PBIC Econ Issues Prospects Sept2010

8/8/2019 PBIC Econ Issues Prospects Sept2010

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Pakistans Economy

Issues and Prospects

September 2010

Haider Hussain(+92-21) [email protected]
mailto:[email protected]:[email protected]


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Pakistan: A middle-tier developing economy

Population 166.5 million, (Rural 64% , Urban 36%)

Total Labor Force 55.8 million

Unemployment Rate 5.5%

Poverty Rate Official 22%, Unofficial 23% - 32%Literacy Rate Official 57%, Unofficial 35% - 41%

GDP PKR 14,414 billion (USD 167.5 million)Per Capita Income USD 1,013

Composition of GDP Services (53%), Agriculture (22%), Small Scale & Other Industries (13%),Large Scale Manufacturing (12%),

Major Industries Textile (33%), Food (19%), Petroleum (7%), Pharma (7%), Chemicals (6%),Automobile (5%), Metals (5%), Fertilizer (5%)

Major Crops Wheat, Rice, Sugarcane, Cotton

Exchange Rate PKR 85.50 per USD

Major Exports Textile (52%), Food (17%), Petroleum Products (5%), Chemicals & Pharma(4%), Cement (3%)

Major ExportDestinations

USA (23%), UAE (9%), Afghanistan (6%), UK (6%), Germany (4%)

Major Imports Petroleum Crude & Products (34%), Machinery (13%), Food (10%)


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Key Issues in the economy

Consumption-led growth model

High vulnerability to exogenous shocks (e.g. international prices) & domesticmarket inefficiencies

Expansionary fiscal policy but weak revenue mobilization

Narrow export base


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Economy is predominantly consumption-based

Relatively few of the resources go into the formation of fixed capital

Source: Ministry of Finance

0%10%

20%

30%

40%

50%

60%

70%

80%

90%

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Share of Consumption & Investment in GDP

Private consumption Gross fixed capital formation

Econom

icGrowt

h


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Easy credit availability sent everyone on a spending spree, demand rose more than domestic supply,rising inflation was the ultimate outcome

Overheating still high despite stabilization efforts, so is inflation


0%

5%

10%

15%

20%

25%

-500

0

500

1,000

1,500

2,000

2,500

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

An Overheating EconomyExcess Demand, PKR bn (LHS) Headline Inflation (RHS)

Econom

icGrowt

h


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Besides overheating, international commodity prices also rose sharply in FY08 and FY09

SBP responded by increasing Discount Rate in FY09 (250bps), but reduced it in FY10 after nascentrecovery

Despite fall in global inflation in FY09, domestic inflation eased only slightly owing to marketinefficiencies

Source: SBP

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

FY07

FY08

FY09

FY10

Discount Rate Headline Inflation Core Inflation

Rising Inflation and Central Bank's response

Econom

icGrowt

h


7/217

Low investment growth, cost-push inflation and higher interest rates resulted in a fall of LSMgrowth in FY09. Poor law & order also contributed in production slump

In FY10, aggregate demand recovered a bit, resulting in considerable manufacturing growth


Services53%

Sectoral Share in GDPAgriculture 22%

Large ScaleManufacturing12%

Small Scale Manufacturing & Energy 13%-10%

-5%

0%

5%

10%

15%

20%

25%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Agriculture Large Scale Manufacturing Services

Growth in GDP Components

Econom

icGrow

th


8/218

As a result, Economy seemed to have completed a boom-bust-recovery cycle in FY10


2.0%

3.1%

4.7%

7.5%

9.0%

5.8%

6.8%

3.7%

1.2%

4.1%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%7.0%

8.0%

9.0%

10.0%

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Boom, Bust, Recovery!

