Pakistan economic/political 2006 forecasts
Brief overview of Pakistans economic/political forecast.
OVERVIEW
The Economist Intelligence Unit expects the president and chief of army staff, General Pervez Musharraf, to remain in power in 2005-06. He has the support of a majority in parliament, the power to dismiss the prime minister and the right to suspend parliament. The biggest risk to political stability is that he may be assassinated. The economy is expected to perform strongly: real GDP growth is forecast at 6.6% in fiscal year 2005/06 (July-June), following an estimated rate of 8.4% in 2004/05. Inflation is forecast to rise, to average of 8.6% in 2005 before falling back to 7.9% in 2006. The current-account deficit will widen to 3.1% of GDP in 2005 and will stand at 3.6% of GDP in 2006, in line with the rising trade deficit.
Key changes from last month
Political outlook
Reacting to a request from the UK government after the July 7th terrorist bombings in London, in late July General Musharraf ordered a crackdown on militants and unregistered madrassas (Islamic schools). He also ordered all foreign students studying in madrassas to leave Pakistan. The move has been met by resentment from the schools and the Islamic parties, who are likely to intensify their opposition to the government.
Economic policy outlook
The price of crude oil (dated Brent Blend) reached US$62.7/b on August 9th, driven by ever-increasing demand and concern over possible supply disruptions. High international oil prices are filtering through into local prices, and the need for the State Bank of Pakistan (SBP, the central bank) to tighten monetary policy has thus become more urgent.
Economic forecast
The SBP has released its Monetary Policy Statement for July-December 2005. In line with the statement, and high international oil prices, the Economist Intelligence Unit has revised up its consumer price inflation forecast for 2006 to 7.9%, from 6.4% previously.
Outlook for 2005-06: Domestic politics
Unless he is assassinated, the president and chief of army staff, General Pervez Musharraf, will remain in power in 2005-06 and beyond. General Musharraf has the support of a majority in parliament and of a loyal prime minister, Shaukat Aziz. In addition, the Supreme Court, in a final ruling, has dismissed legal challenges to his rule mounted by the Pakistan Lawyers' Forum and five opposition parties. In his capacity as army chief he will also be able to rely on the continued loyalty of the army, which has prospered under his rule. The army remains Pakistan's most influential institution and General Musharraf's ultimate guarantor of power. On May 17th 2005 it was announced that General Musharraf would seek to stay on as president when his current term expires in 2007. Pakistan is due to hold parliamentary elections in 2007, and an electoral college is due to choose a president in the same year. Given the current political structure, it is likely that General Musharraf will win the 2007 presidential election.
The main risk to political stability remains the threat that General Musharraf or Mr Aziz could be assassinated by one of a number of radical militant groups. General Musharraf has narrowly survived two assassination attempts, one in late 2003 and the other in 2004, and Mr Aziz narrowly escaped a bomb attack in July 2004. Ongoing insurgencies in the western provinces of Baluchistan and Waziristan, as well as ethnic conflicts between Shias and Sunnis, provide fertile ground for the recruitment of potential assassins and militants. In July the situation worsened. Criticism from the British government (following the July 7th bombings in the UK capital, London) of Pakistan's inability to prevent madrassas (Islamic schools) from teaching extremist views led General Musharraf to order all foreign students to leave Pakistan. This has infuriated Islamic teachers, and is likely to lead to the further radicalisation of some student groups. Militant groups in Kashmir have also been angered by General Musharraf's peace overtures to India, and insurgents in Baluchistan and Waziristan have been angered by operations undertaken against them by Pakistan's army.
If General Musharraf were assassinated, it is likely that either the prime minister, the chairman of the Senate (the upper house of parliament) or another senior general would take over as head of government. Under such a scenario a state of emergency would be declared for an interim period, possibly to be followed by an election. (There is a precedent for this: in 1988, when Pakistan's last military ruler, General Muhammad Zia ul-Haq, was killed in an air crash, he was succeeded as head of state by the chairman of the Senate. Elections followed shortly afterwards.)
