LAHORE: Pakistan’s economic growth outlook, in the short-to-medium term, remains weak in spite of the rising investor confidence on clear signs of economic stability.

Growth outlook depends on the materialisation of the $5.7 billion aid pledged at the Tokyo meeting of the Friends of Democratic Pakistan group and key fiscal reforms to raise taxes and reduce subsidies, according to an analysis of the Pakistan economy published in the Standard Chartered Global Focus.

The analysis downgrades gross domestic product (GDP) growth projection to 2.5 per cent for the current fiscal year from 3.3 per cent the government has forecast in the budget.

‘After a turbulent 2008, the economy has seen a steady turnaround in 2009, and all major indicators are pointing to greater economic stability ahead,’ the analysis by Sayem Ali, country economist for Standard Chartered Bank, says.

Foreign exchange reserves grew to $14.5 billion (covering 4.7 months of imports) in September from $6.5 billion a year earlier, helping to support the rupee. Headline inflation in August printed 10.7 per cent year-on-year, the lowest level in 18 months.

‘Significant tangible gains have also been made in improving the security environment, including the successful conclusion of military operation in Swat. These developments have restored confidence in the economy leading Standard & Poor’s to upgrade Pakistan’s sovereign rating by one notch to B- from CCC+. Moody’s has reaffirmed its B3 sovereign rating and changed the outlook to stable from negative,’ the analysis acknowledges.

It says the S&P rating upgrade has accelerated a pickup in foreign investment in the equity market and nearly $275 million of investment has flowed into the stock market since June, reversing 18 months of capital flight.

The significant build-up of foreign exchange reserves has also improved confidence in government paper. The credit default swap (CDS) on the Pakistan five-year sovereign bond has come down to 650 bps from a peak of 5,000bps in October 2008.

‘This indicates that the market is more confident in the government’s repayment ability and is pricing in a lower risk of default,’ the analysis adds.

The government hopes that GDP will grow 3.3 per cent year-on-year during the current fiscal from two per cent last year on higher public investment spending and a pickup in private credit.

While year-on-year inflation has eased, month-on-month inflation has accelerated sharply during the first two months (July-August) of 2009-10 on the back of higher food prices and heavy government borrowing from the central bank (that is, printing money).

Headline inflation accelerated to 1.7 per cent month-on-month in August from 1.5 per cent in July and one per cent in June. The pickup in inflation has forced the central bank to delay plans to ease monetary policy as it left its policy rate unchanged at 13 per cent in its last monetary policy review on September 29, following two consecutive rate cuts (of 100bps each) in April and August.

High lending rates have discouraged private credit growth. Private credit has contracted by two per cent year-on-year during the first quarter of the current fiscal.

The ambitious government stimulus spending plan outlined in the budget is constrained by declining tax revenues, higher debt servicing costs, and delays in the removal of subsidies, the analysis says. Evidence suggests that there has been significant slippage, forcing the government to borrow Rs106.6 billion from the central bank during the first quarter to September.

‘This is fuelling inflation and crowding out private investment through high interest rates. At the same time, resource constraints are forcing the government to shelve its own investment spending.’

In the given scenario, the analysis points out that fiscal reforms and official capital inflows are critical to recovery in the medium-term. ‘Fiscal reforms to raise tax revenues and rein in unproductive expenditures are essential to creating the fiscal space needed for the government to make necessary investments in the power sector, scale up spending on the poor, and limit the build-up of government debt.’

http://www.dawn.com/wps/wcm/connect/dawn...ng--szh-07