JS Securities Limited – Morning Briefing

Karachi, March 26, 2019 (PPI-OT): Key observations of SBP’s 2nd quarterly report on the economy

SBP released its second quarterly report, titled, ‘The state of Pakistan’s economy’. Most importantly, the central bank revised downwards its Real GDP forecast to 3.5-4.0% from the previous estimate of 4.0-4.5% for FY19.

Overall, there has been a broad based slowdown in the economy, where manufacturing, agriculture and services sectors witnessed sluggish performance, compelling a cut in growth estimates by the central bank.

Unsurprisingly, SBP has also increased its fiscal deficit estimate to 6.0-7.0% from previous expectation of 5.5-6.5%, incorporating the performance of revenue collection during the 2H of the last four years.

Key takeaways from ‘The State of Pakistan’s economy’

The State Bank of Pakistan (SBP) released its second quarterly report for FY19, titled “The State of Pakistan’s Economy” divided in its usual five chapters along with two special sections on “The importance of human capital in the context of CPEC” and “Evaluating the fiscal burden of State-owned Enterprises in the power Section”. We discuss here key observations contained within the central bank’s report. The most glaring one for most readers would be that the central bank has revised downwards its FY19 projected ranges for macro indicators such as (1) Real GDP to 3.5-4.0% (previous 4.0-4.5%), (2) exports to US$25.5bn-27.0bn (previous US$27.0-28.0bn) and (3) imports to US$54.0bn-56.0bn (previous US$56.0bn- 57.0bn).

In addition to this, the fiscal deficit estimate was revised upwards to 6.0- 7.0% (previous 5.5-6.5%). A decline in real GDP estimates was more or less on the cards in our view, given predictive indicators released earlier (such as a slowdown in large-scale manufacturing) whereas the depreciation in the local currency plus tighter restrictions led to falling imports. The increase in the central bank’s fiscal deficit estimates was expected, given the shortfall in revenues and growth in current expenditures. To quote the central bank, “specifically, monetary tightening, exchange rate adjustments, reduction in PSDP spending and regulatory measures have impacted economic activity.” Other major insights gleaned from the report include:

Given the fiscal constraints, the central bank does not expect development spending to pick up for the time being, and consequently manufacturing activities will also remain muted.

Due to limited space available in curbing government expenditures, the need of the hour is to increase revenues to improve the fiscal position.

The central bank recommends diversification of exports and value addition as critical elements in staging a more meaningful recovery in the country’s exports. According to the report, (1) a slowdown in Germany and France negatively impacted textile exports, (2) competition from China (textiles and rice) and Bangladesh (textiles), and (3) withdrawal of export subsidies on sugar and wheat, were major reasons for a lacklustre export performance.

The upward revision in gas prices (in Oct-2018) alone contributed ~1.0% to the recent surge in CPI, which rose 6.5% YoY during 2QFY19, the highest quarterly inflation since 1QFY15 (when crude oil was ~US$100/bbl).

Although private sector credit uptake increased to Rs570.4bn in 1HFY19 from Rs296.3bn in the same period last year, this was mainly due to higher costs of imports (rupee devaluation), rise in energy prices and liquidity crunch due to unsold inventories.

In the real sector, industrial activity suffered due to a slowdown in both public and private consumption, where LSM contracted by 1.5% YoY in 1HFY19. Meanwhile, water shortage was the major reason for a decline in agricultural activity as cotton and wheat production suffered, while the latter was also affected by weak fertilizer off-take. Refreshingly, livestock sector’s growth is forecasted to remain unaffected, given indicators such as credit disbursements to the sector. Finally, the services sector has also witnessed sluggish demand, as a ripple effect is felt due to lacklustre manufacturing and agricultural activity.

The SBP’s report recommends the need for implementing structural reforms to get the economy firmly on track for sustainable growth. Moreover, to improve economic performance, the central bank suggests investments in human capital and technology and financial inclusion, whereas also discusses the need to increase focus on revenue collection.

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