The opposition has stated that General Musharraf’s announcement on May 17th of his intention to remain in power highlights his "dictatorial designs". The main opposition group, the Alliance for the Restoration of Democracy (ARD), is made up of a coalition of the Pakistan People's Party (PPP) and the Pakistan Muslim League Nawaz, or PML (N). It is controlled by two former prime ministers—the leader of the PPP, Benazir Bhutto, and the head of the PML (N), Nawaz Sharif (although the latter officially handed over leadership to his younger brother, Shahbaz Sharif, in 2002). Traditionally fierce rivals, Ms Bhutto and Mr Sharif met in early February 2005 in Saudi Arabia, and agreed to co-operate and to draw up a charter for the restoration of democracy. However, General Musharraf is unlikely to permit either of them to return to Pakistan. Without their presence in the country, their parties will remain weak.
Outlook for 2005-06: International relations
Relations between Pakistan and its long-standing rival, India, have been improving since their low in 2002, when the two countries came close to war. Frightened by the prospect of war becoming a reality, both parties have displayed an increasing maturity and sophistication in peace talks, going beyond rhetoric and general statements to discuss concrete peace and conflict-avoidance initiatives. A major breakthrough occurred in April 2005, when the two countries launched a bus route linking the Indian- and Pakistani-controlled parts of Kashmir. In early August each side formally agreed to pre-notify the other before carrying out missile tests. (This channel of communication already existed, but was previously informal.) Both countries also agreed to maintain a line of communication between their respective foreign secretaries in all eventualities short of the declaration of war. Nevertheless, although improving, relations are likely to suffer setbacks during the forecast period. Exchanges of fire across the Line of Control (the de facto border that divides Kashmir) are likely during forecast period.
Pakistan's long border with Afghanistan, its role as a Muslim ally in the US-led "war on terror" and General Musharraf's willingness to support the US military effort in Afghanistan will override US concerns about Pakistan's lack of democracy and nuclear proliferation. As a result, the US will continue to afford General Musharraf strong diplomatic backing, and will provide Pakistan with substantial economic and military assistance.
Outlook for 2005-06: Policy trends
Pakistan's policymakers have in the past few years created an environment within which the private sector has begun to thrive, and poverty reduction will hinge on whether this trend can be maintained and strengthened. However, inflation remains high, and insufficient action on this front could undermine macroeconomic stability. Action to stem inflation has come late, and this remains the most significant policy risk over the forecast period.
The government will attempt to introduce policies that continue to improve Pakistan's competitiveness, but will be only partially successful, owing to vested economic and political interests. These policy measures include reducing red tape, rationalising utility charges, improving infrastructure and permitting further flexibility in labour markets. Rising expenditure on health and education will contribute to the country's long-term economic growth potential. The need to increase and diversify tax revenue, to expedite the privatisation programme and to improve Pakistan's social infrastructure will continue to be pressing. The government is also keen to enhance banking efficiency further in order to increase the availability of financing, particularly for small and medium-sized enterprises.
Outlook for 2005-06: Fiscal policy
Revenue in the first nine months of fiscal year 2004/05 (July-June) surpassed by 1.3% the target set by Central Board of Revenue (CBR, Pakistan's main tax agency), reaching PRs401.3bn (US$6.6bn). Nevertheless, receipts have not risen in line with above-target GDP growth, and this remains a concern. Overreliance on the petroleum tax meant that government revenue fell when high oil prices forced it to reduce the tax. A sharp rise in expenditure led to a budget deficit during the nine-month period. In addition, with interest rates moving upwards, interest payments on government debt will rise. Aid inflows should remain strong in 2005-06 as the US continues to reward the government for supporting the “war on terror”, but military expenditure is likely to rise.
The burden of taxation remains skewed, falling disproportionately on large-scale manufacturing. Substantive reform of the CBR and a widening of the tax base are needed if Pakistan is to avoid fiscal pressures once aid inflows fall. However, the government is likely to be only partly successful in achieving these objectives. The Economist Intelligence Unit therefore expects the overall fiscal deficit to rise from 2.8% of GDP in 2003/04 to an average of 3.1% of GDP in 2004/05 and 2005/06.
