January 06, 2020 (MLN): Pakistan’s external account showed signs of stabilizing in Q1-FY21 as the country managed to contain the initial domestic spread of Covid-19 and economic activities resumed from July onwards – helped by a significant easing in both the monetary and fiscal policy stances.

The State Bank of Pakistan released its Quarterly Report on the State of Pakistan’s Economy for the fiscal year 2020-21 yesterday. As per the report, the external sector continued to navigate the Covid crisis smoothly as Pakistan’s current account (CA) posted a surplus of US$ 0.8 billion in the first quarter of FY21 after a lapse of 21 quarters. The surplus was largely attributed to a noticeable increase in workers' remittances, low oil prices and a sharp fall in services imports, which more than offset the deterioration in the merchandise trade balance during the review period.

Furthermore, the primary income deficit grew 7.2 percent YoY in Q1-FY21; this growth was lower than the 33.3 percent rise recorded in the same period last year. The increase in the deficit this year was mainly due to a rise in profit and dividend repatriation by foreign firms operating in the country. However, the higher profit repatriation was partially offset by a reduction in interest payments on external debt. The drop in LIBOR, along with the relief in debt servicing through the G20’s Debt Service Suspension Initiative (DSSI) for the Covid pandemic, were the major factors behind the lower interest payments during the quarter.

With Covid-19 paralyzing economic activities across the globe from March 2020 onwards, immigrants and expatriates residing in the developed and emerging economies were expected to become financially constrained due to mobility restrictions and job losses. These developments were initially forecast to lead to a steep drop in the flow of remittances to the recipient economies. However, workers’ remittances to Pakistan grew 31.1 percent YoY to a quarterly record of US$ 7.1 billion in Q1-FY21, with an all-time high monthly flow of US$ 2.8 billion realized in July 2020. Inflows rose from all major corridors, including the advanced economies and the Middle East region.

As a result, the World Bank has also significantly revised its forecast for remittances for CY20, from an initial projection of a 23 percent decline to a growth of 9 percent. A major reason was the orderly foreign exchange rate conditions throughout the pandemic, which helped create a conducive environment for remitters to send money to Pakistan. Some other possible factors behind this favourable development are Air travel restrictions that pushed expatriates to adopt formal banking channels and build-up in savings, Post-outbreak fiscal support that helped shore up expatriates’ incomes, Covid-related incentives to formalize remittance flows and Digitization and other longstanding efforts to formalize inflows.

On the financial front, the report highlighted the financial account recorded a net outflow in Q1-FY21 after a gap of seven years. However, this net outflow was nearly of the same magnitude as the surplus in the current account (Figure 5.8a). The reduced external financing needs and a build-up in trade nostros with commercial banks helped them increase their foreign assets and retire short-term foreign exchange borrowings. This, along with the retirement of bilateral loans, more than offset the lower inflows from FDI and the government’s multilateral and bilateral borrowings during the quarter

According to the report, after the Covid outbreak, investors’ confidence was further eroded by the disruption in input supplies, rising uncertainties, and liquidity and credit constraints for multinational corporations (MNCs). Moreover, re-invested earnings that have a significant share in FDI were likely impacted as well, whereas investments into new projects could have been withheld due to the prevailing uncertainties.

In the case of Pakistan, however, the ripple effect was not felt as strongly because FDI is mainly concentrated in long-term projects, involving government-level collaboration. While net FDI into Pakistan during Q1-FY21 fell by 23.8 percent over the same period last year, the decline primarily reflected the base year effect, as last year’s FDI was inflated by a one-time inflow into the telecom sector to pay the GSM license renewal fees. Adjusting for this one-off development, the net FDI rose by around 75 percent in Q1-FY21 over last year where higher inflows were recorded in power, oil & gas exploration and financial business. These inflows partially offset the drop in other sectors.

With a substantial increase in these inflows, China’s share in the country’s net FDI rose to 24.9 percent in Q1-FY21 from 10.2 percent in Q1-FY20.

In line with developments in the balance of payments position, the country’s foreign exchange reserves rose 2.6 percent during the quarter to US$ 19.4 billion by end-September 2020. Within these, the SBP’s foreign exchange reserves increased by 0.2 percent to US$ 12.2 billion; indicating that the available inflows were sufficient to meet debt repayments. Meanwhile, the commercial banks’ liquid FX reserves increased by 7.1 percent to US$ 7.2 billion in Q1-FY21 and were the driving factor behind the country’s overall reserves trajectory as well as the exchange rate movements during the quarter.

