December 2009

Report Series

Pakistan: Macroeconomic
Assessment and Outlook
Executive Summary
 Pakistan’s policy makers have had the task of managing an economy
impacted by exogenous shocks, domestic security concerns, a volatile
political environment and institutional tensions. The new government took
office in March 2008 when politically-driven macroeconomic management
by the outgoing and interim administrations had compromised the external
and fiscal gains made during 2002-2007. In these circumstances, while
Pakistan’s strategic geographic location has played its role in ensuring
donors stay committed, the government has managed to draw-up a
reform program and obtain funding for it.
 There has been a general improvement in macroeconomic indicators
since the government entered into an IMF program in November 2008.
The fiscal deficit has been reduced; inflation is down; central bank
financing of the fiscal deficit has been eliminated; and donor support has
been forthcoming. As a result, central bank reserves are up and import
cover has improved, leading to strong spread compression on traded
external debt and a reduction in CDS levels. As a result, Pakistan has
been upgraded by ratings agencies.
 However, this recovery has been aided largely by exogenous factors,
which have reduced the need for sharp structural adjustment/demand
management. Importantly, oil prices are off their peak, which has helped
contain the oil import bill. This has lowered external deficits, reducing the
external financing requirement and stabilizing central bank reserves. It
also reduced the need to adjust domestic petroleum prices, an important
factor behind a reduction in inflationary pressures in the economy.
 On the fiscal front, as oil/commodity prices collapsed, the need for
subsidies fell, reducing fiscal pressures. With high inflation, nominal GDP
expanded by over 27 percent in 2009 further casting a positive spin on
end-year fiscal, and other macroeconomic, indicators. Additionally, with a
fall in the nominal size of the fiscal deficit, and in view of strong donor
support, there was little need for central bank financing.
 Looking ahead, while a large front-loaded IMF program has boosted
reserves and enhanced policy oversight, repayments of more than $12
billion will begin in 2012. This highlights the downside with high levels of
multilateral donor support: public sector external debt is expected to rise
Office of the Chief Economist from $41.5 billion in FY08 to $53.9 billion in FY10, and further to $65.1
Economics Department billion in 2012. On the fiscal front, a low tax-to-GDP ratio remains the
Samba Financial Group Achilles’ heel of Pakistan’s macroeconomic imbalances. This is unlikely
P.O. Box 833, Riyadh 11421 to be remedied under the current IMF program since: (a) it is too short a
Saudi Arabia period of time; (b) the institutional capacity to implement real fiscal
change is lacking; and, (c) the political will to implement any major fiscal
ChiefEconomist@samba.com reform, such as a broad-based Value-Added Tax, at a time when the
+9661-477-4770; Ext. 1820 (Riyadh) government has already spent a lot of its political capital, is going to be a
+4420-7659-8200 (London) challenge.
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 December 2009

Pakistan: Macroeconomic Indicators Backdrop

Years ending June 2008e 2009p 2010p
Nominal GDP ($ bns) 164.6 166.5 178.7 The new government took office amidst difficult domestic conditions
Real GDP growth (%) 4.1 2.0 3.0 and weakening global economy