Outlook for 2005-06: Monetary policy
Monetary policy has been kept loose in recent years in order to stimulate economic growth. However, inflationary pressures and international interest rates began to edge upwards in 2004, leading the State Bank of Pakistan (SBP, the central bank) to begin to tighten policy in the latter half of the year. In late 2004 the SBP stated that it would shift from an accommodative monetary policy stance to a neutral one, and in April 2005 the SBP increased its discount rate by a substantial 1.5 percentage points, to 9%. Treasury bill yields have also been raised.
In its Monetary Policy Statement for July-December 2005 the central bank argued that it would continue to tighten policy, citing the need to contain inflation. We expect monetary tightening to continue in the second half of 2005 and into 2006 as relatively strong inflationary pressures persist. High international oil prices, coupled with strong domestic food price rises, have fuelled inflation, and the interest rate changes alone are unlikely to be effective in reducing these pressures. The central bank has therefore also requested that the government use administrative measures, such as reducing domestic fuel taxes, to contain supply-side inflation. The source of the current food price inflation is not entirely clear, as the harvest has been relatively good; it is likely to be the result of market manipulation rather than a shortage of supply.
Outlook for 2005-06: International assumptions
International assumptions summary
(% unless otherwise indicated)
2003c 2004c 2005 2006
Real GDP growth
World 3.9 5.1 4.2 4.0
US 3.0 4.4 3.2 2.8
China 9.3 9.5 9.1 8.0
EU25 1.3 2.4 1.7 2.0
Exchange rates
¥:US$ 115.9 108.1 107.8 103.0
US$:€ 1.1 1.2 1.2 1.3
SDR:US$ 0.71 0.68 0.68 0.67
Financial indicators
¥ 2-month private bill rate 0.03 0.00 0.00 0.17
US$ 3-month commercial paper rate 1.10 1.48 3.41 4.63
Commodity prices
Oil (Brent; US$/b) 28.8 38.5 53.3 50.5
Cotton (US cents/lb) 63.3 62.0 56.7 62.0
Food, feedstuffs & beverages (% change in US$ terms) 6.6 8.6 -0.6 1.1
Industrial raw materials (% change in US$ terms) 13.0 21.0 4.2 -6.2
Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.
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Economic growth in the US is forecast to slow to an annual average rate of 3% in 2005-06, from 4.4% in 2004. This will still constitute a solid performance, and, along with persistently strong (albeit slower) growth in China, will underpin world GDP growth of 4.2% in 2005 and 4% in 2006. However, rising interest rates in the US will mean that emerging-market investments will become less attractive to investors in the OECD. We have revised up our forecast for international oil prices (dated Brent Blend) to an average of US$53.3/barrel in 2005 (from US$50.5/b previously) and US$50.5/b in 2006 (US$46.5/b previously). These high oil prices will constitute a significant threat to Pakistan's economy. The country will also be vulnerable to tighter monetary policy in the US, which will reduce international liquidity and will ultimately put pressure on emerging markets with large financing needs.
Outlook for 2005-06: Economic growth
The government estimates real GDP growth (at factor cost) in 2004/05 at 8.4%. Agricultural expansion, at around 7.5%, substantially exceeded the government's target of 4% for 2004/05, driven by a bumper wheat and cotton crop. The strong cotton crop fuelled the growth of the textile industry, owing to the fact that domestic cotton prices consequently remained low. The manufacturing sector achieved double-digit growth in 2004/05, while the services sector grew by around 8%. Low interest rates supported growth in 2004/05, with both investment and private consumption recording healthy growth rates. Real GDP is forecast to grow by 6.6% in 2005/06, driven by a strong monsoon and continued expansion of textile production and other manufacturing output, as well as strong private consumption and growth in gross fixed investment. The strength of the industrial and agricultural sectors means that growth in services output should also remain buoyant. However, higher interest rates, although helping to rein in inflation, will dampen growth, and agricultural output is expected to be far less strong in 2005/06 than in 2004/05. The main domestic policy risks to the economy include a possible reversal of economic reforms, perhaps caused by a political crisis, and a much sharper than expected tightening of monetary policy triggered by an oil-related surge in inflation.
