Pakistan’s Economy

Issues and Prospects

Haider Hussain
(+92-21) 32059014
haider.hussain@pakbrunei.com.pk

September 2010
 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 Export USA (23%), UAE (9%), Afghanistan (6%), UK (6%), Germany (4%)
Destinations
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) & domestic

market 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
Economic Growth

Share of Consumption & Investment in GDP

Private consumption Gross fixed capital formation
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
FY01

FY02

FY03

FY05

FY06

FY08

FY09
FY00

FY04

FY07

FY10
Source: Ministry of Finance

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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
Economic Growth

An Overheating Economy
Excess Demand, PKR bn (LHS) Headline Inflation (RHS)
2,500 25%

2,000
20%

1,500
15%

1,000

10%
500

5%
0
FY04

FY05

FY06

FY08

FY09

FY10
FY00

FY01

FY02

FY03

-500 FY07 0%

Source: Ministry of Finance

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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 nascent
recovery
 Despite fall in global inflation in FY09, domestic inflation eased only slightly owing to market
inefficiencies
Economic Growth

Rising Inflation and Central Bank's response

Discount Rate Headline Inflation Core Inflation
25.0%

20.0%

15.0%

10.0%

5.0%

0.0%
FY07

FY09

FY10
FY08

Source: SBP

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  Low investment growth, cost-push inflation and higher interest rates resulted in a fall of LSM
growth in FY09. Poor law & order also contributed in production slump
 In FY10, aggregate demand recovered a bit, resulting in considerable manufacturing growth
Economic Growth

Growth in GDP Components

Agriculture Large Scale Manufacturing Services
25%
Sectoral Share in GDP
20% Agriculture 22%

15%

10%
Services
5% 53%
Large Scale
0% Manufacturing
12%
-5%
Small Scale Manufacturing & Energy 13%
-10%
FY04

FY05

FY06

FY07

FY08

FY09

FY10

Source: Ministry of Finance

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

Boom, Bust, Recovery!

Real GDP Growth

10.0%
9.0%
9.0%
8.0%
7.0% 7.5%
6.0% 6.8%

5.0% 5.8%

4.0% 4.7%
4.1%
3.0% 3.7%
3.1%
2.0%
2.0%
1.0%
1.2%
0.0%
FY02

FY04

FY05

FY06

FY08

FY09

FY10
FY01

FY03

FY07

Source: Ministry of Finance

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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
Fiscal Developments

Revenue Mobilization
Real GDP Growth (LHS) Tax-to-GDP (RHS)
10% 15%
9%
14%
8%
7%
13%
6%
5% 12%
4%
11%
3%
2%
10%
1%
0% 9%
FY91
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Source: Ministry of Finance, PBIC Research

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  Expansionary fiscal policy especially after FY05, despite weak revenue mobilization
 Government has resorted to borrowings and grants in order to fuel fiscal expansion
Fiscal Developments

Expenditure Revenue Gap Financing of Government Expenditure

Revenue to GDP Expenditure to GDP As % of Expenditure
Borrowings Grants & Privatization Revenue
24% 100%
90%
22%
80%
20% 70%
60%
18% 50%
40%
16%
30%
14% 20%
10%
12% 0%

FY04

FY06

FY08

FY10
FY05

FY07

FY09
FY01

FY02

FY05

FY06

FY07

FY10
FY03

FY04

FY08

FY09

Source: Ministry of Finance, PBIC Research

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  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
External Sector Dynamics

Current Account Deficit - Rise & Fall

Remittances (USD billion, RHS) Trade Deficit, % of GDP (LHS)
Current A/C Deficit, % of GDP (LHS)
10.0% 10.0
8.0% 9.0
8.0
6.0%
7.0
4.0% 6.0
2.0% 5.0
0.0% 4.0
3.0
-2.0%
2.0
-4.0% 1.0
-6.0% 0.0
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10
Source: SBP, PBIC Research

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  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…
External Sector Dynamics

FX Reserves and Exchange Rate

FX Reserves, USD bn (RHS) PKR/USD (LHS)
90 18
Current PKR/USD parity @ PKR 85.7 per USD
16
85
14
80 12
10
75
8
70 6
4
65
2
60 0
Oct-08

Oct-09
Jun-08

Jun-10
Jun-09
Aug-08

Dec-08

Aug-09

Dec-09
Apr-08

Apr-09

Apr-10
Feb-09

Feb-10
Source: SBP, PBIC Research

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 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
External Sector Dynamics

