Pakistan – Counting the costs of the floods
by Sayem Ali
Chief Economist, Standard Chartered Bank
• Floods have hit economy hard; preliminary estimates put losses at USD 4bn (2% of GDP)
Floods cause widespread damage
Losses to the economy are estimated at close to USD 4bn (2% of GDP). We now expect a significant slowdown in GDP growth in FY11 (ends June 2011) and lower our growth forecast to 2.5% from 4.5%; this would follow growth of 4.1% in FY10. We also now expect FY11 inflation to jump sharply to 15%, versus our earlier forecast of 12%, depending on the extent of damage and the measures taken by the government to reconstruct and rebuild the affected areas. However, the details will be known only after the completion of a damage assessment report jointly initiated by the World Bank and the Asian Development Bank (ADB), due in October.
Losses to agriculture and livestock
1. The cotton crop, the country’s main cash crop, has suffered the most, with an estimated 2.25mn bales destroyed, a loss of USD 835mn. Initial estimates for the cotton yield this year were close to 14mn bales, but the current estimate is closer to 11.75mn bales.
2. Rice crops of close to 1.6mn tonnes were destroyed in the floods, inflicting a loss of USD 660mn. Initial estimates for rice production were 6.9mn tonnes in FY11, but this has been revised to 5.3mn tonnes.
3. The sugar crop also sustained significant damage, with an estimated 7.6mn tonnes of sugarcane destroyed in the floods. The economy will lose USD 226mn from this. Initial estimates for sugarcane crop were 58.4mn tonnes; this has now been revised down to 47.2mn tonnes.
4. Damage to the production of vegetables, fruit and pulses is estimated by MINFAL at USD 1.14bn. The total area under plantation is 2.8mn hectares and the devastated area is 0.6mn hectares.
5. The livestock sector has also been hit hard, with MINFAL predicting losses of USD 450mn. Nearly 2mn head of livestock have perished in the floods, while the hit to the poultry sector is estimated at USD 100mn.
Pakistan Electric Power Company (PEPCO) has stated that it suffered a loss of more than PKR 10bn (USD 120mn) to its installations across the country owing to the floods. Three water-hydel generation stations – Jigran (30 MW), Malakand (80 MW) and Chashma (160 MW) – suffered significant damage and have been shut down. The floods also hit three thermal power plants: Pak-Gen (350MW), ASE Lalpir (350MW) and KAPCO (1386MW), although the exact nature of the damage is unknown. This could exacerbate the demand-supply gap, which is estimated by the National Electric Power Regulatory Authority (NEPRA) at 4052MW. This gap could widen to 5000MW, further damping economic growth prospects.
Inflation on the rise
Monetary policy will remain hawkish given inflation concerns. The central bank hiked policy rates at its July 2010 meeting in a pre-emptive move to counter inflationary pressures; we see a further 100bps of rate hikes in the current fiscal year. However, the central bank will balance inflation concerns with concerns about the slowdown in growth, and will likely wait to hike further until there is more clarity on the extent of the economic damage from the floods.
Fiscal deficit likely to be higher, at 6.5% of GDP
The government will need to create fiscal space to pay for relief, rehabilitation and reconstruction expenditures and limit the build-up of public debt. The immediate measures announced by the government include freezing investment spending to FY10 levels and allocating PKR 153bn (0.9% of GDP) for flood-related spending. However, the government will need to undertake significant fiscal reforms, including introducing a sales tax aimed at boosting tax revenues by PKR 86bn, to fund reconstruction activity. Power-sector subsidies are also expected to be phased out, bringing an additional savings of PKR 127bn (0.7% of GDP).
Increased downside risks to the PKR
Large FX aid flows may be able to cushion the economic impact of the floods. So far, the response from donor agencies has been slow, according to the NDMA. Aid of only USD 142mn has come in, against pledges of USD 952mn made during a recent UN conference. The ADB has committed to a USD 2bn soft loan for reconstruction spending, and the World Bank has committed USD 1bn. However, this aid money has been diverted from other projects, and does not constitute new aid commitments. Hence, the downside risks to the PKR are high and are likely to be only partially covered by FX aid. The key for the medium-term PKR outlook is the release of the IMF funds.
Relations with the IMF critical to medium-term stability
While Pakistan’s short-term economic prospects are worrisome, reconstruction spending over the medium term will provide a significant boost to domestic output. This was the case in the aftermath of the 2005 earthquake, which caused an estimated USD 6.4bn loss to the economy. The short-term impact on growth was negative, with growth slowing to 5.8% in FY06 from 9% in FY05. However, the economy received a boost in the subsequent two years, expanding by an average of 6% per annum, primarily owing to reconstruction spending.
The writer is an Economist with the Standard Chartered Bank and holds a Masters in Economics from School of Oriental & African Studies, University of London. This Article is based on a report recently prepared by Mr. Sayem Ali. Comments may be directed to email@example.com.
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