Outlook for 2005-06: Inflation
Inflationary pressures have been rising strongly since 2004, and remain the biggest threat to the economy. The central bank believes that if inflation is not contained it could lead to a significant rise in inflationary expectations, with strong repercussions on long-term growth. According to the central bank, consumer price inflation has remained high, averaging 8.7% year on year in June 2005 (although this was lower than the rates of 9.8% recorded in May 2005 and 11.1% in April). The main culprit is food price inflation, which accounts for 60% of the overall consumer price index; food prices were up by 12.6% year on year in May and by 9.3% in June. Non-food inflation is lower, but it too has been rising as a result of high oil prices, the rapid rate of credit expansion and inflated asset prices. However, a good harvest this year and monetary tightening by the central bank will help to stem the rise in inflation. Overall, we expect inflation to average 8.6% in 2005 and to slow to 7.9% in 2006.
Outlook for 2005-06: Exchange rates
The Pakistan rupee remained stable at PRs59.1-59.7:US$1 in the first seven months of 2005, and is expected to remain strong against the US currency during the remainder of 2005, averaging PRs59.6:US$1 for the year as a whole. Inflows of remittances from Pakistanis working overseas have remained strong, despite a weakening in recent months, and are expected to continue to support the Pakistan rupee. We expect the currency to weaken against both the US dollar and the euro in 2006, largely as result of the widening current-account deficit. The rate of currency depreciation could be faster than forecast if the domestic political situation deteriorates or relations with India sour.
Outlook for 2005-06: External sector
Despite strong growth in exports in 2004, even higher import growth (largely driven by high international oil prices) caused the trade balance to deteriorate. As a result, the current account is estimated to have moved from a surplus equivalent to 4.3% of GDP in 2003 to a deficit of 0.9% of GDP in 2004. In 2005-06 textile exports are expected to post strong growth, owing to the abolition of textile and garment export quotas for World Trade Organisation member countries at end-2004. (This is despite a relatively poor start during the first few months of the new trading regime.) Exports generally will be boosted by government efforts to strengthen trade links, including through bilateral trade deals, with Pakistan's main trading partners. On the import side, however, high oil prices will remain a concern. In addition, stronger textile exports will require higher imports of related raw materials and machinery. Inflows of remittances will provide some support to the current-account balance, but the services deficit will widen, as relatively strong GDP growth boosts demand for imported business services. On balance, we expect the current-account deficit to rise to US$3.2bn (3.1% of GDP) in 2005 and US$4.1bn (3.6% of GDP) in 2006.
Outlook for 2005-06: Forecast summary
Forecast summary
(% unless otherwise indicated)
2003a 2004b 2005c 2006c
Real GDP growth 5.8 6.4 8.4 6.6
Industrial production growth 17.9b 9.3 10.4 7.1
Gross agricultural production growth 4.1 2.6 7.5 1.0
Unemployment rate (av) 7.6b 7.0 6.6 6.3
Consumer price inflation (av) 2.9 7.4a 8.6 7.9
Consumer price inflation (year-end) 5.4 7.4a 9.1 7.3
Short-term interbank rate 2.1 2.7a 4.6 6.1
Consolidated central government balance (% of GDP) -2.9 -2.8a -3.1 -3.0
Exports of goods fob (US$ bn) 11.9 13.4 14.9 17.0
Imports of goods fob (US$ bn) -12.0 -16.7 -20.6 -23.3
Current-account balance (US$ bn) 3.6 -0.8 -3.2 -4.1
Current-account balance (% of GDP) 4.3 -0.9 -3.1 -3.6
External debt (year-end; US$ bn) 36.4 35.9 39.3 41.9
Exchange rate PRs:US$ (av) 57.8 58.3a 59.6 60.5
Exchange rate PRs:¥100 (av) 49.8 53.9a 55.3 58.7
Exchange rate PRs:€ (av) 65.4 72.5a 73.1 76.2
Exchange rate PRs:SDR (av) 80.9 86.3a 87.6 90.2
a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.