Core FX Inflow to FX Reserve Ratio

Core FX inf low = export of goods & services + interest & dividend earned on f oreign investment +
remittances + f oreign investment in Pakistan
50%
45%
40%
35%
30%
25%
20%
15%

Jan-10
Jan-09
Sep-08

Sep-09

Nov-09
Nov-08
Jul-08

Jul-09

Mar-10
Mar-09
May-08

May-09

May-10
Source: SBP, PBIC Research

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14
External Sector Dynamics

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
Inter-day Standard Deviation

Source: SBP, PBIC Research

23-Mar-08
23-Apr-08
Exchange Rate Volatility

23-May-08
23-Jun-08
23-Jul-08
23-Aug-08
23-Sep-08
23-Oct-08
23-Nov-08
 Exchange rate volatility fell sharply after Nov-08

23-Dec-08
23-Jan-09
23-Feb-09
23-Mar-09
23-Apr-09
confusion over IMF’s tranche disbursement during late FY10

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

23-Jun-10
  International debt market’s response was positive after increase in FX reserves and fall in current
account deficit
External Sector Dynamics

Credit Default Swap on Pakistan's 5-Year Eurobond

4000
Peak @ 3,144 bps in Dec-08, Current @ 540 bps
3500

3000

2500

2000

1500

1000

500

0
Mar-08

Mar-09

Mar-10
Jan-08

Jan-10
Jan-09

May-09

May-10
May-08
Sep-07

Sep-08

Nov-08

Nov-09
Nov-07

Sep-09
Jul-07

Jul-10
Jul-08

Jul-09

Source: SBP, PBIC Research

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  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 FDI
and FPI)
External Sector Dynamics

Foreign Direct Investment Foreign Portfolio Investment

USD million USD million
6,000 2,000

5,000
1,500

4,000
1,000

3,000
500
2,000
-
1,000

FY02

FY05

FY06

FY09

FY10
FY03

FY04

FY07

FY08
(500)
-
FY02

FY03

FY07

FY08
FY04

FY05

FY06

FY09

FY10

(1,000)

Source: SBP, PBIC Research

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  Money supply grew faster than GDP, another reason behind contractionary monetary policy post
FY05
 After FY07, money supply grew less than nominal GDP thus system became relatively less liquid
Debt Market and Interest Rates

Monetary Liquidity
Growth in Money Supply Nominal GDP Growth
25.0%
23.0%
21.0%
19.0%
17.0%
15.0%
13.0%
11.0%
9.0% Excess Liquidity post Monetary tightening and
9-11 inflows fall in liquidity
7.0%
5.0%
FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10
Source: SBP, PBIC Research

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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)
Debt Market and Interest Rates

Policy Tightening & Secondary Market Transaction Demand for Money & Interest
Yields Rates
6-month Tbill Yield SBP Discount Rate Currency in Circulation as % of M2 (LHS)
6M Tbill (RHS)
16% 26% 14%
15% 14%
25% 13%
14%
24% 13%
13% 12%
12% 23% 12%
11% 11%
22% 11%
10%
21% 10%
9% 10%
8% 20% 9%

Jul-09

Jul-10
Jul-08

Jan-09

Jan-10
Jan-08
Jun-08
Jan-08

Nov-08
Dec-05

Aug-07

Sep-09
Jul-05

Apr-08

Apr-09

Apr-10
Oct-08

Oct-09
Apr-09
Mar-07

Feb-10
May-06
Oct-06

Source: SBP, PBIC Research

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 August 2010 Floods
Initial Assessment
Exogenous Shock and changing prospects

 Economic stabilization efforts took a serious blow after worst floods in the history
 Catastrophic damages severely affected medium term economic outlook
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 billion
Power Shortfall 3.135 gigawatts
Source: Various news reports

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

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 August 2010 Floods
Aftermath
Exogenous Shock and changing prospects

FY11 - Government FY11 - Post flood

Targets 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 billion
Source: News reports, PBIC Research

 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 announced
by multilateral and bilateral sources)
 Restructuring of existing IMF loan (not very significant likelihood)

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 Contact Details

Treasury Group
Fixed Income Investments and Marketing Unit Team

Ahmed Ateeq
Head, MM, Fixed Income and TMU
(+92-21) 5361370-3
ahmed.ateeq@pakbrunei.com.pk

Haider Hussain
Unit Head, Research
(+92-21) 32059014
haider.hussain@pakbrunei.com.pk

Zain Ali Shams

Analyst
(+92-21) 35361215-9 Ext. 141
zain.shams@pakbrunei.com.pk

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

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