Pak should take steps to control power theft, ADB

Islamabad (Ishfaq A Mughal) Asian Development Bank urged on Pakistan's government  that it must take solid steps to control power theft and line losses in next fiscal year. 

The Bank in its recent Asian Development Outlook 2014 (ADO) report said that due to reforms and stabilization introduced by the government, Pakistan's economy is showing signs of recovery in 2014.

The report sad that the GDP growth is projected at 3.4% for FY2014, marginally slower than in FY2013. Agriculture is expected to be weaker due to a drop in cotton output, which partly set the improvement in sugarcane and rice crops. Ongoing rains, however, may benefit the upcoming wheat crop,  despite a reduction in the sowing area this year.

Weak agriculture will be partly compensated by the pickup in large-scale manufacturing, which grew by 6.7% during the first 6 months of FY2014, three times the rate during the same period a year earlier (Figure 3.20.6). Larger and more reliable power supply, partly reflecting better controls on unscheduled load shedding, as well as increasing use of alternative fuels is helping to revive the production of food, fertilizers, chemicals, electronics, and leather products, while petroleum refinery output continued its robust growth, it said.

ADB says the textiles are expected to recover from existing weak growth as they benefit from Generalized Scheme of Preferences Plus status granted by the European Union from January 2014. Improved manufacturing performance will spur retail and trade activity. Performance in transport and communication will, however, continue to be affected  by financial losses incurred by Pakistan Railways and Pakistan International Airlines.

On the demand side, private consumption will remain the main driver of economic growth, supported by the sustained inflow of remittances, low real interest rates, and better credit availability at banks. Government spending will be contained by fiscal consolidation to bring down the budget deficit, but accelerated credit flows to the private sector during the first 7 months of FY2014 indicate an uptick in private investment. Net exports are expected to be modestly negative as import growth quickens to support improved capacity utilization in manufacturing. GDP growth is expected to be higher in FY2015, at 3.9%, as the impact of fiscal consolidation eases somewhat, energy supplies improve, and the global economy strengthens, he said.

In the first 8 months of FY2014, inflation averaged 8.6%, reflecting the increase in the general sales tax rate by 1 percentage point to 17%, increases in power tariffs in August and October 2013 for commercial and bulk residential and industrial users, and significant currency depreciation against the major currencies. Reflecting short supply of perishable items and higher wheat prices, food inflation rose to 13.0% in November 2013 before receding to 7.2% in January 2014 for an average of 9.3% over the 8 months (Figure 3.20.7). Core inflation was relatively stable and averaged 8.4% during the period. Further adjustments to electric and gas tariffs, as well as a levy to support gas infrastructure development, are expected to keep inflation elevated over the forecast period. Average consumer price inflation is projected at 9.0% in FY2014 and 9.2% in FY2015, the band further said.

Monetary policy was tightened in response to a depreciating currency and rising inflation during the first half of the FY2014. The SBP raised the policy interest rate by 50 basis points in September 2013 and again in November, bringing it up to 10% from 9% in FY2013 (Figure 3.20.8). While inflation eased in January 2014, the SBP kept the policy rate unchanged in its monetary policy meeting that month.

Monetary management continues to be challenged by high government borrowing from the banking system in FY2014. As a result, the end-December International Monetary Fund (IMF) ceiling for government borrowing from SBP was breached. As foreign inflows remained negligible, and commercial banks lacked interest in government securities because short-term money market rates had risen more quickly than the policy rate, the burden of borrowing once again shifted from commercial banks to the SBP. During 1 July 2013 to 21 February 2014, government borrowing from the SBP increased to PRs890 billion, against net retirement of PRs184 billion to commercial banks. Credit to the private sector picked up to PRs280 billion during this period from PRs107 billion a year earlier, largely reflecting credit to private businesses for fixed investment and working capital as business activity in textiles, power, and trade improved, as well as for consumer credit.

Weighted average bank lending rates have been relatively stable at just over 10%. Broad money growth slowed to 4.9% during this period from 7.5% in the previous year, as the marked contraction in the banking system’s net foreign assets reflected a deteriorating overall balance of payments.

The fiscal framework under the 3-year extended fund facility agreed in September 2013 with the IMF focuses on strengthening the revenue base, limiting power subsidies, ending the drain on the budget from loss-making state-owned enterprises, and compressing non-salary expenditure. With the framework, the budget deficit is expected to be held to 5.8% of GDP (excluding grants) in FY2014, which is somewhat lower than the original budget target of 6.3%. The fiscal deficit was contained at 2.1% of GDP during the first half of the FY2014 mainly by higher sales tax and nontax revenues from CSF receipts ($322 million), as well as by containing expenditure. The increase in tax revenues partly reflects measures already taken under the federal budget for FY2014, including raising the general sales tax rate and eliminating some tax exemptions. Tax collection of PRs1.031 trillion during first 6 months is broadly consistent with the fiscal framework target of PRs2.3 trillion for FY2014.

Consolidated expenditure for the first half of FY2014 was contained partly by reduced interest payments following the earlier clearance of accumulated power sector arrears—the circular debt. Interest payments are likely to be high in second half of FY2014 as domestic borrowing finances the deficit. In addition, the risk of a rebuild of circular debt in FY2014 remains high. Public sector development spending was subdued (PRs243 billion) in the first 6 months of FY2014 and is likely to remain so to contain the budget deficit due to high current expenditures. This will have negative implications for long-term investment and growth.