OVERVIEW
The Economist Intelligence Unit expects the president and chief of army staff, General Pervez Musharraf, to remain in power in 2005-06. He has the support of a majority in parliament, the power to dismiss the prime minister and the right to suspend parliament. The biggest risk to political stability is that he may be assassinated. The economy is expected to perform strongly: real GDP growth is forecast at 6.6% in fiscal year 2005/06 (July-June), following an estimated rate of 8.4% in 2004/05. Inflation is forecast to rise, to average of 8.6% in 2005 before falling back to 7.9% in 2006. The current-account deficit will widen to 3.1% of GDP in 2005 and will stand at 3.6% of GDP in 2006, in line with the rising trade deficit.
Key changes from last month
Political outlook
Reacting to a request from the UK government after the July 7th terrorist bombings in London, in late July General Musharraf ordered a crackdown on militants and unregistered madrassas (Islamic schools). He also ordered all foreign students studying in madrassas to leave Pakistan. The move has been met by resentment from the schools and the Islamic parties, who are likely to intensify their opposition to the government.
Economic policy outlook
The price of crude oil (dated Brent Blend) reached US$62.7/b on August 9th, driven by ever-increasing demand and concern over possible supply disruptions. High international oil prices are filtering through into local prices, and the need for the State Bank of Pakistan (SBP, the central bank) to tighten monetary policy has thus become more urgent.
Economic forecast
The SBP has released its Monetary Policy Statement for July-December 2005. In line with the statement, and high international oil prices, the Economist Intelligence Unit has revised up its consumer price inflation forecast for 2006 to 7.9%, from 6.4% previously.
Outlook for 2005-06: Domestic politics
Unless he is assassinated, the president and chief of army staff, General Pervez Musharraf, will remain in power in 2005-06 and beyond. General Musharraf has the support of a majority in parliament and of a loyal prime minister, Shaukat Aziz. In addition, the Supreme Court, in a final ruling, has dismissed legal challenges to his rule mounted by the Pakistan Lawyers' Forum and five opposition parties. In his capacity as army chief he will also be able to rely on the continued loyalty of the army, which has prospered under his rule. The army remains Pakistan's most influential institution and General Musharraf's ultimate guarantor of power. On May 17th 2005 it was announced that General Musharraf would seek to stay on as president when his current term expires in 2007. Pakistan is due to hold parliamentary elections in 2007, and an electoral college is due to choose a president in the same year. Given the current political structure, it is likely that General Musharraf will win the 2007 presidential election.
The main risk to political stability remains the threat that General Musharraf or Mr Aziz could be assassinated by one of a number of radical militant groups. General Musharraf has narrowly survived two assassination attempts, one in late 2003 and the other in 2004, and Mr Aziz narrowly escaped a bomb attack in July 2004. Ongoing insurgencies in the western provinces of Baluchistan and Waziristan, as well as ethnic conflicts between Shias and Sunnis, provide fertile ground for the recruitment of potential assassins and militants. In July the situation worsened. Criticism from the British government (following the July 7th bombings in the UK capital, London) of Pakistan's inability to prevent madrassas (Islamic schools) from teaching extremist views led General Musharraf to order all foreign students to leave Pakistan. This has infuriated Islamic teachers, and is likely to lead to the further radicalisation of some student groups. Militant groups in Kashmir have also been angered by General Musharraf's peace overtures to India, and insurgents in Baluchistan and Waziristan have been angered by operations undertaken against them by Pakistan's army.
If General Musharraf were assassinated, it is likely that either the prime minister, the chairman of the Senate (the upper house of parliament) or another senior general would take over as head of government. Under such a scenario a state of emergency would be declared for an interim period, possibly to be followed by an election. (There is a precedent for this: in 1988, when Pakistan's last military ruler, General Muhammad Zia ul-Haq, was killed in an air crash, he was succeeded as head of state by the chairman of the Senate. Elections followed shortly afterwards.)
