December 28, 2021 (MLN): As fears of Omicron remain unfounded with little to no impact on commodity prices, Pakistan is now facing another set of risks that will test the fiscal as well as monetary management.
Firstly, a higher inflation outlook for December 2021 and January 2022 (both expected to remain above the 12%YoY mark) will be a key test to the current monetary settings. To note, the State Bank of Pakistan (SBP) in its December monetary policy committee meeting had hinted at the end of the hike cycle, saying that it has achieved its targets of positive real interest rates. However, the recent weekly Sensitivity Price Index (SPI) readings for the week ended on December 23 witnessed the highest YoY increase in the calendar year. The majority of the increase in the weekly readings was contributed from an increase in electricity charges, LPG prices, cooking oil and vegetable ghee. The weekly readings will keep the CPI inflation readings for December in double digits, putting additional pressures on core prices which are downward sticky.
Secondly, the SBP and the Ministry of Finance have bet a lot on ease in international commodity prices to rein in the twin deficits and inflation from January 2022 onwards. So far, during the 5MFY22, the trade and current account deficits have clocked in at -$17 billion and -$7.08bn respectively. Going by this trend, the trade gap is likely to clock in at $40bn. Thus, the current account deficit by the year-end would likely end up somewhere in the range of $13-16bn for FY22. The SBP and the government are expecting some moderation in imports partly from i) ease in international commodity prices i.e., crude oil, palm oil, steel, food, etc. and ii) reduction in demand for imported products amid increased cash margins, high-interest rates and double-digit inflation. Even though it seems highly likely that the rising prices and high-interest rates will check demand growth in the months ahead, the government is unlikely to win the bet against international commodity prices. As per the CY2022 outlook unveiled by various international banks and multilateral organizations, the prices of crude, palm oil and steel for example are expected to remain at their current levels. Some are even predicting oil prices to trade at $100 per barrel in the next six months. This will not exacerbate the situation on the external front, but will also lead to higher inflation forcing the SBP to announce further tightening.
Thirdly, there are additional headwinds on the economic growth front. Large-scale manufacturing declined by 1.19% during October. The decline in output was largely on account of lower cement, fertilizer and electronics production during the month under review. However, it is pertinent to mention here that since October 2021, things have worsened for the industrial sector in the form of gas load shedding. The production figures for the months of November and December will likely be lower than October since most news reports claim low provision of gas to the industrial sector of the country. Beyond the energy shortage, the increase in the policy rate, cash margin on raw materials, and proposed withdrawal of sales tax exemptions from raw materials will keep LSM readings in check. This will in turn test the overall GDP growth of 5% being targeted by the government.
Fourthly, there are also reports of fertilizer shortages affecting the prospects of the wheat crop in the coming season. Additionally, revised cotton crop estimates by the Pakistan Cotton Ginners Association (PCGA) show lower-than-expected growth in the fibre crop. Sugar production, which will be reflected in the November LSM figures will show whether there has been an increase in sugar cane output in the current fiscal year. Rice and maize continue to witness a sharp increase in per-acre yields and are likely to grow in line with their historical trend. Overall, the outlook for the agriculture sector is positive so far however a lot depends upon wheat production.
The country’s economic managers have a lot on their plate in the 2HFY22 and the direction of policies will likely be dictated by commodity prices especially crude oil.
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