Pakistan Macro Economic Update – January 2010

The figures for July- December 2009 are guardedly encouraging as there are some signs that the economy is on the road to recovery. Trade deficit has narrowed due to a decline in imports (because of reduced oil and commodity prices in this period as well as the slowdown in economic activity) which have outweighed the decline in exports during this time. Net foreign assets have finally started building up again leading to growth in M2 for the first time since June 2009 on account of external factors. In the area of current transfers, worker’s remittances have increased at a healthy pace but this is being over shadowed by the recurrence of a 2 rupee spread between the Interbank and Kerb market. There has also been an increase in inflows from the IMF from loan tranches received in 2009. The capital markets recovered significantly in 2009 on the back of participation from foreign and local investors, however volumes have still stayed away from averages seen in 2006, 2007 and 2008. In December 2009 the KSE 100 index was up 60% from its level in January 2009.

On the down side inflationary pressures continue to exist due to international commodity prices which are once again on the rise, food prices, electricity and gas tariffs and higher domestic financing needs of the government. The government has been reasonably conservative in setting its monetary policy, trying to find an adequate balance between managing the pressure from its liquidity needs and instability in the external market caused by rising commodity prices and the weakening rupee. When inflation dipped in the latter part of the August 2009 and early in the 2^nd quarter of 2010 the SBP cut the policy interest rate overall by only 150 basis points in the first half of FY 2010 to boost investment in the depressed private sector, but the move was significantly lower than expectations. These cuts have generally been viewed as insufficient and investment in the private sector has remained fairly lack lustre which is reflected through both by the very nominal increases in credit to the private sector reported in M2 numbers as well as the low foreign direct investment during this period.

Inflation (Year on Year)

CPI based inflation stood at 8.9% in October 2009. However increased electricity and gas tariffs and resurgence in the international oil and other commodity prices have pushed inflation upwards. In December the CPI grew by 10.52% over the corresponding month in the previous fiscal year but declined by 0.49% over November 2009 inflation. In view of these down side risk factors the IMF has moved its inflation forecast for FY2010 upwards from 9% to 11%.

WPI and core inflation of CPI have increased by 14.96% and 10.7% respectively on a year on year basis.

To understand this pick up in WPI we first need to dissect the composition of both WPI and CPI. The dissection that follows below shows that the primary increases in both indices is on account of external factors (fuel, electricity and gas tariffs) and food prices for CPI and increase in raw material prices for WPI. A large part of food related inflation is linked to cross border smuggling through Chaman into Afghanistan and relates to structural issues that cannot be fixed by Monetary Policy. Which then implies that we will see inflation resist downward pressures in the coming months and a higher discount rate as well as historically high real rate of interest will no longer have any significant impact on the government’s ability to control inflation.

Consumer Price Index

The CPI in Pakistan covers retail prices of 374 items in 35 major cities. It reflects the changes in the cost of living of urban areas. The items are grouped into 10 major commodity groups. The base year is 2000-01. The first graph shows the percentage change in CPI for each commodity group over their December 2008 CPI. The second graph, the pie chart, shows the impact that each commodity group had on the overall change in CPI by accounting for their respective weights in the given basket of products.

Wholesale Price Index

The WPI in Pakistan covers wholesale prices of 106 commodities (425 items) in 18 major cities. Commodities covered fall into five major groups namely, food, raw material, fuel, lighting and lubricants, manufacturing and building material. The base year is 2000-01. The first graph shows the percentage change in WPI for each commodity group over their December 2008 WPI. The second graph, the pie chart, shows the impact that each commodity group had on the overall change in WPI by accounting for their respective weights in the given basket of products.

Broad Money M2 Growth

According to M2 report of 2^nd January 2010 money supply has increased by 6.5% since the beginning of FY 2009/10. However in the following week ended 9^th January 2010 the M2 numbers went down by Rs 26 billion rupees to Rs 5.44 trillion. Growth registered over the 12 month period January – December 2009 was 17.18% as compared to 6.62% for 2008. The most significant elements of the 2^nd January update were a reduction in currency in circulation, a reduction in borrowing from SBP and an increase in Net Foreign Assets.

