August 28, 2020 (MLN): Following a small contraction in FY20, Pakistan economy could grow by 1.8% in FY21 driven by some recovery in private consumption, Institute of International Finance in its latest report said.
However, risks to the economic outlook are tilted to the downside, amid uncertainty regarding the magnitude and duration of the pandemic.
According to the report, the sharp depreciation of the rupee has reduced external vulnerability. Pakistan’s exchange rate is market-determined and has depreciated by 22% in real effective terms since 2017. The effects of currency depreciation and weaker domestic demand are visible, as imports dropped by 18%in nominal dollar terms, more than offsetting the decline in exports of 7%, in FY 2020 (July 2019 to June 2020).
In addition to this, the workers’ remittances, which slightly exceeded exports of goods, continued their increase, supported by a more depreciated exchange rate and appropriate policy steps implemented by the authorities as reducing the threshold for eligible transactions from $200 to $100 under the Reimbursement of Telegraphic Transfer (TT) Charges Scheme, an increased use of digital channels, and targeted marketing campaigns has promoted usage of formal channels.
Thus, the decline in the trade deficit combined with higher remittances narrowed the current account deficit from 4.8% of GDP in FY 2019 to 1.1% in FY 2020, the report added.
Report further highlighted that net capital flows have more than offset the current account deficit, leading to a substantial increase in official reserves (excluding gold) to the equivalent of 2.8 months of import coverage. While the current account deficit may widen slightly to 1.6% of GDP due to some recovery in imports and slightly lower remittances in FY2021, the increase in net capital inflows would lead to a further rise in official reserves.
On the fiscal front, low tax revenue mobilization, and high public indebtedness remain major challenges. As per the report, resistance to tax reforms and cost-recovery in the energy sector from entrenched elites could undermine the fiscal consolidation strategy and put public debt sustainability at risk.
The report further underscored that completion of the second Extended Fund Facility (EFF) review has been delayed pending implementation of key reforms. The narrowing of the deficit in FY 2020 (ending June 2020) to 8.1% of GDP was largely due to one-off factors, including the jump in profit transfers from SBP to the budget, which bolstered non-tax revenue.
Spending increased by 15.6% due to sharp increases in interest payments on debt and social transfers. The budget for the FY 2021 envisages cuts in subsidies, freezing salaries and pensions, and increases in petroleum levies. However, rising defense spending, higher interest payments (6.3% of GDP), and rollover of fiscal stimulus from FY 2020could widen the deficit to 8.7% of GDP, compared with a budgeted deficit of 7%, which is based on growth of 2.1%. Public debt could rise to 86% of GDP by June 2021, compared with 70% in 2018, it added.
However, the improvement in the current account, rollover of short-term debt, and Debt Service Suspension Initiative (DSSI) have eased Pakistan’s external financing needs and shored up its official reserves, which could increase further to $15.4billion (excluding gold) by June 2021(3.3months of imports of goods and services), the external funding picture warrants caution as debt amortization remains high in years to come, the report underlined.
Lastly, the report apprised that the policy rate is expected to remain the same in the next MPC meeting, thus dampening inflationary expectations. Although rising food prices continue to exert upward pressure on inflation, weak demand is likely to keep inflation in upper single digit levels as the 12-month headline inflation was 9.3% YoY in July 2020.
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