Fiscal Indicators Tensions between government entities and civil society organizations,
Fiscal deficit (% GDP) -7.3 -5.0 -4.2 security problems, and the transition to a new administration in March 2008
Govt. debt (% GDP) 58.4 56.0 56.8
prevented the authorities from taking unpopular but necessary decisions
External sector during the course of the year. Coupled with the sharp rise in global
Curr a/c def (% GDP) -8.3 -5.1 -4.7 commodity prices and risk aversion in global markets, these developments
Trade Deficit ($ bns) -15.0 -12.0 -11.7 led to a severe deterioration in Pakistan’s headline macroeconomic indicators
Oil Imports ($ bns) 10.5 9.9 10.3 by the third quarter of 2008.
Remittances ($ bns) 6.5 7.8 7.1
Gross financing ($ bns) 15.1 11.5 11.2 Reflecting this, consumer prices in August 2008 rose more than 25 percent
Gross Reserves ($ bns) 8.6 9.1 13.5 from a year earlier. Central bank reserves fell by more than $10 billion to $3.3
Import Cover (months) 2.7 2.9 4.1
billion in the 12 months to October 2008, equivalent to about one month’s
FDI ($ bns) 5.4 3.4 2.9
Portfolio Invest. ($ bns) 0.04 -1.2 -0.5
import cover. The fiscal and current account deficits nearly doubled to over 7
External Debt ($ bns) 44.6 49.8 57.4 percent of GDP and $14 billion by June 2008. The rupee depreciated more
Public 41.6 46.7 53.9 than 30 percent in the 10 months to October 2008. The government had to
Private 2.9 3.2 3.5 impose a floor on the stock exchange index, which lost 40 percent of its value
in the six months preceding September 2008. In addition, as a consequence
Monetary (%)
of tighter monetary policy, the six months Karachi Interbank Offer Rate (Kibor)
M2 Growth 15.3 9.6 13.0
rose by nearly 500 basis points to roughly 15 percent.
CPI (ann. avg) 12.0 20.8 10.0

Banking System (%)* 2007 2008 2009

The IMF has supported the government’s reform program
Capital adequacy 13.2 12.2 12.9
NPLs to gross loans 7.2 9.1 11.5
As political tensions eased with the exit of General Pervez Musharraf from the
Return on equity 15.5 11.3 10.7 presidency in August 2008, the new government moved to focus on restoring
Liq. assets to deposits 45.1 36.9 41.5 macroeconomic stability. As part of these efforts, the International Monetary
Source: IMF; 2007 and 2008 as of Dec; 2009 Fund (IMF) was approached to elicit support for macroeconomic stabilization
relates to March.
measures. The government secured a front-loaded $7.6 billion 23-month
Stand-By Arrangement in November 2008, which included the immediate
disbursement of a $3.1 billion first tranche to augment central bank reserves.
The program size was increased by an additional $3.7 billion in early August
this year in view of slow progress on bilateral assistance and higher risks from
the global credit crisis. To date, three tranches have been disbursed totalling
$5.1 billion, while another $1.3 billion tranche is expected after the on-going
third program review is completed.
Pakistan: Real GDP Growth
(lowest levels in last 50 years; percent)
4
3.3
Macroeconomic Assessment
3
Real growth is expected to rebound in FY10 to around 3 percent
2.0
2 1.7 1.8
1.2
Economic growth fell sharply in the fiscal year ending June 30, 2009 (FY09)
0.9 to 2.0 percent, representing a second straight year of slowing economic
1
activity. The industrial sector, accounting for 24.3 percent of GDP, contracted
by 3.6 percent over the year - the largest drop since records began in 1951 -
0
while growth in services (53.8 percent share in GDP) slowed to 3.6 percent
FY60 FY71 FY97 FY01 FY09 FY10f*
Source: SBP; *forcast

2
 December 2009

Pakistan: Agriculture Sector Growth compared to the previous year’s 6.6 percent. Both sectors were hit by severe
15 (percent)
energy shortages, a deteriorating security situation, and weak aggregate
10 demand/poor credit availability. Growth was also affected by an economic
5 downturn in Pakistan’s major export markets. The bright spot was agriculture
0 (21.8 percent of GDP), where real growth rebounded by 4.7 percent in FY09.
The principal impetus came from record production of wheat, rice and maize,
Major crops (33%)

Livestock (52%)

Forestry (1%)
Minor crops (12%)

Fishing (2%)
Overall

-5
together accounting for 62% of major crops, due to an increase in government
-10 procurement prices and favourable weather conditions.
-15
-20 Looking ahead, while quarterly GDP data is not produced by the Pakistani
authorities, there are clear signs of a recovery in economic activity. Imports
Source: SBP FY08 FY09 have started to pick-up after bottoming out in February this year, while
manufacturing growth turned positive in August, after 13 consecutive months
Pakistan: Import Growth
(YoY; percent) of contraction. For the full year, Pakistani authorities and the IMF/other
40.0
multilaterals expect real growth to rebound to around 3 percent. While the
20.0 outlook is fraught with risks, especially in terms of continuing domestic
0.0 security problems and questions surrounding the fragile global recovery,
May-09
Mar-09
Sep-08

