Research and analysis

Pakistan economic update: April 2014

Published 1 May 2014

The State Bank of Pakistan in its latest report forecast GDP growth of 3.5-4.5% for the fiscal year, but sounded caution over agricultural performance. Meanwhile, Finance Minister Dar delivered on two promises: tapping global debt markets and the 3G/4G spectrum auction. While the Eurobond auction generated better-than-expected investor interest, and raised £1.2 billion; the much-awaited telecoms licence auction will bring in £700 million over the next 5 years – close to budget targets, but below expectations. Nevertheless, an improved external position has seen the SBP’s reserves climb to a 12-month high. This has sustained the rupee’s dramatic rebound last month. While this is seen as an achievement by Dar, the IMF believes that the currency is overvalued. The textile industry agrees. It has said that at current exchange rates, Pakistan’s products are uncompetitive in export markets. Meanwhile, the tax authority, struggling to meet the downward revised revenue target, has admitted to withholding taxpayer refunds – vindicating businesses’ claims. And with the onset of summer, power cuts could intensify - beyond the currently reported 12-18 hours - as the circular debt piles up again.

1. In its latest report, the State Bank of Pakistan expects growth of between 3.5-4.5% in the current fiscal year. While closer to the Government’s estimates, the Bank appears more optimistic than most multilaterals. The SBP’s growth projections are based on the strong performance of large-scale manufacturing (LSM) – currently at a multi-year high. It believes that the sector will continue to drive growth (despite accounting for just over a tenth of GDP) due to backward and forward linkages with services, particularly retail and wholesale trade. It also expects the telecom industry to perform better than last year. However, it has warned that the main downside risk to its forecast is the worse-than-expected performance of the agricultural sector, particularly the cotton crop. Multilaterals including the IMF and ADB appear more cautious in their growth estimates for the Pakistani economy; although the World Bank expects 4% growth.

2. Meanwhile, the country raised £700 million on global debt markets after a hiatus of 7 years. This has seen the Central Bank’s reserves climb to a 12-month high. Inflows from the Eurobond issuance (of 5 and 10 year tenors) have helped sustain the rupee’s climb on the back of the Saudi “gift” last month. The auction generated better-than-expected investor interest: while the Government raised £1.2 billion, it received offers of £3 billion. As the biggest-ever single transaction, it is seen by the Government as a resounding success. However, some analysts have questioned whether it was worth the price: the sale was priced at 550 basis points above US Treasuries (compared with 325 bps at the last issuance in 2007). Others believe the cost was justified given Pakistan’s ‘junk’ credit rating. Instead, they argue that the successful issuance reflects positive sentiment towards the Pakistani market, and in the PML-N’s policies, thus far.

3. The much-awaited 3G/4G spectrum auction was held earlier this month. The Government raised £700 million, close to budget target but well below expectations of £1.2 billion. Despite a couple of unsold licences, the Finance Minister described it as a success, citing delays under the previous administration. While the sale itself has been welcomed by the business community and public at large, there are concerns. A lack of competition in the auction meant that all licences went to incumbent players, dashing Government hopes of attracting new entrants. Apart from Zong - the Chinese service provider that secured both, 3G and 4G permits – other successful bidders are likely to raise rupee financing from local banks to pay for their fees; potentially with half the payment now, and the rest in equal instalments over 5 years. Analysts believe this could limit new FX inflows under the auction to just £310 million.

4. Export-oriented industries are concerned over the rupee’s strength. Seen by the IMF as overvalued – but considered by the Finance Minister as a key achievement – exporters argue that it makes Pakistan’s exports uncompetitive in global markets. The textile sector, Pakistan’s biggest exporter, is particularly concerned about the rupee’s unexpected rebound. The industry’s lobbying arm, the All Pakistan Textile Mills Association, believes an overvalued rupee could wipe out any gains from GSP+ status. Worse, they fear losing out to regional competitors in the US market, where Pakistan does not enjoy preferential market access along the lines of the EU’s GSP+. Through public appeals to the Government, they claim that the textile industry has faced significant revaluation losses; and could face factory closures and layoffs. To prevent this, they have asked for preferential energy supplies, as well as reimbursement of outstanding sales tax refunds.

5. While tax-revenue collection has appeared promising so far, the tax authority has finally admitted that it is withholding tax refunds. Adjusting for these, the Government’s performance on revenue collection is more modest. Responding to the Senate Committee on Finance and Revenue, the Chairman of the Federal Board of Revenue (FBR) conceded that around £580 million of refunds due to taxpayers had been withheld. His admission confirms the claims of economists and the business community who appeared sceptical of the FBR’s claims of achieving 16% revenue growth over last year; and predicted that the FBR could withhold refunds as it struggles to achieve even the downward revised annual tax-collection target. Adjusting for these, the increase in tax collection compared with last year is closer to 8% - half the Government’s 16% claims. Furthermore, some commentators believe actual refunds withheld by the FBR are closer to £2.7 billion.

6. Now, with the onset of the summer, and a build-up of unpaid electricity bills, power cuts appear set to intensify. Media reports suggest that private power producers have again approached the Government to clear their dues for the sale of power to the state-owned transmission company. This ‘circular debt’ is reported to have reached around £1.8 billion – widely seen as the threshold between manageable and crippling power outages. Last year, soon after taking office, the PML-N Government cleared nearly £ 3 billion in unpaid bills to private power producers. This brought idle generation capacity online, improving power supply and boosting growth. However, stalling recoveries of consumer bills and peak summer demand mean that power outages across the country could get worse.

7. While power shortages hurt industrial activity, a curtailment of gas supplies is equally – if not more – disruptive. The Government will continue to face challenges in allocating gas between competing users. The Government has said that it will ensure gas supply to export-oriented industries. But it must balance this against a variety of other users including households; power plants; and the fertiliser industry. Media reports suggest that so far this year, power plants have received less than half the gas they were promised. This has forced them to operate below capacity, or rely on costly substitutes e.g. diesel. The Government claims it is working on plans to import LNG. But it is unclear how it will tackle large subsidies on gas consumption in the form of low domestic prices – particularly for household users – with import prices that are nearly five times higher.

8. In an attempt to capture industrial trends at a higher frequency, one of the country’s biggest banks has launched a Purchasing Managers Index. While it points to continued expansion, it reaffirms business concerns over energy supplies. The new index launched by MCB surveys 200 large and small companies across a variety of sectors. Its second reading for the month of March came in at 65.1 – marginally lower than January’s 66.5, but above the 50 point threshold that indicates an expansion in economic activity. Separately, a bi-annual business confidence survey run by the Overseas Chambers of Commerce and Industry (OICCI) also declined compared with its last update six months ago. The decline reflects a return of power and gas shortages, which were cited by the business community as their biggest concern. The OICCI claims its survey reflects feedback from a cross-section of businesses representing 80% of the country’s GDP, operating across Pakistan.