While the government’s commitment to severely limit energy subsidies is underscored by various initial measures, such efforts need to be more comprehensive. Apart from further price adjustments, substantial governance reforms to reduce theft and losses in transmission and distribution are needed. Similarly, it will be necessary over the medium term to change the energy mix through very large investments in new generation capacity. While the energy sector measures will help contain the expenditure overruns, efforts on widening the revenue base need to be accelerated.

Fiscal devolution under the 18th constitutional amendment in 2011 has made consolidated budget outcomes more dependent on provincial  fiscal performance. Expenditure containment envisaged under the federal budget for FY2014 called for a combined provincial budgetary cash surplus of PRs23.1 billion.

Provincial fiscal operations for the first half of FY2014 indicate a consolidated cash surplus for the period, which needs to be sustained during the second half in order to meet the overall fiscal deficit target for FY2014. A slower-than-expected progress towards the issuance of 3G spectrum licenses and issues around pending proceeds from telecom privatization, raise concerns over whether these receipts will be realized during FY2014. The delays in expected CSF receipts ($878 million) could also be a challenge for the fiscal target.

To protect the poor from adverse effects of fiscal adjustments and other negative shocks, the federal government is providing cash transfers through the Benazir Income Support Program to families identified through a poverty scorecard system. The number of program beneficiaries increased to 4.8 million in FY2013.

The federal government budget for FY2014 plans to nearly double the allocation for the program to PRs75 billion. The program has started piloting a number of additional initiatives for beneficiaries, including health insurance, skills training, loans to develop small businesses, and primary education co-responsibility cash transfers for children.

ADB said that the deficits in trade and services accounts worsened with revived imports and delays in CSF receipts, widening the current account deficit during the first 7 months of FY2014 to $2.1 billion. Imports grew by 4.2%, compared with negligible growth in the corresponding period a year earlier, as the textile and power industries bought machinery. Export growth also picked up to 3.3% in the first 7 months of the fiscal year, stimulated by 8% growth in textile exports, which offset the decline in exports of other manufactures and slow growth in food exports. Exports overall are expected to grow further in the remainder of the fiscal year, as benefits from the Generalized Scheme of Preferences Plus are realized. With worker remittances showing a 10.1% increase in the first 7 months of FY2014, the current account deficit is projected at 1.4% of GDP. The current account deficit for FY2015 is forecast to be marginally lower at 1.3% of GDP, as lower global commodity prices partly compensate for higher imports needed to support the modest pickup in GDP growth.

the bank said in report that the key risks emanate from low official foreign exchange reserves as weak official inflows and high debt repayments outweighed IMF disbursement during the first half of FY2014. Net foreign direct investment inflows, at $523 million during first 7 months of FY2014, were essentially unchanged from a year earlier, and net financial account inflows totaled only $251 million, though improved from a slight deficit in the earlier period. Gross official reserves having plunged from $6.0 billion at the end of June 2013 to $3.1 billion in January 2014, equal to less than 1 month of imports, resurged to $3.9 billion at end February reflecting foreign inflows during this month. The Pakistani rupee, as a result appreciated to PRs100.3/$, following a 6.5% depreciation during the first 7 months of FY2014.

It said that the achieving fiscal sustainability is a major recurring challenge for policy makers in Pakistan. Fiscal discipline has eroded in recent years with the persistent need to finance expanding energy sector subsidies, growing losses incurred by state-owned enterprises, and high expenditures for security.

The bank said that the Pakistan’s (FBR collected) tax-to-GDP ratio stood at 8.5% in FY2013, which is one of the lowest in the region and reflects structural and administrative issues. As a result, spending for badly needed infrastructure has relied largely on foreign inflows. Additional spending requirements have emanated from consecutive natural disasters in the past few years, as well from the need to establish social safety nets. Higher fiscal deficits and very limited foreign inflows during the past 2 years have significantly increased short-term domestic borrowing, causing interest payments to balloon. Moreover, high government borrowing from commercial banks also contributes to low private sector credit.

The bank said that the domestic portion of public debt increased sharply for the second year in a row, from 38.0% of GDP at the end of FY2012 to 41.5% in FY2013, to finance high fiscal deficits. Foreign debt fell by 4.6% of GDP in FY2013, mainly as IMF debt was repaid. Total public debt (including external liabilities) at the end of FY2013 amounted to 63.3% of GDP, exceeding the legal limit of 60% set under the Fiscal Responsibility Debt Limitation Act, 2005. Although a generally favorable negative differential between real interest rates and GDP growth has eroded the real value of government debt, growth in the primary deficit would endanger debt sustainability

The bank said that the federal government is implementing its fiscal framework under the IMF’s 3-year program. Immediate measures affecting the federal budget for FY2014 pertain to raising the general sales tax rate and certain power tariffs to contain subsidies. Structural reforms to widen the revenue base are, however, critical for restoring fiscal sustainability. These include improving tax administration, eliminating exemptions to certain sectors, and bringing all sectors including agriculture under the tax net. Efforts would be required from federal and provincial governments alike, as some taxes (notably on agriculture) fall under provincial administration and reforms would help enhance their own revenues. Currently, over 90% of provincial revenues are transfers of federal shared taxes. As provinces have assumed a greater share of federal resources and spending responsibilities through devolution, their fiscal performance has become even more important in relation to the national fiscal outcomes. For instance, collecting sales tax on services is now a provincial government responsibility, and most social sector responsibilities have been transferred to provinces.

Clearly, the allocation of 57.7% of the national shared tax base to provinces determined under the 2010 National Finance Commission award requires greater fiscal prudence and discipline on the part of the provinces. A mechanism to ensure provincial fiscal discipline is likely to be a crucial consideration in upcoming discussions for the 2015 award, the bank believes.