Riphah International University Faculty of Management Sciences

Riphah School of Leadership

Final Term Examinations, Spring 2020
Subject: Principles of Macroeconomics B
Teacher Name: Dr. Munir Khan
Marks: 60 (Weightage 20%)
Time Allowed: 3 hrs.

SAP ID: 11850

NAME: HAMID RAZA NASIR

Q: 1
Discuss how the following three factors can affect investments in Pakistan’s economy.

Change in income

Population

Existing stock of capital

FACTORS
Population:
With an increasing rate of population, expectations of entrepreneurs change so that they turn to
believe certain investments to be profitable
Change in income:
Changes in real income can result from nominal income changes, price changes, or currency
fluctuations. When nominal income increases without any change to prices, this makes
consumers able to purchase more goods at the same price, and for most goods consumers will
demand more.
Existing stock of capital:
A larger capital stock enables more real production at a given price level, causing an increase in
both long-run and short-run aggregate supply.

Q: 2
Give an overview of monetary policy adopted by the State Bank of Pakistan over the past
twelve years (three governments) and how that can affect the future of Pakistan’s economy,
specifically under COVID19 scenario.
DEFINITATION:
Monetary policy is the term in of macroeconomics’ policy used by the central bank. It is
involved in the management of money supply and interest rate and is the demand of economic
policy used by the government of any country to achieve macroeconomic objectives as inflation,
consumption, growth and liquidity.
Monetary policy adopted by the State Bank of Pakistan in 2008
Policy Measures Taken:
SBP has taken many measures to actively address the challenges.
Since the beginning of FY08, corrective policy measures taken by SBP include:
 Staggered increase in the SBP policy rate to 13 percent;
 Timely changes in Cash Reserve Requirement (CRR) and Statutory Liquidity
Requirement (SLR) for good liquidity management;
 Encouraging aggressive resource mobilization in private sector by catalyzing banks to
raise more deposits through imposition of minimum
Interim Monetary Policy Measures, November20082deposit rate and exempting long tenor
deposits from reserve ratios–later not only allowed banks to encourage savings but address their
asset-liability mismatches;
 Steps to stabilize volatility in foreign exchange markets –though macroeconomic
fundamentals.
 Assessing and monitoring closely the liquidity in the financial system and ensuring the
release of desired level of liquidity through all monetary tools available at hand.
The general sales tax (GST) rate was raised one percent point to 16 percent and tax revenue
collection have been enhanced.
Government has raised the wheat procurement price to stimulate production.
Further there has been a change in Government strategy for domestic borrowing.
Outcome for Jul-OctoberFY09 has deviated from expectations. Not completing these measures,
additional unanticipated developments emerged and the outcome during the first four months of
FY09 deviated substantially.
Interim Monetary Policy Measures,
November2008 expectations.
Three principal factors complicating macroeconomic management are:
One, continued growth in public sector spending beyond resource availability as indicated by
excessive recourse to inflationary borrowing from the SBP, which reached to Rs369 billion
during 1st July to 8th November 2008; of this Rs128 billion is on account of maturing T-bills,
which commercial banks did not subscribe to in the auctions conducted over this period. Also
Rs21.1 billion is on account of accrued profits on SBP holding of T-bills.
Two, surge in import bill by 35.2 percent during Jul-Oct, FY09 is unsustainable given the low
level of financial inflows and depleting reserves. The import bill would have had a more severe
impact on the external imbalances had exports and remittances not been buoyant.
Three, inflation accelerated and its expectations strengthened due to pass through of
international oil prices to domestic market, increases in the electricity tariff and the general sales
tax, and rising exchange rate depreciation.
These developments resulted in a further rise in headline as well as core inflation (20 percent
weighted trimmed measure) to 25 percent and 21.7 percent respectively in October 2008.
These developments have generated multiple and diverse set of debates.

