs Monetary Policy Statements and Annual and Quarterly Reports. Data for consolidated fiscal operations indicates a deficit of 2.5 percent of GDP for H1-FY12 This deficit was slightly lower compared to the first half of FY11. The good news is that this came primarily from the revenue side; FBR tax collections reached Rs 840.1 billion during H1-FY12, showing a YoY growth of 27.1 percent. Moreover, SBP profits of Rs 104.0 billion contributed significantly non-tax revenues. Nevertheless, it is important to note that financing this contained fiscal deficit in H1-FY12 was challenging as compared to H1-FY11. As mentioned earlier, the burden of financing fell squarely on domestic sources, since the expected external inflows did not materialize. Specifically, uncertainty about inflows from the Coalition Support Fund (CSF) and the Eurobond issuances still prevails. The slowdown in foreign exchange inflows has also raised concerns about countrys balance of payments. Specifically, Q2-FY12 data shows that the overall external account deficit has increased to US$ 1.0 billion compared to US$ 0.8 billion in the first quarter of the year; this takes the H1-FY12 external deficit to US$ 1.8 billion. The composition of the BoP reveals that the current account deficit has widened to US$ 2.2 billion, against an almost nil balance during H1-FY11. Within the current account, a positive was the growth in worker remittances, which reached US$ 6.3 billion during the first half of the year. Excluding remittances, all other components of the current account deteriorated during the period under review. The import bill increased on account of higher international oil prices and the import of fertilizer. These two items alone accounted for 60 percent of the increase in imports during H1-FY12. On the other hand, export growth has slowed to 3.9 percent compared to 18.9 percent during the first half of the previous year.6 The deceleration was largely concentrated in Q2-FY12, as exports actually fell on a YoY basis for all three months of that quarter. The fall was driven primarily by a decline in quantum; this is an indication of domestic structural weaknesses, as unit values (prices) actually increased for most of the textile items. Despite these weaknesses, the size of the current account deficit should not be a major source of concern, given Pakistans history. The real challenge is financing the current account deficit, as both debt and non-debt inflows have declined. Quarterly numbers indicate that financial/capital accounts posted a deficit of US$ 0.4 billion during Q2-FY12, which implies that the overall external deficit had to be financed by drawing down foreign exchange reserves. Hence, SBPs foreign exchange reserves saw a reduction of US$ 1.9 billion during H1-FY12 to US$ 12.9 billion. This decline in reserves was accompanied by a depreciating Pak Rupee, which lost 4.4 percent of its value during the first half of the year.

1) Real Sector
Shaped by real sector developments, the export and import baskets also underwent some changes. For instance, while manufactured goods exports declined (mainly led by textiles), agri-based food exports remained strong. Similarly, a decline in agriculture product imports was offset by higher demand for intermediate goods and machinery, particularly in Q2-FY12. Services trade balance also deteriorated in H1-FY12. Overall, net exports had a downward pull on aggregate demand in H1-FY12.

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 Agriculture Sector
Most of the major kharif crops (cotton, rice, sugarcane) have already been harvested and preliminary estimates show strong performance by these crops.This improved performance is commendable given that farmers faced multiple challenges during the crop season, including floods in the summer, sharp fall in prices of agri produce and increase in input costs.

Industry
Half-way into FY12, the industrial sector has been showing some improvement over the previous year However, this performance must be qualified, as part of the growth in Q1FY12 reflects the effect of a low base. As this base effect fadeout, large-scale manufacturing with a share of 52.3 percent in overall industry) posted decline in October and November 2011 before finally picking up in December.