Feb-09

Sep-09
Jan-09
Aug-08

Nov-08

Aug-09
Jul-09
Apr-09

Jun-09
Dec-08

growth is likely to be helped by lower inflation, lower benchmark interest rates,

Oct-08

Oct-09

-20.0
and a nascent recovery in Pakistan’s export markets.
-40.0

-60.0 Inflation has continued to moderate since its peak in August 2008
-80.0
Machinery Transport
A significant tightening of the central bank’s benchmark repo rate along with
Source:
SBP Textiles Metals exogenous factors helped curb aggregate demand in the economy. Central
bank efforts to control price pressures were assisted by improved food
availability, lower international commodity prices and high base-effects. As a
Pakistan: YoY Growth in Exports to 5 Largest
Markets result, headline consumer inflation fell by over 1600 basis points from its peak
(figures in brackets represent share in total in August 2008 to 8.9 percent in October 2009, allowing the central bank to
exports; percent)
100 lower rates for a third time this year to 12.5 percent on November 24. And
1
while the IMF may not have objected to yet another rate cut , core inflation
50 measures have remained in double digits, indicating the lagged effect of the
government deficit financing mix in the previous two years. Looking ahead,
0 with the recent increase in domestic electricity tariffs, anticipated hikes in gas
Apr-09
Apr-07

Apr-08

Oct-08
Oct-07

Oct-09
Jan-09
Jan-07

Jan-08
Jul-07

Jul-08

Jul-09

tariffs, a doubling of international oil prices, the rupee’s continued weakness,

-50
and severe sugar shortages in the domestic economy, price pressures will
Afghanistan (6%) China (6%) gather pace in the coming months. Indeed, November data show a pick-up in
Source: UAE (7%) UK (6%)
SBP USA (19%) consumer inflation to 10.5 percent due to a sharp increase in wholesale and
food costs, driven in part by low base effects and higher global commodity
prices; the government had also hiked power tariffs by 7 percent in October.
Pakistan: Inflation
30 (YoY; percent)
25 Although the fiscal deficit fell in FY09, Q1-FY10 has seen deterioration
20
15 Based on full-year data from the central bank, the fiscal deficit fell from Rs
10 777 billion in June 2008 (7.6 percent of GDP) to Rs 680 billion in June 2009
5
(5.2 percent of GDP). This Rs 97 billion reduction was the result of growth in
0
total revenues (23.4 percent year-on-year) outpacing growth in consolidated
Nov-08

Nov-09
Apr-09

Jun-09
Dec-08
Oct-08

Oct-09

-5
May-09
Mar-09
Feb-09

Sep-09
Jan-09

Aug-09
Jul-09

expenditures (11.2 percent). The slower pace of growth in expenditures was

Core inflation (YoY)

CPI (MoM)
1
In the press release following the second program review in May, the visiting mission stated that “any
further cut in the SBP’s discount rate will await a significant decline in core inflation’. Core inflation, as
Source: SBP WPI (YoY) measured by non-food, non-energy inflation, fell from 16.6 percent in May to 11 percent in October.
3
 December 2009

Global Food Prices largely due to an IMF-mandated reduction in subsidies, a collapse in

150
(YoY Percent Change; 2002-4: 100) 2
international oil and food prices and lower development expenditures.
100
The most important change on the fiscal front was the change in deficit
50
financing mix. This is reflective of IMF conditionality, which requires that net
0 government borrowing from the State Bank of Pakistan (SBP)--the central
bank--be reduced to zero at the end of each quarter. On a cash basis, central
Feb-08