Monetary policy adopted by the State Bank of Pakistan in 2013:

In the monetary policy statement of February 2013, SBP highlighted two main challenges for
monetary policy:
To manage the balance of payment position and
To contain the possible increase in inflation.
Since then, SBP’s foreign exchange reserves have declined by another $2billion; from 8.7 billion
at end-January 2013 to $6.7billion as of 5th April 2013, mainly due to debt payments.
Other than the expectations, however, year-on-year inflation has come down by 1.5 percentage
points; from 8.1 percent in January 2013 to 6.6 percent in March 2013.
These developments pose divergent policy choices for the SBP. .A net capital and financial
inflow of $34 million during July –February, FY13 is insufficient to finance the external current
account deficit of $700 million for the same period.
While the external current account deficit is expected to widen further in the remaining months
of FY13. It is important to know that it is not the size of the external current account deficit,
which is projected to be small and manageable, but the lack of adequate financial inflows that is
exerting pressure on the balance of payments. So, the pressure on foreign exchange reserves is
likely to remain in the coming months.
SBP has played an active role in managing the conditions, but only a consistent increase in
foreign exchange can ensure sustainable stability in the market.
 Interest rate is also important in this context as it determines the return on rupee denominated
assets relative to foreign currency assets. The idea is to discourage speculative demand for
dollars by keeping rupee denominated assets sufficient.
Real returns on rupee denominated assets have marginally increased due to a great decline in
inflation. Moreover, led by a depreciation of 5.2 percent in the Nominal Effective Exchange Rate
(NEER), the Real Effective Exchange Rate (REER) has also depreciated by 4.2 percent during
July –February, FY13. This bodes well for the competitiveness of the external trade sector.
Real cost of borrowing has increased, which may be not needed in the wake of declining private
investment and low growth in the economy. Despite continued energy shortages and substantial
fiscal borrowings from the banking system, credit extended to private businesses has shown
some nascent recovery.

Monetary policy adopted by the State Bank of Pakistan in year 2018:

Pakistan’s growth in economy is on track to get its highest level in the last eleven years. Average
amount inflation remains within the forecast range of State Bank of Pakistan, but core inflation
has continued to increase. Fiscal deficit for FY18 is expected to fall close to the last year’s2.5
percent. There has been great improvement in export growth and remittances are marginally
higher.
However, largely due to high level of imports the current account deficit remains under
pressure. The exchange rate adjustment in December 2017 is expected to help ease the pressure
on the external front.
Similarly, large scale manufacturing recorded a healthy growth of 7.2 percent during Jul-Nov
FY18 as compared to 3.2 percent during the same period last year.
While there could be some deceleration in LSM growth due to sector specific issues such as
sugar, POL and fertilizer, overall industrial activity is likely to remain strong. Benefiting from
both infrastructure and CPEC related investments, construction and its allied industries are
expected to maintain their higher growth momentum.
As a result, State Bank of Pakistan’s liquid foreign exchange reserves
Monetary policy committee state bank of Pakistan witnessed a decline of US$ 2.6billion since
end June 2017 to reach US$ 13.5billion as of 19thJanuary 2018.
Moving onwards, the PKR depreciation in December 2017, the export package, the lagged
impact of adjustments in regulatory duties, favorable external environment, and expected
increase in workers’ remittances, will contribute to a gradual reduction in the country’s current
account deficit. While increase in international oil prices pose major risk to this assessment,
managing overall balance of payments in near term depends on the realization of official
financial flows.
Four key factors of Pakistan’s economy have witnessed important changes since November 2017
First:
PKR has depreciated by around 5percent.
Second, oil prices are hovering near USD 70 per barrel.
Third, a number of central banks have started to adjust their policy rates upwards adversely
affecting PKR interest-rate.
Fourth, different indicators show that the output gap has significantly narrowed indicating a
buildup of demand pressures.
Based on these developments, the Monetary Policy Committee has decided to raise the policy
rate by 25 bestow 6.00 percent
FUTURE OF PAKISTAN’S ECONOMY:

Before the COVID-19 showed up, economy of Pakistan was struggling to stay good but was in
not in danger of collapse. While COVID-19, has severely impacted the nation’s economy and
pushed it to the verge of bankruptcy. No doubt almost all nations have substantially affected by
the global health emergency, Pakistan’s economy does not have the capacity to absorb the
massive disruption caused by the COVID-19.

Months before the pandemic, in July 2019, Pakistan was forced to seek an Extended Fund
Facility (EFF) programme with the International Monetary Fund (IMF) due to its twin deficit
problem, i.e. fiscal and current account. With massive devaluation, the country managed to
reduce the current account deficit (CAD) by over 70 percent in the first seven months of
Financial Year (FY) 2019-20. However, this came at the expense of economic growth, which fell
from 5.6 percent in 2018 to 3.3 percent in 2019.