Real GDP Growth

Econom

icGrow

th


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Weak revenue mobilization, marked by low tax-to-GDP ratio

More Importantly, tax revenues have failed to reflect episodes of high GDP growth

Fisca

lDeve

lopmen

ts

9%

10%

11%

12%

13%

14%

15%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

FY91

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Real GDP Growth (LHS) Tax-to-GDP (RHS)

Revenue Mobilization

Source: Ministry of Finance, PBIC Research


10/2110

Expansionary fiscal policy especially after FY05, despite weak revenue mobilization

Government has resorted to borrowings and grants in order to fuel fiscal expansion

Fisca

lDeve

lopmen

ts

Source: Ministry of Finance, PBIC Research

0%

10%

20%

30%

40%

50%60%

70%

80%

90%

100%

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

Borrowings Grants & Privatization Revenue

Financing of Government ExpenditureAs % of Expenditure

12%

14%

16%

18%

20%

22%

24%

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

Revenue to GDP Expenditure to GDP

Expenditure Revenue Gap


11/2111

Excess demand satiated through imports, result was high trade and CA deficits in FY08

After fall in international commodity prices and curb on imports, both deficits came down

Exports remained flat due to their low elasticity of consumption demand

Continuous rise in remittances also helped

Source: SBP, PBIC Research

Exte

rna

lSec

tor

Dynam

ic

s

0.01.0

2.0

3.0

4.0

5.0

6.07.0

8.0

9.0

10.0

-6.0%-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Current Account Deficit - Rise & FallRemittances (USD billion, RHS) Trade Def icit, % of GDP (LHS)

Current A/C Deficit, % of GDP (LHS)


12/2112

Higher import bill caused FX reserves to decline and exchange rate to depreciate

IMF loan and global price softening halted the pace of depreciation after Nov-08

Nonetheless, mild depreciation continues afterwards


Exte

rna

lSec

tor

Dynam

ic

s

0

2

4

6

8

10

12

14

16

18

60

65

70

75

80

85

90

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

FX Reserves, USD bn (RHS) PKR/USD (LHS)

FX Reserves and Exchange Rate

Current PKR/USD parity @ PKR 85.7 per USD


13/2113

Why currency is depreciating even after buildup in FX reserves?

Decline in Core FX inflow to FX reserve ratio, implying diminishing external competitiveness

Buildup in reserves due to foreign loans, implying future debt servicing pressure

Also because of power production needs leading to higher future oil demand


Exte

rna

lSec

tor

Dynam

ic

s

15%

20%

25%

30%

35%

40%

45%

50%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Core FX Inflow to FX Reserve RatioCore FX inflow = export of goods & services + interest & dividend earned on foreign investment +remittances + f oreign investment in Pakistan


14/2114

Exchange rate volatility fell sharply after Nov-08

Though pressure re-emerged after non-materialization of foreign budgetary funding and

confusion over IMFs tranche disbursement during late FY10


Exte

rna

lSec

tor

Dynam

ic

s

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

23-Jul-07

23-Aug-07

23-Sep-07

23-Oct-07

23-Nov-07

23-Dec-07

23-Jan-08

23-Feb-08

23-Mar-08

23-Apr-08

23-May-08

23-Jun-08

23-Jul-08

23-Aug-08

23-Sep-08

23-Oct-08

23-Nov-08

23-Dec-08

23-Jan-09

23-Feb-09

23-Mar-09

23-Apr-09

23-May-09

23-Jun-09

23-Jul-09

23-Aug-09

23-Sep-09

23-Oct-09

23-Nov-09

23-Dec-09

23-Jan-10

23-Feb-10

23-Mar-10

23-Apr-10

23-May-10

23-Jun-10

Exchange Rate Volatility

Inter-day Standard Deviation


15/2115

International debt markets response was positive after increase in FX reserves and fall in current

account deficit


Exte

rna

lSec

tor

Dynamic

s

0

500

1000

1500

2000

2500

3000

3500

4000

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Credit Default Swap on Pakistan's 5-Year Eurobond

Peak @ 3,144 bps in Dec-08, Current @ 540 bps


16/2116

FDI surged between FY04-FY08. FPI followed with FY07 being the most fertile year

However, macroeconomic imbalances caused FDI to decline sharply

Narrow-based foreign investments: remained concentrated in banks, telecom and oil (both FDIand FPI)