Feb-09

Aug-09
Aug-08
Apr-08

Apr-09
Jun-08

Jun-09
Dec-07

Dec-08
Oct-07

Oct-08

Oct-09

-50 bank financing of government spending fell from Rs. 676.9 in FY08
(equivalent to 6.7 percent of GDP) to Rs. 114 billion in FY09 (1.0 percent of
-100 3
Overall Food Prices Diary GDP).
Oil Sugar
Source: FAO More recent numbers suggests that the improvement witnessed in fiscal
accounts last year has been reversed in the current fiscal year. The deficit for
Q1-FY10 (July – September 2009) amounted to 1.5 percent of GDP,
Pakistan: Fiscal Outcomes
compared with 1 percent in the year-earlier period. The driving force was a
% GDP; FY basis Q1-08 Q1-09 Q1-10
Total Revenues 3.1 2.9 2.9
sharp increase in total expenditures, which registered growth of 24.5 percent
Tax 2.2 2.1 2.0 (yoy), more than double the 11 percent growth in total revenues. This led to a
Non-tax 1 0.8 0.9 62.3 percent (yoy) expansion in the fiscal deficit to Rs223.7 billion. Under the
Total two major expenditure headings, current spending (including debt servicing
Expenditures 4.5 3.9 4.4
Current 3.4 3.4 3.5
and defence) rose a relatively modest 14.2 percent (yoy), while discretionary
Development 1.1 0.4 0.8 development spending doubled to 0.8 percent of GDP.
Fiscal Deficit 1.6 1.0 1.5
Source: MoF; AHL Equities Research Although these costs may have been unavoidable, the pace of expansion in
the fiscal deficit is worrisome. This is all the more true since historically it is
the last two quarters when the deficit rises most as public sector entities rush
Pakistan: Quarterly Trade & Current to book expenditures before year-end. If last year’s quarterly fiscal deficit
Account Deficit
($ Millions) distribution holds in FY10, and under the current pace of expansion, the
Q108 Q308 Q109 Q309 Q110
overall fiscal deficit for full FY10 is likely to exceed 7.4 percent of GDP, which
0
would be above the current IMF target of 4.6 percent.
-1000
Lower imports have reduced the external financing requirement
-2000
-3000 Pakistan’s current account deficit fell from a record $13.8 billion in FY08 to
-4000 $9.4 billion in FY09. This was due to sharply lower goods/services imports,
-5000 following a collapse in international oil prices and weak domestic demand.
Current account balance The moderation in Pakistan’s current account deficit was also supported by
Source: SBP Trade balance
higher inward remittances, which rose from $6.4 billion in FY08 to $7.8 billion
in FY09, despite a downturn in major expatriate markets (including the GCC,
U.S. and U.K.). Average monthly inflows have risen from $585 million in
Pakistan: Home Remittances calendar 2008 to over $700 million so far in 2009. The outlook, however, is
(YoY change; 12-mon rolling balance; percent) somewhat uncertain especially if the rise in such inflows represents savings
30
transfers of workers returning home as a result of job loss.
25
20
2
Development outlays are easier to cut given their discretionary nature and the fact that a large proportion
15 of the funds remain unspent at year-end. For example, press reports from May 2009 suggest that total
unspent public sector funds (federal ministries, autonomous organizations and provincial governments)
10
with commercial banks amounted to Rs 700 billion. The latest IMF program documents suggest that while
5 these balances have been reduced, the remainder will be transferred to the Federal Consolidated Fund by
June 2010.
3
0 Prior to the approval of IMF program on November 24, 2008 the federal government borrowed Rs. 357
billion from the central bank between July 1st, 2008 (the start of FY09) and November 15, 2008. Given
Nov-05 Nov-06 Nov-07 Nov-08 Nov-09
that the end fiscal year number was Rs. 114 billion, this implied the government retired Rs. 243 billion in
Source: SBP central bank debt over the remainder of FY09 (November 16, 2008 to June 30, 2009).
4
 December 2009