The opposition has stated that General Musharraf’s announcement on May 17th of his intention to remain in power highlights his "dictatorial designs". The main opposition group, the Alliance for the Restoration of Democracy (ARD), is made up of a coalition of the Pakistan People's Party (PPP) and the Pakistan Muslim League Nawaz, or PML (N). It is controlled by two former prime ministers—the leader of the PPP, Benazir Bhutto, and the head of the PML (N), Nawaz Sharif (although the latter officially handed over leadership to his younger brother, Shahbaz Sharif, in 2002). Traditionally fierce rivals, Ms Bhutto and Mr Sharif met in early February 2005 in Saudi Arabia, and agreed to co-operate and to draw up a charter for the restoration of democracy. However, General Musharraf is unlikely to permit either of them to return to Pakistan. Without their presence in the country, their parties will remain weak.
Outlook for 2005-06: International relations
Relations between Pakistan and its long-standing rival, India, have been improving since their low in 2002, when the two countries came close to war. Frightened by the prospect of war becoming a reality, both parties have displayed an increasing maturity and sophistication in peace talks, going beyond rhetoric and general statements to discuss concrete peace and conflict-avoidance initiatives. A major breakthrough occurred in April 2005, when the two countries launched a bus route linking the Indian- and Pakistani-controlled parts of Kashmir. In early August each side formally agreed to pre-notify the other before carrying out missile tests. (This channel of communication already existed, but was previously informal.) Both countries also agreed to maintain a line of communication between their respective foreign secretaries in all eventualities short of the declaration of war. Nevertheless, although improving, relations are likely to suffer setbacks during the forecast period. Exchanges of fire across the Line of Control (the de facto border that divides Kashmir) are likely during forecast period.
Pakistan's long border with Afghanistan, its role as a Muslim ally in the US-led "war on terror" and General Musharraf's willingness to support the US military effort in Afghanistan will override US concerns about Pakistan's lack of democracy and nuclear proliferation. As a result, the US will continue to afford General Musharraf strong diplomatic backing, and will provide Pakistan with substantial economic and military assistance.
Outlook for 2005-06: Policy trends
Pakistan's policymakers have in the past few years created an environment within which the private sector has begun to thrive, and poverty reduction will hinge on whether this trend can be maintained and strengthened. However, inflation remains high, and insufficient action on this front could undermine macroeconomic stability. Action to stem inflation has come late, and this remains the most significant policy risk over the forecast period.
The government will attempt to introduce policies that continue to improve Pakistan's competitiveness, but will be only partially successful, owing to vested economic and political interests. These policy measures include reducing red tape, rationalising utility charges, improving infrastructure and permitting further flexibility in labour markets. Rising expenditure on health and education will contribute to the country's long-term economic growth potential. The need to increase and diversify tax revenue, to expedite the privatisation programme and to improve Pakistan's social infrastructure will continue to be pressing. The government is also keen to enhance banking efficiency further in order to increase the availability of financing, particularly for small and medium-sized enterprises.
Outlook for 2005-06: Fiscal policy
Revenue in the first nine months of fiscal year 2004/05 (July-June) surpassed by 1.3% the target set by Central Board of Revenue (CBR, Pakistan's main tax agency), reaching PRs401.3bn (US$6.6bn). Nevertheless, receipts have not risen in line with above-target GDP growth, and this remains a concern. Overreliance on the petroleum tax meant that government revenue fell when high oil prices forced it to reduce the tax. A sharp rise in expenditure led to a budget deficit during the nine-month period. In addition, with interest rates moving upwards, interest payments on government debt will rise. Aid inflows should remain strong in 2005-06 as the US continues to reward the government for supporting the “war on terror”, but military expenditure is likely to rise.
The burden of taxation remains skewed, falling disproportionately on large-scale manufacturing. Substantive reform of the CBR and a widening of the tax base are needed if Pakistan is to avoid fiscal pressures once aid inflows fall. However, the government is likely to be only partly successful in achieving these objectives. The Economist Intelligence Unit therefore expects the overall fiscal deficit to rise from 2.8% of GDP in 2003/04 to an average of 3.1% of GDP in 2004/05 and 2005/06.
