Flood impact on Pak economy is difficult to quantify, ADB

ISLAMABAD, The Asian Development Bank (ADB) has suggested to eliminate a substantial gap between the cost of power production and tariff rate, Pakistan government has to increase power rates in coming days, said in the annual report “Asian Development Outlook 2010 Update’ released on Tuesday in Manila.

The report stated the drain of subsidy requirements for the energy sector also needs attention. The federal government has already increased consumer tariffs of energy sector but a substantial gap still remains and requiring a combination of efficiency gains and further tariff increases. The energy sector as a whole will need to be placed on a financially viable footing if the necessary investment in productive capacity is to be realized.

“It seems evident, however, that the economic impact will be heavily negative in the short run, due to extensive damage and reallocation of resources to cater for urgent needs. As losses in crops and livestock, damage to infrastructure and limited economic activity in a large part of the country will damp growth prospects in virtually every sector, such that tepid GDP growth of 2.5% is expected in FY2011. Nevertheless, reconstruction and rehabilitation activities will subsequently have a positive impact on GDP” warned in the report.

The report said the impact on economic prospects of the massive flooding is difficult to quantify. The picture should also be a little clearer when an international donors’ conference is held in late November.

Regarding the impacts of the flood on inflation, the bank projects average inflation in FY2011 at 13 percent which was 9.5 percent projected in the budged. The price hike emanating largely from the supply constraints will pose challenges for effective monetary management of the State Bank of Pakistan. The report indicated the central bank will find it difficult to fully implement its earlier monetary stance in the existing circumstances; it will need to make substantial efforts to keep demand for credit from exacerbating inflation pressures.

The bank further stated in the report, due to severely damages of infrastructure, the shortages of goods and services even with rapidly ramped-up imports are expected to put substantial upward pressure on prices. Moreover, the likelihood of delayed sowing of crops in the upcoming season will create shortages of food and other commodities while undermining farmers’ incomes.

Both the magnitude and the composition of federal spending in recent years have undermined the macroeconomic stability and sustainability, and these trends must change. The compression of development spending to accommodate runaway recurrent costs is not consistent with fiscal sustainability, and neither is an improvement in the external account built on restrained imports needed for investment and capital development.

“Pressures on the current account will also intensify in FY2011. These will stem both from a steeper than earlier forecast rise in imports and from domestic supply shortages pushing food, raw cotton, and other essential imports upward. Limits on existing infrastructure capacity and flood damage are expected to hold down export growth already, flood-related damage has curtailed cotton and rice exports.

If substantial grant aid is provided for relief, the deterioration in the current account deficit may be limited to 4.3% of GDP.

Flood-related expenditure will also alter the fiscal outcome, relative to the budget posted for FY2011, widening the fiscal deficit from the targeted 4.0% (Box 3.7.1). In this context, it will be even more important to address trends that were troublesome for the FY2010 outturn. Revenue measures are more urgent in view of the massive reconstruction requirements, as are improvements in revenue administration and collection, stated in the report.

The massive flood-related devastation underscores the need for reprioritization on the fiscal front so as to expand fiscal space for reconstruction. The federal government in the budget for FY2011 has already emphasized its commitment to fiscal consolidation and to policies needed to support a robust expansion of the economy.

Flood-related damage and social safety net requirements will necessarily impact the expected deficit for FY2011.

Additional revenue measures are being formulated to generate revenue for relief and reconstruction activities, the bank said.

The report said the investment spending was reprioritized to secure more timely completion of key ongoing projects in the areas of transportation, hydropower, and water.

An alignment between expenditure and the policy priorities that provide the fiscal space to support critical investments in infrastructure is needed both to broaden the economic base and to achieve sustainable improvements to the current account. Lower imports, lower development spending, and an explosion of unproductive recurrent spending for subsidies simply increase the apparent risk to investment, reducing the inflows needed to put the economy on a sustainable path.