ISLAMABAD, Sept 16: The Asian Development Bank has forecast that Pakistan will miss major economic targets set for the current fiscal year, with growth faltering at 4.5 per cent, inflation rising to 20 per cent and fiscal and current account deficits going beyond budgeted limits.

In its “Asian Development Outlook 2008 Update” released here on Tuesday, the bank also warns of political risks including further increase in political uncertainty and a deterioration in the security situation on the country’s western border.

The country needs to adopt and implement a coherent and credible short- to medium-term economic stabilisation and reform programme to move forward, it said.

The bank said: “With continued high oil prices, an ongoing power deficit, and tightened demand management policies to correct macroeconomic imbalances, economic growth in fiscal year 2009 is put at only 4.5 per cent” rather than budgeted target of 5.5 per cent, with a continued slowdown in commodity producing sectors.

It said high inflation will persist as domestic fuel, food, and power subsidies are rationalised. Although imbalances are expected to shrink they cannot be eliminated quickly.

The bank believes the continued power shortages will increase the cost of doing business and therefore exacerbate inflation to touch 20 per cent against targeted 11 per cent. Domestic spending will have to rise less than output for the current account deficit to shrink. Therefore, the export growth becomes crucial, as it will help make the current adjustment less painful.

The report pointed out that tightening of expenditure policies could act as deflationary force resulting in underused production capacity and higher unemployment. Therefore, the government should adopt effective anti-inflation tool by identifying and eliminating fiscal programmes that induce inflationary bias in the economy, combined with pushing through moderate increases in interest rates to limit excessive credit expansion.

Moreover, to prevent a wage-price spiral, the authorities should consider implementing policies that link nominal wage increases to productivity increases and that limit increases in firms’ mark-ups, through, for example, tripartite agreements among the state, employer and the worker.In agriculture, cotton production is likely to fall short of target due to a reduction in the sown area and to a mealy bug virus attack, which will hurt the textile industry. The services sector is expected to post robust growth, although it will be affected by the tax measures announced in the budget and by power shortages.

On the demand side, private consumption in current year will be hit by higher prices as food, oil and power subsidies are rationalised. The bank said the investment levels will be restrained by uncertainty, low capital inflows and power shortages.

Private investment, it said, has stagnated, falling to 14.2 per cent of GDP while national savings as a share of GDP declined even more, widening the savings-investment gap.

“With the government setting out to progressively rationalise the oil subsidy by passing on higher prices to consumers and by reducing the subsidy between the full-cost producer price and tariffs charged for electricity, average inflation is projected to reach 20 per cent, higher than the target of 11 per cent”. The planned adjustment of the domestic procurement wheat price will contribute to the higher food inflation.

It said the State Bank of Pakistan has increased the discount rate from 9.5 per cent in June 2007 to 13 per cent, yet the inflation has climbed. To achieve targeted 14 per cent increase in money supply, the government would need to have strict limits on budget access to SBP credit. Since the inflation in Pakistan is driven mostly by high commodity prices, monetary tightening will have limited impact on inflation and will “most likely aggravate the economy’s other structural problems”.

Excessive dependence on higher interest rates to stabilise price will make firms reluctant to use debt financing and therefore push them to rely more heavily on self-financing, which might lead to less efficient capital allocation. Moreover, unless interest rates are raised significantly, it will probably take a long time for monetary policy to have an impact on the economy and inflation.

The bank said in last financial year, the oil imports increased by 43 per cent and food imports by 46 per cent, causing the trade deficit to worsen and touch $15.3 billion. Though the export target of $19.2 billion was exceeded it was mainly because of higher rice exports and some improvement in cement exports.