Outlook for 2005-06: Monetary policy
Monetary policy has been kept loose in recent years in order to stimulate economic growth. However, inflationary pressures and international interest rates began to edge upwards in 2004, leading the State Bank of Pakistan (SBP, the central bank) to begin to tighten policy in the latter half of the year. In late 2004 the SBP stated that it would shift from an accommodative monetary policy stance to a neutral one, and in April 2005 the SBP increased its discount rate by a substantial 1.5 percentage points, to 9%. Treasury bill yields have also been raised.
In its Monetary Policy Statement for July-December 2005 the central bank argued that it would continue to tighten policy, citing the need to contain inflation. We expect monetary tightening to continue in the second half of 2005 and into 2006 as relatively strong inflationary pressures persist. High international oil prices, coupled with strong domestic food price rises, have fuelled inflation, and the interest rate changes alone are unlikely to be effective in reducing these pressures. The central bank has therefore also requested that the government use administrative measures, such as reducing domestic fuel taxes, to contain supply-side inflation. The source of the current food price inflation is not entirely clear, as the harvest has been relatively good; it is likely to be the result of market manipulation rather than a shortage of supply.
Outlook for 2005-06: International assumptions
International assumptions summary
(% unless otherwise indicated)
2003c 2004c 2005 2006
Real GDP growth
World 3.9 5.1 4.2 4.0
US 3.0 4.4 3.2 2.8
China 9.3 9.5 9.1 8.0
EU25 1.3 2.4 1.7 2.0
Exchange rates
¥:US$ 115.9 108.1 107.8 103.0
US$:€ 1.1 1.2 1.2 1.3
SDR:US$ 0.71 0.68 0.68 0.67
Financial indicators
¥ 2-month private bill rate 0.03 0.00 0.00 0.17
US$ 3-month commercial paper rate 1.10 1.48 3.41 4.63
Commodity prices
Oil (Brent; US$/b) 28.8 38.5 53.3 50.5
Cotton (US cents/lb) 63.3 62.0 56.7 62.0
Food, feedstuffs & beverages (% change in US$ terms) 6.6 8.6 -0.6 1.1
Industrial raw materials (% change in US$ terms) 13.0 21.0 4.2 -6.2
Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.
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Economic growth in the US is forecast to slow to an annual average rate of 3% in 2005-06, from 4.4% in 2004. This will still constitute a solid performance, and, along with persistently strong (albeit slower) growth in China, will underpin world GDP growth of 4.2% in 2005 and 4% in 2006. However, rising interest rates in the US will mean that emerging-market investments will become less attractive to investors in the OECD. We have revised up our forecast for international oil prices (dated Brent Blend) to an average of US$53.3/barrel in 2005 (from US$50.5/b previously) and US$50.5/b in 2006 (US$46.5/b previously). These high oil prices will constitute a significant threat to Pakistan's economy. The country will also be vulnerable to tighter monetary policy in the US, which will reduce international liquidity and will ultimately put pressure on emerging markets with large financing needs.
Outlook for 2005-06: Economic growth
The government estimates real GDP growth (at factor cost) in 2004/05 at 8.4%. Agricultural expansion, at around 7.5%, substantially exceeded the government's target of 4% for 2004/05, driven by a bumper wheat and cotton crop. The strong cotton crop fuelled the growth of the textile industry, owing to the fact that domestic cotton prices consequently remained low. The manufacturing sector achieved double-digit growth in 2004/05, while the services sector grew by around 8%. Low interest rates supported growth in 2004/05, with both investment and private consumption recording healthy growth rates. Real GDP is forecast to grow by 6.6% in 2005/06, driven by a strong monsoon and continued expansion of textile production and other manufacturing output, as well as strong private consumption and growth in gross fixed investment. The strength of the industrial and agricultural sectors means that growth in services output should also remain buoyant. However, higher interest rates, although helping to rein in inflation, will dampen growth, and agricultural output is expected to be far less strong in 2005/06 than in 2004/05. The main domestic policy risks to the economy include a possible reversal of economic reforms, perhaps caused by a political crisis, and a much sharper than expected tightening of monetary policy triggered by an oil-related surge in inflation.
