November 13, 2020 (MLN):  In the run-up to the recent global health crisis, Pakistan's balance of payments has been on the path to recovery due to various economic measures taken by the government and SBP such as import restrictions, export packages, Pakistan Remittance Initiatives (PRI), monetary easing and a number of other measures.

A recent research report by Arif Habib Limited covered and provided the discussion of the current growth performance of Pakistan’s external account as well as the latest forecasts prepared by research analyst considering the impact of the second wave of COVID-19. However, FY21 forecasts presented in this research are uncertain, depending on the severity of the unprecedented crisis, both within Pakistan and in its major export countries as there is no recent historical example of parallel magnitude and nature to this crisis.

Amid COVID-19, the global social and economic dynamics have changed dramatically, posing a global threat to economic growth and stability. Therefore, the economic situation in Pakistan has clearly become a challenge over time. During 2HFY20, the PKR fell nearly 8% compared to the greenback, the IMF program was temporarily halted, and lockdowns around the world put further pressure on Pakistan's already weakening international trade.

As per the report, the current account is expected to turn red and post a deficit of USD 2.5bn in FY21, with a 2% increase in quantum of imports, a 3% increase in exports and remittances, both as shown in the figure.

While, for a shred of evidence, Pakistan managed to post a 78% lower Current Account Deficit (CAD) of USD 3 billion in FY20 on the back of a 30% reduction in the Balance of Trade (BoT), strengthening by a 6% increase in remittances during the year despite all impediments stated earlier. A hike of 88% in Foreign Direct Investment and program loans of USD 2.5 billion from multilateral agencies provided further support to the financial health of the economy. Pakistan received USD 13 billion external inflows from bilateral and multilateral sources during FY20. This translated the overall reserves at USD 17.9 billion by June’20.

So far, Pakistan has been successful to curb the spread of COVID-19, but the latest second wave is blocking the recovery between the 2QFY21 and 3QFY21 that cannot be ignored.

With the onset of the new Fiscal Year 2021, demand and supply-side disruption remained a peril to the growth of the external sector of Pakistan. The global economy continues facing turmoil in 2020. Amidst global headwinds, the Current Account Balance remained impressive over the first three months of FY21 as Pakistan posted a Current Account Surplus of USD 792mn during1QFY21 against a deficit of USD 1,492mn recorded in the same period last year, although exports were slower relative to 2020.

For the remaining period of the current Fiscal Year 2021, the research is of the view that the trade balance is still on shaky ground as global uncertainty escalates. Thus, it is expected that the trade balance swinging to the deficit, in 2HFY21 particularly, as domestic seasonality increases, and global uncertainty prevails.  With economic activity expected to pick further pace, import growth is expected to outpace export growth, hence dragging the current account balance. Despite the government following a policy of limiting the import of certain products, rationing imports and increasing reliance on local production, the research expected a 2% likely jump in the total imports – goods & services (USD 52bn) in FY21.

The research highlighted that the resurgence of imports was witnessed as aggregate demand inflected after the ease of lockdown. As the government is considering various measures to propel demand through an expansionary fiscal policy, it is expected that goods’ imports in the upcoming year to expand 4% YoY to settle at USD 44 billion. Going forward, the research further anticipated that the textile sector may witness a jump in imports (+26% YoY) as the cotton crop is expected to suffer from locust attacks and monsoon rains. For the same reason, food imports will likely go up too (+13% YoY) as the country has already started importing essentials food items such as wheat and sugar. Further, the research by Arif Habib predicted the imports of transport to record yearly growth of 22%. The machinery group may also increase 9% in FY21 as major expansionary cycles of the cement, steel and related sectors are expected to resume once the economy starts recovering.

By sector, the main drag on overall imports will be primarily led by lower petroleum imports on account of noticeably lower crude oil prices (FY21 average prices assumed at USD 45/bbl vis-à-vis USD 54/bbl in FY20) following the outbreak of COVID-19 which resulted in a drastic slump in global oil demand.

