Oct 4, 2010

Post-flood indicators

By Hussain H. Zaidi

In its recent assessment of Pakistan's post floods economy, the International Monetary Fund (IMF) has stated that the impact of the calamity goes beyond humanitarian crisis to have significant implications for growth and external and fiscal accounts, leading to revision of the current financial year's budget. The IMF has announced $451 million emergency credit to ease pressures on the public exchequer and foreign exchange reserves.

The economy, according to the IMF, was picking up before the floods hit the country. The real GDP grew by 4.1 percent, the current account deficit narrowed to $3.5 billion (2 per cent of GDP) and both exports ($19.63 billion) and remittances ($8.90 billion) went up during the last financial year (FY10). However, the budget deficit surpassed the 5.1 percent revised target to reach 6.3 per cent of GDP.

The economic cost of floods is likely to be enormous in terms of loss caused to agriculture, livestock, infrastructure and potential GDP. The agricultural sector, which accounts 21 percent of GDP and 45 percent of employment, has been hit the hardest as more than 2.3 million hectares of standing crops, including 3.5 million bales of cotton, have been washed away.

Sugarcane and rice crops have also been significantly damaged. Since Pakistan is an exporter of primary products and agriculture and livestock-dependent manufactured goods (textiles, leather), the country's export performance is likely to be affected. Besides, the country will have to import essential commodities to meet the domestic shortage as well as capital goods for post-floods reconstruction and rehabilitation, which will inflate the import bill.

On the basis of data provided by the Pakistan government, the IMF has predicted that during the current fiscal year, real GDP growth will come down to 2.8 percent ($190.20 billion) from the pre-floods estimates of 4.3 percent ($190.66 billion); the current account deficit will increase to 3.1 percent ($5.86 billion), 0.6 percentage points higher than the pre floods estimates of 2.5 percent ($4.62 billion); inflation will rise to 13.5 percent from 11.7 percent estimates before the deluge; exports and imports will grew by 3 percent and 8.7 percent respectively compared with earlier estimates of 4.7 and 6.9 percent resulting into trade deficit of $13.52 billion.

External debt will surpass the post floods projections of $58.55 billion to reach $60.40 billion. Foreign direct investment is projected to be $3.08 billion down from original forecast of $3.28 billion, while foreign portfolio investment will be $278 million down from the $428 million projection.

Rehabilitation of the flood-hit people will put serious pressures on the public exchequer in a situation when revenue collection is likely to be lower due to disruption of economic activity. Accordingly, the government will have to re-prioritise budgetary allocation as well as broaden the tax base resulting into what is commonly called a mini budget.

The first will entail diversion of development expenditure to rehabilitation of floods affected people. However, the second is easier said than done and the axe is likely to fall again on the salaried class in the form of a temporary 10 percent income tax surcharge as committed by the government in a letter dated September 10, 2010 addressed to the IMF requesting for the emergency credit. The same letter also commits the government to reform the general sales tax (GST) incorporating features of a value added tax (VAT).

The major economic indicators in the post floods scenario present a mixed picture. During first two months of the current fiscal year (FY11 July August), current account deficit went up to $944 million compared with $635 million for the corresponding period of the last financial year (FY11 July August).

Imports increased to $6.25 billion compared with $5.16 billion; however, exports also rose to $3.56 billion compared with $2.90 billion. Foreign investment dropped to $267 million from $405 million; however, remittances increased to $1.72 billion from $1.52 billion. Inflation (CPI) went up to 12.79 percent from 10.93 percent during the corresponding period of last fiscal year.

The devastation wrought by the floods is so enormous that the Pakistan government cannot cope with it on its own and thus direly needs foreign assistance. According to Economic Affairs Division, as of September 24, 2010 total multilateral and bilateral pledges worth $1.46 billion have been made of which $411.28 million are in the form of grant and $709 million in kind.

However, only $53.38 million grant has been disbursed, while relief goods worth $285 million have been received. In addition, the World Bank and the Asian Development Bank will provide $1 billion and $500 million respectively in credit. The IMF's $451 million loan has already been mentioned.

An important development is the indication given by the European Union (EU), which is Pakistan's single largest trading partner, to reduce tariffs on certain number of products of Pakistan's export interest to help the country grapple with the devastation caused by the floods. However, since the proposed tariff concessions will be Pakistan-specific, the EU will be required to obtain a waiver from the WTO in order to make them compatible with the international trade regime.

Granted that such a waiver is obtained, which itself is a difficult task, the actual impact on Pakistan's exports will be contingent upon several factors, including the products on which tariff concessions will be granted, the margin of preference, the period during which tariffs will be lowered, and the domestic supply side situation.

Floods have undone the economic recovery -- fragile though it was -- that began in the last financial year. The economic slowdown will result in loss of jobs and incomes as well as revenue. The level of domestic savings (10.1 per cent of GDP) and investment (16.6 per cent), which is already quite low, will further come down and reduce future growth prospects.

Balance of payment problems will increase partly due to projected hike in the current account deficit and partly due to projected fall in foreign investment, which will make the country more dependent on foreign credit thus adding to total foreign debt as well as debt servicing. The increase in inflation, particularly of food items, will hit hard the salaried class, which will be required to pay more in the form of flood surcharge as well as a 'reformed' GST.

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