Outlook for 2005-06: Inflation
Inflationary pressures have been rising strongly since 2004, and remain the biggest threat to the economy. The central bank believes that if inflation is not contained it could lead to a significant rise in inflationary expectations, with strong repercussions on long-term growth. According to the central bank, consumer price inflation has remained high, averaging 8.7% year on year in June 2005 (although this was lower than the rates of 9.8% recorded in May 2005 and 11.1% in April). The main culprit is food price inflation, which accounts for 60% of the overall consumer price index; food prices were up by 12.6% year on year in May and by 9.3% in June. Non-food inflation is lower, but it too has been rising as a result of high oil prices, the rapid rate of credit expansion and inflated asset prices. However, a good harvest this year and monetary tightening by the central bank will help to stem the rise in inflation. Overall, we expect inflation to average 8.6% in 2005 and to slow to 7.9% in 2006.
Outlook for 2005-06: Exchange rates
The Pakistan rupee remained stable at PRs59.1-59.7:US$1 in the first seven months of 2005, and is expected to remain strong against the US currency during the remainder of 2005, averaging PRs59.6:US$1 for the year as a whole. Inflows of remittances from Pakistanis working overseas have remained strong, despite a weakening in recent months, and are expected to continue to support the Pakistan rupee. We expect the currency to weaken against both the US dollar and the euro in 2006, largely as result of the widening current-account deficit. The rate of currency depreciation could be faster than forecast if the domestic political situation deteriorates or relations with India sour.
Outlook for 2005-06: External sector
Despite strong growth in exports in 2004, even higher import growth (largely driven by high international oil prices) caused the trade balance to deteriorate. As a result, the current account is estimated to have moved from a surplus equivalent to 4.3% of GDP in 2003 to a deficit of 0.9% of GDP in 2004. In 2005-06 textile exports are expected to post strong growth, owing to the abolition of textile and garment export quotas for World Trade Organisation member countries at end-2004. (This is despite a relatively poor start during the first few months of the new trading regime.) Exports generally will be boosted by government efforts to strengthen trade links, including through bilateral trade deals, with Pakistan's main trading partners. On the import side, however, high oil prices will remain a concern. In addition, stronger textile exports will require higher imports of related raw materials and machinery. Inflows of remittances will provide some support to the current-account balance, but the services deficit will widen, as relatively strong GDP growth boosts demand for imported business services. On balance, we expect the current-account deficit to rise to US$3.2bn (3.1% of GDP) in 2005 and US$4.1bn (3.6% of GDP) in 2006.
Outlook for 2005-06: Forecast summary
Forecast summary
(% unless otherwise indicated)
2003a 2004b 2005c 2006c
Real GDP growth 5.8 6.4 8.4 6.6
Industrial production growth 17.9b 9.3 10.4 7.1
Gross agricultural production growth 4.1 2.6 7.5 1.0
Unemployment rate (av) 7.6b 7.0 6.6 6.3
Consumer price inflation (av) 2.9 7.4a 8.6 7.9
Consumer price inflation (year-end) 5.4 7.4a 9.1 7.3
Short-term interbank rate 2.1 2.7a 4.6 6.1
Consolidated central government balance (% of GDP) -2.9 -2.8a -3.1 -3.0
Exports of goods fob (US$ bn) 11.9 13.4 14.9 17.0
Imports of goods fob (US$ bn) -12.0 -16.7 -20.6 -23.3
Current-account balance (US$ bn) 3.6 -0.8 -3.2 -4.1
Current-account balance (% of GDP) 4.3 -0.9 -3.1 -3.6
External debt (year-end; US$ bn) 36.4 35.9 39.3 41.9
Exchange rate PRs:US$ (av) 57.8 58.3a 59.6 60.5
Exchange rate PRs:¥100 (av) 49.8 53.9a 55.3 58.7
Exchange rate PRs:€ (av) 65.4 72.5a 73.1 76.2
Exchange rate PRs:SDR (av) 80.9 86.3a 87.6 90.2
a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.
posted by Marko at 2/04/2006 12:22:00 PM
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