Assuming constant volumes, the research forecasted the savings of approximately USD 2 billion. However, as aggregate demand is likely to increase next year, it is believed that the volumetric growth in petroleum products will partially offset the saving effect. Petroleum imports accounted for 22% of the total import bill in FY20 and are expected to contribute 19% to the bill in FY21.

With regards to exports, the research expected exports of goods will grow by 3% YoY to USD 23 billion. This would hugely depend on trading partners starting their rehabilitation phase more robustly. The textile sector which accounts for 55% of total exports will post a 6% YoY higher export growth during FY21. Another important factor for textile exports, as per the report, would be PKR/USD parity which the research expecting to reach 161/ USD by Dec-20 end. However, any appreciation of the Rupee from here would put pressure on textile exports.

Workers’ remittance, a lifeline for Pakistan’s economy is expected to continue the momentum of USD 2 billion till Dec-20. However, as the year unfolds, remittances flow might weaken with international economies returning to normalcy, the research added.

Regional markets, too, have portrayed high resilience in recent months. As seen in Figure, most countries in the region like Sri Lanka, Bangladesh and India were well supported by unusual strength in remittances | CAGR 7.3%, 5.4% and 4.9% respectively, over a decade.

One of the important parts of the external account’s equation is foreign reserves. Pakistan’s international forex reserves rose to USD 19.4 billion in Oct-20 from USD 17.9 billion at the end of Dec-19. At almost 2.9 months of import coverage, Pakistan’s foreign reserves are slightly below the IMF’s minimum 3 months threshold. Compared to regional players, Pakistan stands well above the average Import Cover of the countries graphically illustrated in the Figure below.

With the current level of reserves, Pakistan faces increasing external debt servicing pressures as the amount due in FY21 is USD 10.3 billion. On the other hand, so far USD 798 million has been repaid in the first two months of FY21 and the remaining amount (over USD 9.5 billion) is to be paid in the next 10 months.

According to the AHL research, Pakistan will be relying on financing from the IMF and other bilateral partners to meet its external debt requirements in FY21. It is assumed that the net increase in FX reserves during FY21 would amount to USD 1.5 billion, which is likely to be raised from Euro bonds and Sukuk; USD 200-300 million Panda bods inclusive. Moreover, the continuation of the IMF EFF, foreign aid from multilateral sources, Roshan Digital Accounts/Naya Pakistan Certificates, Hot money and Commercial borrowing can build up the foreign reserves.

Considering the Real Effective Exchange Rate (REER) for Pakistan over this fiscal year, the local unit has appreciated to its highest level of PKR 158.33 (on 12-Nov-20). The REER is currently below the lower standard deviation band (implying that it is undervalued). The report anticipated PKR to be 161 per USD by Dec-20 with REER inching up wherein SBP is expected to adopt greater flexibility in the short term, allowing PKR to appreciate, but still accumulate more reserves.

While in the short-term SBP may sterilize excess liquidity by selling government securities to ward-off a further flaring up of the headline CPI inflation, an enduring solution could be to use the inflow of capital for real investments and capacity creation, thereby managing growth, inflation and financial conditions consistently and positively.

In the longer term, there are a few key considerations given by the report such as i) addressing the speculations on heavy external borrowing by GoP, ii) the repayments scheduled from 2HFY21 onwards, and iii) widening CA deficit will put pressure on the PKR/USD parity which is expected to reach 165 per USD by Jun-21.

Though currency depreciation as per the report, is a concern for the economy, it should be considered mostly positive because it benefits key market-driving sectors as far as their short-term profitability is concerned such as IPPs (USD-based ROE), Textiles (for better exports), E&Ps (product pricing in USD), while the situation is neutral to negative for Cement (import of raw materials), neutral to positive for Fertilizer and negative for OMCs (FX losses), Autos, Pharmaceuticals and Consumer sectors.

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