Large-scale manufacturing
Large-scale manufacturing growth decelerated during the quarter, from 2.8percent YoY in Q1-FY12 to negative 1.0 percent in Q2-FY12. It was anticipated that the drivers of Q1 growth export demand and favorable post-flood base effect would not help. However, further deterioration occurred on account of continuing gas shortages during the peak winter months, which constrained production in fertilizer, cotton weaving, and steel re-rolling. As a result, only 46 percent of LSM subsectors showed positive YoY growth in Q2-FY12 compared to 57 percent in Q1.On a cumulative basis, H1-FY12 growth stands at 0.8 percent

2) Inflation and Monetary Policy

The government announcement of zero quarterly limits on its borrowing from SBP, projections of a relatively small current account deficit and the likelihood of average CPI inflation to remain close to the 12 percent target for FY12 at the beginning of the year, allowed the central bank to adopt an accommodative monetary policy during H1-FY12.

Developments in Monetary Aggregates

Changes in broad money supply and its major components during H1-FY12 were driven primarily by the developments in the external accounts, government borrowing, and a oneoff settlement of circular debt. Moreover, quarterly data indicates that the monetary expansion witnessed during H1-FY12 is entirely concentrated in the second quarter of the year due to seasonal credit off-take and a revival in government borrowing from the SBP.

Inflation
Headline inflation fell to single digits in Dec-11 after almost two years This was undoubtedly positive news for the economy. However, our analysis indicates that inflation fundamentals have not changed much.

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3) Fiscal Policy and Public Debt

Fiscal Policy
Although some degree of fiscal restraint was observed in the first half of the current fiscal year with a budget deficit of 2.5 percent of GDP lower than that in H1-FY11, tougher fiscal discipline will still be needed in the second half to achieve the full year target. The target for FY12 budget deficit has been revised upward to 4.7 percent; however, it will be challenging to achieve.

Domestic & external debt

Pakistan public debt stock recorded a sharp increase in Q2-FY12, reaching Rs 12.0 trillion by end December 2011 (Table 4.4). The surge in debt burden, during the second quarter, was the outcome of a one-off settlement of circular debt of power sector PSEs and public procurement agencies by the government.

4) External Sector
Q2-FY12 data indicates further deterioration in external accounts with overall deficit widening to US$ 1.0 billion compared to US$ 0.8 billion in Q1-FY12. It may be recalled that against the deficit of US$ 1.8 billion in H1-FY12, the country had posted a surplus of almost US$ 1.0 billion in H1-FY11.

Economys review of last three quarters

Economic Indicators Growth rate (percent) GDP (at factor cost) 2.4 1.2 -4.0 4.8 3.7 -0.1 1.0 2.1 0.8 Q4 2011 Q1 2012 Q2 2012

Agriculture
Major crops Minor crops Live stock Industry LSM

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Services Export(fob) Import(CIF) Tax revenue (FBR) CPI (12 months) Private sector credit Money supplyM2 Billion US dollar Total liquid reserves Home remittances Net investment

4.1 28.1 14.7 12.2 13.9 3.3 13.7

7.6 20.2 29.7 12.0 2.5 2.3

3.9 18.9 27.1 10.9 6.2 5.7

17.2 9.0

16.9 5.2 0.3

17.0 6.3 0.4

foreign 1.4

Percent of GDP Fiscal deficit Trade deficit Current deficit 4.5 5.8 account 0.3 1.2 2.7 0.9 2.5 3.3 0.9

Looking Forward
Developments during H1-FY12 indicate that risks to macroeconomic stability are stemming from the external sector and the continued weaknesses on the fiscal side. In terms of the real sector, there has been some improvement since the publication of SBPs 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. In spite the lower fiscal deficit during H1-FY12, containing the overall fiscal deficit to its revised target of 4.7 percent of GDP seems to be challenging. Quarterly data for previous years has shown that the deficit remains relatively higher in the second half of the year. The achievement of the revised fiscal deficit is dependent on the realization of: (1) the envisaged surpluses from provincial governments, which are likely to be lower than expected;7 (2) the non-tax revenues, which depends on inflows into the Coalition Support Fund, and the auction of 3G licenses;8 and (3) strict control over expenditures.

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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. 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 materialize in time. This, together with the scheduled repayment of IMF loans (US$ 1.1 billion) during H2-FY12, may draw down SBPs foreign exchange reserves.

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