Pakistan: Quarterly Services and Income

Account Deficits
Recent balance of payments data from the central bank suggests that
($ Millions) Pakistan’s external deficit continued to narrow in the first quarter of FY10.
Q108 Q308 Q109 Q309 Q110 The current account deficit fell to $540 million (12.7 percent of level a year
0 ago), on the back of a sharp reduction in the trade, services and income
deficits. Weak aggregate demand and lower international oil prices resulted
-500
in oil imports running 40 percent below their peak in September 2008. This,
-1000 however, is likely to change going forward, given that oil prices have more
than doubled since their lows in December 2008. This will be somewhat
-1500 offset by the still-anaemic recovery in domestic demand that should keep the
-2000
trade deficit below the IMF’s program projection of $11.7 billion for FY10.
Source: SBP Services deficit Income deficit
In the financial account, net foreign portfolio investment amounted to a
negative $1 billion (outflows) in FY09, a sharp reversal from previous years,
Pakistan: Imports vs. Oil Prices
reflecting the downturn in global markets and enhanced Pakistan risk. Recent
5000 160
numbers suggest that net portfolio inflows turned positive during July-October
140
4000
120
this year on the back of improved fundamentals and greater risk appetite
100 globally. Looking ahead, with the benchmark Karachi Stock Exchange being
3000
80 battered by security concerns and profit taking in recent sessions, inflows
2000 60 could slow again.
40
1000
20 Net foreign direct investment fell to $3.7 billion in FY09, compared to $5.5
0 0 billion the previous year. The decline continued in the first four months of
Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09
Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

FY10 with inflows of just $622 million, about half the level in the previous
comparable period. The inflows are unlikely to improve in the short term
Source:
Bloomberg Imports (lhs; $ mlns) since: (a) much of the foreign direct investment over the last few years has
been in sectors catering to domestic consumer spending. With private sector
credit growth almost negligible on the back of security problems, high interest
Pakistan: Quarterly Net Foreign Investment
($ Millions) rates and slow economic activity, consumer spending should remain muted
2500
for now. (b) The bulk of foreign direct investment into Pakistan originates
2000 from the U.S., U.K., Netherlands, and the UAE, economies which have only
1500 4
just started to emerge from recession. And (c) mounting domestic security
1000 risks will make it difficult for the government to start its privatization program.
500
0 As for net other investment, which records debt creating inflows, the principal
inflows relate to higher government lending, while increases in private sector
Q3-FY08

Q4-FY08

Q1-FY09

Q2-FY09

Q3-FY09

Q4-FY09

Q1-FY10

-500
debt were muted by depressed domestic economic activity and tight credit
conditions globally. With the U.S. Congress approving a five year $7.5 billion
FDI Portfolio aid package, inflows under this heading should remain healthy, especially if
Source: SBP
U.S. assistance is able to attract other bilateral commitments. Net other
investment should also rise on the back of higher inflows into resident and
Pakistan: Stock of Foreign Currency Accounts
4.5 ($ Billions) non-resident foreign currency accounts (FCAs). As of October 2009, total
5
FCAs amounted to over $4 billion, close to their peak last year.
4.0

3.5 As a result of lower external financing requirements and strong support from
3.0 the IMF, SBP’s net foreign exchange reserves, have risen to $10.7 billion,
from a low of $3.3 billion in October 2008, equivalent to four months of import
2.5

2.0 4
In recent years, South East Asian countries such as Hong Kong, Singapore, Malaysia and China have also
Apr-04

Apr-06

Apr-08
Apr-05

Apr-07

Apr-09
Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

become increasingly important sources of direct investment inflows.

5
Although these inflows are not the explicit liability of the central bank - they are held and invested abroad
by commercial banks - a run on FCAs would probably have to be financed from central bank reserves,
Source: Bloomberg unless banks have maintained very liquid investments.
5
 December 2009

Pakistan: Central Bank Reserves cover. SBP’s net foreign assets remain around $3 billion, reflecting the fact
($ billions) $11.2bn that the rise in reserves is primarily due to debt creating inflows.
11

9 05 Dec:
$9.9bn
7 Outlook
5
Fiscal and current accounts deficit could rise again...
$3.5bn
3
A tentative recovery in economic activity will be helped by last month’s 50 bps
May-09
Mar-09
Sep-08