Foreign Investment and Remittances

Workers Remittances increased by 24% in the period first half of the FY2010 as compared to the same period in the previous fiscal year from US$ 3,640 million to US$ 4,531 million. However since October remittances have shown a declining trend on a month on month basis.

Foreign Direct Investment (FDI) was more than 56% lower in July-December 2009 (US$ 1,012 million) as compared to the July –December 2008 (US$ 2,350 million). However in December 2009 the FDI showed a 78% increase over November 2009 numbers rising from US$ 134 million to US$ 238 million. December 2009 registered net outflow for foreign portfolio investment (FPI) of US$ 39 million.

Balance of Trade

For November 2009 the exports had declined by 10% and imports had only declined by 1% as compared to those of November 2009%, which means that the trade deficit increased as compared to that one last year. In December however, both imports and exports increased over the corresponding month last year by 1.64% and 13.21% respectively. Trade deficit registered a 12.68% decline as compared to December 2008 figures. Over the first half of FY 2010 the balance of trade was 30% lower than that of the first of half of FY 2009.

On a month on month basis imports increased by 20% as compared to exports which only showed a 15% increase in figures. This led to an increase in the trade deficit from US$ 781 million in November 2009 to US$ 1,015 million in December 2009, a 30% increase.

According to the recent IMF report, exports have been projected to be US$18.56 billion for the FY 2010 whereas imports have been projected at US$ 30.59 billion.

Foreign Exchange Reserves

Total liquid foreign exchange reserves were 40% higher in December 2009 as compared to the reserves in the corresponding month a year back and they have grown by over 12.5% since the beginning of the fiscal year.

As of 9^th January 2010 the FX reserves stood at US$ 15.2 billion a 50% increase on a year on year basis and almost 9% higher that year end 2009 figures.

The increase in FX Reserves is due largely to the tranches received by the IMF against an approved loan standby arrangement of US$ 11.3 billion. As of the end of the year, Pakistan had received four tranches amounting to a total of US$ 6.54 billion. Of the US$ 1.2 billion dollar tranche received in

December 2009 US$ 800 million was apportioned to foreign exchange reserves whereas US $ 400 million would be used for budget support and other expenditure.

Trade Analysis – Imports

Imports in ‘000 US$
	December (P)	November (R)	December	July-December
	2009	2009	2008	2009-10 (P)	2008-09
Total Imports	2,863,914	2,384,032	2,781,887	19,769,965	16,225,581
Freight & Insurance	220,129	185,883	181,241	1,462,972	1,205,750
Net Imports	2,643,785	2,198,150	2,600,646	18,306,993	15,019,830

All major import groups have registered an increase in December 2009 as compared to the corresponding month of the preceding year, except for the Machinery Group which declined by 13%. Similarly all groups import receipts increased over those in November 2009 with Machinery Group going up 66% from US$263 million to US$ 437 million. Overall imports saw a 20% increase over those of the previous month by value. Petroleum, agriculture & chemicals and the machinery group had the greatest share by value to overall imports.

Trends in Imports

Trade Analysis – Exports

Exports in ‘000 US$
	December (P)	November (R)	December	July-December
	2009	2009	2008	2009-10 (P)	2008-09
Total Exports	1,661,194	1,445,085	1,497,311	10,432,621	9,473,323
Freight on Export	32,100	28,300	58,400	342,060	167,600
Net Exports	1,629,094	1,416,785	1,438,911	10,090,561	9,305,723

The most significant increase in the exports has been in the petroleum group which grew by over 150% in value as compared to December 2008. Exports receipts of all major groups have increased both on a year on year as well as on a month on month basis. Overall exports increase by 13% on a year on year basis over December 2008 figures. The major share of exports lies with the textile group, which continues to gain share to overall export receipts, followed by food and other manufacture groups respectively.