The report underlined that the Pak Rupee parity appreciated by 1.4 percent against the US dollar in Q1-FY21, as compared to a 2.4 percent increase witnessed in Q1-FY20. The Pak Rupee appreciation in Q1-FY21 was supported by the sizable improvement in the current account balance and a trend reversal in commercial banks’ trade Nostro balances abroad from June 2020 onwards. The inflows under trade nostros contributed to the build-up in the commercial banks’ reserves (instead of SBP’s reserves) and improved the foreign exchange liquidity in the interbank market.

Meanwhile, the Real Effective Exchange Rate (REER) appreciated by 1.2 percent in Q1-FY21. Higher domestic inflation relative to the inflation in the trading partners of Pakistan led to the appreciation in the REER in this quarter, the report said.

The trade deficit widened during Q1-FY21 on a YoY basis for the first time in over two years and reached US$ 5.8 billion, mainly due to a reversal in the declining trend in imports.

Unlike last year when the policy stance was geared towards achieving macroeconomic stabilization, the fiscal and monetary policies in Q1-FY21 were coordinated to revive growth and encourage long-term Capex investments after the Covid-induced contraction by the end of FY20. This policy stance – coupled with rising prices of non-energy commodities and supply gaps in the availability of key agricultural commodities – led to an increase in imports during the quarter.

With imports rising, exports were stable at last year’s level; that said, exports did depict a V-shaped recovery and were up significantly over the Covid-impacted Q4-FY20.  In fact, Pakistan was among those economies whose exports recovered more strongly in Q1-FY21 on a QoQ basis (Figure 5.18b). The country’s relatively better performance in keeping Covid cases under check allowed the easing of lockdowns from the start of FY21, which allowed industrial and transport activities to resume. As the quarter progressed and of industries like textiles, cement and pharmaceutical products, also rebounded. The improved export performance of these sectors partially offset weaker exports of food commodities, especially rice.

The country’s exports rebounded to US$ 5.5 billion in Q1-FY21 from the 14-year low level of US$ 4.0 billion in the Covid-impacted Q4-FY20. However, on a YoY basis, the exports were stable at last year’s comparable level. It is worth noting that exports had risen during both July and September 2020 on a YoY basis, but overall Q1 exports were dragged down by the sharp 14.8 percent drop in August 2020, when record rainfalls, especially in the port city of Karachi, had disrupted intra-country transport activity.

As per the report, imports increased slightly by 0.8 percent to US$ 11.3 billion in Q1-FY21, as opposed to declining by 20.9 percent in Q1-FY20. The rise in values came entirely from a wide array of non-energy imports, which rose for the first time since Q1-FY18 mainly on account of cell phones, palm oil, raw cotton, and power generating machinery. These imports dominated the impact of price-driven lower energy imports in the quarter.

The outlook for the external sector has improved since the previous set of projections published in SBP’s FY20 Annual Report. The current account deficit is now projected to be in the range of 0.5-1.5 percent of GDP (earlier: 1.0 to 2.0 percent of GDP). The revision is mainly due to an upward adjustment in workers’ remittances, which are now expected to be in US$ 24.0-25.0 billion (earlier: US$ 22.0-23.0 billion), the report added.

However, projections of workers’ remittances are subject to risk from the outlook for the oil-exporting GCC economies, whose fiscal balances might deteriorate further with the escalation in global Covid infections. This may translate into a sizable reduction in their demand for foreign workers, leading to lower remittance inflows to Pakistan.

The outlook of exports and imports largely remains unchanged from their earlier assessment. The exports (fob) are projected to be in the range of US$ 24.0-24.0 billion while imports (fob) are expected to be in the scale of US$ 43.0-44.0 billion. The greater quantum of high value-added textiles and food commodities – especially rice – are expected to generate above target growth in exports. That said, the key downside risk to this outlook stems from the resurgence of Covid in major export destinations of Pakistan, which has the potential to suppress demand. On the upside, the incentives given in the industrial support package since early November 2020 may help the textile sector exports perform better. Similarly, imports are projected to surpass their annual target. The increase in food imports and domestic economic activity is mainly expected to drive import growth. That said, the increase in global Covid infections and associated further decline in crude oil price could lower import payments, the report said.

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