Sep-09
Jan-09
Nov-08

Nov-09
Jul-08

Jul-09

cut in the central bank’s benchmark discount rate. However, given the
Source: State Bank of Pakistan nascent state of the global recovery, there are still significant risks on the
macroeconomic front, even though investor perceptions have improved of
Pakistan: SBP Discount Rate late. Paramount amongst these is resurgence in inflation in the coming
16 (percent)
months on the back of higher government spending, domestic retail
14
gas/electricity tariff increases agreed to with multilateral donors and rising
12 global oil/commodity prices. The latter is particularly important as this also
increases the external trade deficit. Moreover, exports, which have started to
10
rise in the last few months, could be dented in the event that the global
8 economy takes a turn for the worst.
6
As noted, much of the improvement in the economy is on account of strong
Nov-00

Nov-03

Nov-06

Nov-09

donor support, particularly from the IMF. Thus continuation of the IMF
program is central to Pakistan capitalizing on the progress made thus far. In
Source: Bloomberg
this context, the country has had a chequered history with the IMF; only two
programs out of the eleven negotiated since 1988 have been completed. And
Pakistan: CDS and Stock Market
11500 6000 while the country’s geopolitical importance limits to some extent the downside
5000 to what might happen if IMF program conditions are not met, continued fiscal
9500 slippages could led to program termination as in the past.
4000
7500 3000
Progress on structural reforms remains slow
2000
5500
1000 Further weighing on the outlook are critical infrastructure shortages in the
3500 0 country. Foremost amongst these is electricity shortages with peak demand
Jun-08

Jun-09
Dec-07

Dec-08

Dec-09

outstripping peak supply by about 3000MW. Although the government has

taken steps to address this shortfall, namely by permitting the setting up of
Source: KSE-100 Index (lhs) rental power plants, this is likely to remain a short-term solution. Over the
Bloomberg 5-YR CDS (bps; rhs)
longer-term, the government will need to invest substantially in electricity
generation, transmission and distribution to bring additional capacity online
International Oil Prices and reduce power outages.
(WTI; $/bbl)
149
129 Political instability could complicate the reform program agreed with
109 donors
89
Although the political environment has improved considerably since the exit of
69
Pervez Musharraf from the presidency in August 2008, the government
49
continues to face an activist judiciary, an anti-incumbent media and vocal
29
opposition parties demanding constitutional reform that would reduce the
Nov-08

Apr-09
Jun-08

Dec-09
Oct-07

Mar-08

Sep-09
Jan-08

Jan-09
Aug-07

Aug-08

Jul-09

presidency to a figurehead. While there is little that opposition parties can

affect through parliamentary measures since the incumbent Pakistan People’s
Source: Bloomberg Party (PPP) enjoys a majority in the national assembly, political and public
6
 December 2009

pressure channelled through an independent media will likely result in the

Pakistan: EMBIG Strip Spreads incumbent president relinquishing many of his powers (appointing service
2500 (basis points) chiefs, being head of the nuclear command authority, and the power to
6
2000 dissolve the assembly). With the PPP-led government fighting on several
fronts, the possible neglect of the reform agenda agreed to with the IMF
1500
cannot be ruled out.
1000
500 There has been deterioration in security conditions since our last report
0
Security problems continue to present a major risk to economic recovery and
Nov-08
Apr-08

Dec-09
Oct-07

May-09
Mar-07

Feb-09
Jan-08

Aug-08

Aug-09
Jul-07

policy consistency in the foreseeable future. Retaliatory strikes by militants

have targeted urban centres, along with military officials and parliamentarians.
Source: JP Morgan EMBIG Pakistan We are concerned that fiscal costs from expanded military operations, the
displacement of many civilians, and reconstruction activities will strain
budgetary outcomes in the next few years.

6
The constitutional amendments put in place by former President Musharraf reinforced the president’s
office and made him the real seat of power in the government. However, under the original 1973
constitution, the elected prime minister was the head of government, while the president was merely a
figurehead, obliged to act under the advice of the prime minister.
7
 December 2009

Keith Savard
Director of Economic Research
Keith.Savard@samba.com

James Reeve
Senior Economist
James.Reeve@samba.com

Andrew B. Gilmour
Senior Economist
Andrew.Gilmour@samba.com

Raza A. Agha
Research Economist
Raza.Agha@samba.com

Touheed Ahmed
Management Associate
Touheed.Ahmed@samba.com

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