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Pakistan’s economy slowing as it passes through yet another macroeconomic crisis: World Bank

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October 14, 2019 (MLN): Word Bank recently released a document titled ‘Making De(centralization) Work’, which talks about recent economic developments as well as economic outlook of South Asian countries, including Pakistan.

According to the report, Pakistan’s economy is slowing as the country passes through yet another macroeconomic crisis with high twin deficits and low international reserves. With an IMF Extended Fund Facility supported stabilization program in place, growth is expected to remain low in the near term.

The medium-term growth outlook hinges upon the country’s ability to implement necessary structural reforms to boost competitiveness and achieve sustained growth. Progress in poverty reduction is expected to be limited during the macroeconomic adjustment period.

Recent economic developments

The report suggests that the GDP growth decelerated to 3.3 percent in FY19—2.2 percentage points lower than FY18—as gradual policy adjustments to tackle macroeconomic imbalances started to take effect. These adjustments included a tightened monetary stance, cuts in public sector development expenditures, and enhanced focus on higher tax collections. As a result, large scale manufacturing, which accounts for half of overall industrial output, contracted by 3.6 percent in FY19.

The services sector, which contributes over 60 percent to total output, decelerated to 4.7 percent in FY19 compared to 6.2 percent last year. In agriculture, major crops registered a 6.6 percent decline in production due to adverse weather conditions. On the demand side, policy adjustments slowed private consumption growth from 6.8 percent in FY18 to 4.1 percent in FY19, while investment contracted by 8.9 percent in FY19 as compared to a growth of 7.1 percent in FY18.

Headline inflation increased to 7.3 percent in FY19 compared with 3.9 percent in FY18, primarily because of a cumulative depreciation of 25.5 percent of the PKR against the USD during the fiscal year. To check these inflationary pressures, the State Bank of Pakistan (SBP) gradually raised its policy rate by 675 bps to 13.25 by July 2019.

The current account deficit (CAD) narrowed to USD 13.5 billion (4.8 percent of GDP) in FY19 compared to USD 19.9 billion (6.3 percent of GDP) in FY18. The decline in the CAD was primarily driven by a fall in imports (goods imports declined by 7.4 percent while services imports fell by 14.9 percent). Exports, however, did not respond to the depreciation in FY19, as regaining competitiveness after extended periods of an overvalued exchange rate will take time.

Financial flows increased due to substantial liquidity injections from Saudi Arabia, UAE and China. However, these injections did not stem the declining (net) foreign reserves, which fell from USD 9.8 billion (1.7 months of import cover) in end-June 2018 to USD 7.3 billion in end-June 2019 (1.5 months of import cover).

Fiscal performance in FY19 deteriorated substantially due to revenue underperformance and higher interest payments. The consolidated fiscal deficit (including grants) stood at 8.8 percent of GDP—2.4 percentage points higher than FY18. Tax revenues almost stagnated at last year’s level and non-tax revenues declined by 44 percent as the exchange rate depreciation reduced SBP profits, resulting in lower transfers to the government.

As a result, overall revenues contracted by 6.3 percent. With fiscal slippages and the large exchange rate depreciation, Pakistan’s public debt rose sharply to 86.5 percent of GDP by end-June 2019 compared to 73.0 percent in FY18.

To restore macroeconomic stability, the government signed a 39-month USD 6 billion Extended Fund Facility (EFF) program with the IMF in July 2019. Key steps initiated under the EFF include a shift towards a market-based exchange rate regime, expenditure consolidation, increased revenue collections, stronger coordination between federating units, an upward adjustment in energy prices and tighter monetary policy.

Outlook

Growth is projected to decelerate to 2.4 percent in FY20 with continued fiscal consolidation and a tight monetary policy stance. The IMF adjustment program entails a rebalancing from domestic to external demand. Growth is expected to recover slowly, to 3.0 percent in FY21, as macroeconomic conditions improve and external demand picks up on the back of structural reforms and increased competitiveness. This recovery is conditional on relatively stable global markets, a decline in international oil prices and reduced political and security risks.

Inflation is expected to rise in FY20 to 13.0 percent, and afterwards start declining gradually. The increase in prices will be driven by the second-round impact of exchange- rate pass-through to domestic prices. Pakistan’s commercial banks remain well capitalized. However, rising public sector demand for credit (mainly central government borrowing) and rising interest rates are expected to crowd out private credit in the near-term.

The current account deficit is expected to decline to 2.6 percent of GDP in FY20 and further to 2.2 percent of GDP in FY21, as increased exchange-rate flexibility will support a modest recovery in exports and rationalization of imports. The consolidated fiscal deficit (including grants) is projected to reach 7.5 percent of GDP in FY20 and remain elevated at 6.2 percent of GDP in FY21.

The public debt-to-GDP ratio is expected to remain high in FY21 at 80.8 percent, increasing Pakistan’s exposure to debt-related shocks. Fiscal consolidation across the federation will be needed for the public debt to decline, but the debt-to GDP ratio is not expected to fall below 70 percent of GDP – the debt burden benchmark for high risk emerging markets – over the medium term. Pakistan’s debt vulnerabilities will remain high due to large foreign currency debt amortizations and sizeable refinancing of short-term domestic debt.

Risks and challenges

Economic policies over the past few years have resulted in increased debt levels and erosion of fiscal and external buffers, limiting the economy’s ability to absorb shocks. The country needs to restore these buffers, especially since (i) turbulence in global financial markets could affect Pakistan’s access to private external financing; and (ii) the weakening global economy and rising trade tensions could dampen external demand.

The main domestic risk emerges from potential difficulties in implementing the necessary adjustments and structural reforms. Vulnerable households’ ability to weather the economic impact of the crisis will depend critically on the inclusiveness of growth, food and nonfood inflation, and the resilience of sectors relevant for their employment (agriculture, construction and wholesale/ retail trade).

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Posted on: 2019-10-14T11:40:00+05:00

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