In 2020, it was being known to fall further to 2.4 percent, without accounting for the pandemic.
In the meantime, the fiscal deficit problem continued unchecked partly because the revenue
collections fell drastically short of the targets and because the government slashed developmental
expenditure to demonstrate a positive primary balance, which was one of the conditionality’s of
the IMF programme.

Amidst the ongoing COVID-19 pandemic, both these deficits are likely to re-emerge, with a
drastic decline in exports and foreign remittances. In 2019, Pakistan’s military had voluntarily
foregone any increase in the defense budget. It is likely to demand a substantial increase. Further,
the government will be forced to reverse the trend of cutting expenditure on health, education
and other social service sectors.

These issues are compounded by Pakistan’s growing public debt, the servicing of which
constitutes a substantial part of the government expenditure.

Consequently, Pakistan is treating COVID-19 as an opportunity to obtain concessions, bailouts

and debt relief, to avoid undertaking the reforms it had accepted as part of the 2019 IMF bailout.
The country is also seeking bailouts from China and Saudi Arabia. These helpful measures
cannot replace the underlying need for deep structural reform in Pakistan.

Conclusion:
Monetary policy in Pakistan is currently operating in an environment in which fiscal deficits and
government debt are increasing, the government is continuously borrowing from SBP, and there
is concern that inflation and debt growth would not be controlled.

Q: 3
Give an overview of fiscal policy adopted by the government of Pakistan over the past
twelve years (three governments) and how that can affect the future of Pakistan’s economy,
specifically under COVID19 scenario.
FISCAL POLICY:
In economics and political science, fiscal policy is the use of government revenue collection and
expenditure to influence a country's economy
Historically, Pakistan experienced mix of high and low periods in terms of fiscal performance
over the last two decades.
Fiscal policy used in the year 2007‐08:
Fiscal year 2007‐08 has been a difficult year for Pakistan’s economy in which many events were
unexpectedly on both domestic and external fronts. Absence of effective policy response during
the political transition to a new government further highlighted the macroeconomic difficulties.
Long delays in passing the large increases in international oil and food prices to the domestic
consumers resulted in marked deterioration of fiscal and external positions. Monetization of the
fiscal deficit contributed to the inflationary pressure.
Fiscal year 2007‐08 showed that a loose fiscal policy is the first step towards an unsustainable
debt path that can lead to a macroeconomic crisis.
Fiscal policy used in the year 2012-13:
Fiscal performance in 2012-13 again showed the pattern of past years as expenditure outstripped
revenue by a wide margin, reflecting the continuation of excessive subsidies and lower tax
collection.
The fiscal deficit increased to 8 percent against the budgeted target of 4.7 percent of GDP mainly
owing to around 19 percent in FBR budgeted tax revenue, under estimation of subsidies and
interest payments.
The fiscal deficit includes Rs.322 billion on account of settlement of power sector circular debt
without which the fiscal deficit is calculated at 6.6 percent.
Fiscal policy used in the year 2017-18
The present government, has devised a strategy to control twin deficits by focusing on
broadening the tax base instead of increasing burden on current tax payers as well as enhancing
foreign exchange earnings of the country.
At the same time, reduction in unnecessary expenditures of losses in public sector enterprises
are also being pursued to bring down the fiscal deficit, which is the main cause of higher levels
of borrowing and resultant indebtedness.
Overall, analysis of the last two decades of fiscal performance showed that high subsidies
remained a major burden on fiscal account combined with falling tax to GDP ratio.
Low tax to GDP ratio has also translated into falling total revenue to GDP ratio, as it decreased
from an average 18 percent during 1992-96 to 13.4 percent during 2008-13.
Astonishingly, during the period of fiscal improvement (1999-2004), tax to GDP ratio continued
to slide.

The current account deficit is expected to continue narrowing to the equivalent of 2.8% of GDP
in FY2020 with a reduction in the trade deficit resulting from currency depreciation, the
imposition of regulatory duties to contain import demand, and continued recovery in workers’
remittances following declines in FY2016–FY2018.
In the first half of FY2020, the current account deficit narrowed sharply from 5.8% of GDP a
year earlier to 1.5%. Modest growth in the key exports textiles, rice, and leather was supported
by loans under a central bank export finance scheme and long-term financing facility for
exporters. This was complemented by a notable reduction in imports restrained by higher import
duties. Thanks primarily to the lower oil price, the current account deficit is projected to narrow
further to equal 2.4% of GDP in FY2021.