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Pakistan’s resistance to external shocks diminishes: World Bank

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October 08, 2018 (MLN): The recently published report titled “Budget Crunch” by the World Bank has said that Pakistan’s resistance towards external shocks has reduced considerably, largely owing to declining reserves and increasing debt ratios. Therefore, appropriate policy measures are needed to correct these imbalances, increase buffers to absorb future shocks and support a positive growth outlook, the report suggests.

Such responses would entail increased flexibility of the exchange rate, strengthening the fiscal position through renewed efforts to improve revenue collection and better coordination between federal and provincial governments to reduce public spending

The country’s macroeconomic situation remains flimsy as consumption-led growth is expected to hold up due to fiscal and perhaps monetary tightening. Therefore, short-term measures for fiscal consolidation and export growth need to be accompanied with medium-term structural reforms to wrench the economy out of recurrent boom-and-bust cycles.

Recent Economic Developments

Pakistan’s macroeconomic imbalances are increasing. Economic growth reached 5.8 percent in FY18, 0.4 percentage points higher than in FY17.

On the demand side, growth was driven by consumption which contributed seven percentage points towards GDP growth.

On the supply side, recovery in the agricultural and industrial sectors and consistent acceleration in the services sector contributed to the GDP growth.

Although headline inflation remained benign and was recorded at 3.9 percent in FY18, core inflation rose indicating underlying inflationary pressures. Therefore, the State Bank of Pakistan increased the policy interest rate by 175 bps to 7.5 percent between January 2018 and July 2018.

The current account deficit increased to 5.8 percent of GDP in FY18, from 4.1 percent in FY17. The widening current account deficit shows the growing trade deficit as exports are not growing as fast as imports. Imports are improving due to high domestic demand and import-intensive investments related to the China-Pakistan Economic Corridor.

The State Bank intervened heavily in the foreign exchange market in the first half of FY18 to maintain the value of the rupee, resulting in a large decline in international reserves from $16.1 billion (2.9 months of imports) at end-June 2017 to $10.2 billion (or 1.7 months of imports) by Aug 24, 2018.

Under intense market pressure, the currency depreciated by almost 18 percent between Dec 1, 2017, and July 25, 2018. Post-election, with emerging political certainty, the rupee recovered three percentage points against the US dollar and was trading at Rs. 124.3 per USD on September 7, 2018.

The fiscal deficit has widened over the past two years, reversing fiscal consolidation efforts in previous years and raising public debt levels. The 2018 fiscal deficit (including grants) reached 6.5 percent of GDP, a slippage of 2.5 percentage points compared to the budget target. This was due to limited revenue growth and large increases in recurrent spending at both the federal and provincial levels.

Thus, Pakistan’s public debt reached 73.5 percent of GDP by end-June 2018, significantly raising debt-related risks. The newly elected government recognizes the need for macroeconomic adjustments to overcome these challenges and has already announced its plans to reduce expenditures, improve the management of public enterprises, and undertake revenue mobilization reforms.

Outlook

The GDP growth is anticipated to slow down to 4.8 percent in FY19, as authorities are expected to tauten fiscal policy to overcome imbalances. However, growth is expected to recover in FY20 and reach 5.2 percent as macroeconomic conditions improve.

This recovery is conditional upon the restoration of macroeconomic stability, a supportive external environment, including relatively stable international oil prices, and a strong recovery in exports.

Inflation is expected to rise to 8 percent in FY19 and remain high in FY20, driven by exchange rate pass through to domestic prices and an increase in international oil prices. The pressure on the current account is expected to persevere and the trade deficit is expected to remain high during FY19 and FY20

Remittances will continue to partly finance the current account deficit, although slower growth in member countries of the Gulf Cooperation Council will affect remittances. Foreign direct investment, multilateral, bilateral, and private debt-creating flows are expected to be the main financing sources in the near to medium term.

The fiscal deficit is projected to narrow in 2019 due to post-election adjustments and some fiscal measures.

It is expected that there will be some scaling down of public investment spending at the federal and provincial levels, and increase in revenue collection through tax base expansion and other administrative measures.

Fiscal consolidation would improve debt dynamics, but the public debt to GDP ratio is expected to stay around 70 percent of GDP during FY19 and FY20 – the debt burden benchmark for high-risk in case of Emerging Markets.

Growth deceleration and higher inflation are expected to slow down poverty reduction in fiscal year 2019, though overall poverty decline is projected to continue reflecting GDP growth. The presence of safety net programmes will mitigate the negative impact of inflation on poverty.

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Posted on: 2018-10-08T12:29:00+05:00

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