Exte

rna

lSec

tor

Dynamic

s

-

1,000

2,000

3,000

4,000

5,000

6,000

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Foreign Direct Investment

USD million

(1,000)

(500)

-

500

1,000

1,500

2,000

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

USD million

Foreign Portfolio Investment


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Money supply grew faster than GDP, another reason behind contractionary monetary policy postFY05

After FY07, money supply grew less than nominal GDP thus system became relativelyless liquid


De

btMar

ke

tan

dInteres

tRate

s

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

23.0%

25.0%

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Growth in Money Supply Nominal GDP Growth

Monetary Liquidity

Excess Liquidity post9-11 inflows

Monetary tightening andfall in liquidity


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Interest rates rose sharply not only because of contractionary monetary policy

but also because of increase in transaction demand for money (people opted to hold higher

cash balances)


De

btMar

ke

tan

dInteres

tRate

s

8%

9%

10%

11%

12%

13%

14%

15%

16%

Jul-05

Dec-05

May-06

Oct-06

Mar-07

Aug-07

Jan-08

Jun-08

Nov-08

Apr-09

Sep-09

Feb-10

6-month Tbill Yield SBP Discount Rate

Policy Tightening & Secondary MarketYields

9%

10%

10%

11%

11%

12%

12%

13%

13%

14%

14%

20%

21%

22%

23%

24%

25%

26%

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Currency in Circulation as % of M2 (LHS)6M Tbill (RHS)

Transaction Demand for Money & InterestRates


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Exogenous

Shoc

kan

dc

hang

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ts

August 2010 FloodsInitial Assessment

Economic stabilization efforts took a serious blow after worst floods in the history

Catastrophic damages severely affected medium term economic outlook

These figures are only provisional. ADB and World Bank are working on damage assessmentreport (will be available in November 2010)

Flood Damages

Population affected 20 million

Land affected 17 million Acres

Agriculture Produce 4.3 million acres (PKR 245 billion)

Cotton 700,000 acres (2 million bales)

Wheat 500,000 tonnes

Rice 1.5 million acres (1.5 million Tonnes)

Sugarcane 200,000 acres

Livestock 150,000

Animal Fodder 300,000 acres

Infrastructure, properties PKR 600 billionPower Shortfall 3.135 gigawatts

Source: Various news reports


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Exogenous

Shoc

kan

dc

hang

ingprospec

ts

August 2010 FloodsAftermath

Aggravating inflationary pressure in first as well as in second round

Higher domestic borrowing, thus higher interest rates

Affected credit portfolios of the banking system, thereby increasing NPLs

Silver lining

Complete and timely disbursement of foreign aid (so far, close to USD 2.5 billion has been announcedby multilateral and bilateral sources)

Restructuring of existing IMF loan (not very significant likelihood)

FY11 - Government

Targets

FY11 - Post flood

scenario

Real GDP growth 4.50% 2.0%-2.5%

Inflation 9.50% 16%-17%

Budget Deficit PKR 685 billion PKR 800-850 billion

Trade Deficit USD 11.7 billion USD 13.7-14.5 billionSource: News reports, PBIC Research


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Treasury Group

Fixed Income Investments and Marketing Unit Team

Ahmed Ateeq

Head, MM, Fixed Income and TMU

(+92-21) 5361370-3

[email protected]

Haider Hussain

Unit Head, Research

(+92-21) 32059014

[email protected]

Zain Ali Shams

Analyst

(+92-21) 35361215-9 Ext. 141

[email protected]

Contact Details

Pak Brunei Investment Company

Khadija Towers, Plot No. 11/5, Block No. 2, Scheme No. 5, Clifton, Karachi

Tel: (+92-21) 35361215-9, Fax: (+92-21) 35370873

http://www.pakbrunei.com.pk
mailto:[email protected]:[email protected]:[email protected]://www.pakbrunei.com.pk/http://www.pakbrunei.com.pk/mailto:[email protected]:[email protected]:[email protected]

PBIC Econ Issues Prospects Sept2010

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