September 28, 2018 (MLN): Fitch Solutions and Macro Research, on Thursday, maintained their forecast for Pakistan’s real GDP growth, expecting it to slow down to 4.7 percent in the fiscal year 2019 and to 4.3 percent in the fiscal year 2020, from 5.8 percent in the previous fiscal year.
According to the research house that works independently of Fitch Ratings, Pakistani economy is overheating and will likely face a reset in one form or another over the coming quarters, leading to a sharp reduction in imports on the back of a likely contraction in non-energy imports.
While the net exports account (a component of GDP by expenditure breakdown) will improve dramatically, this will likely come at the expense of a collapse in investment and consumption growth as reduced availability of imports undermines domestic production, said a report published by the research house on Thursday.
The report, ahead of the Monetary Policy announcement by the State Bank of Pakistan scheduled for Saturday, September 29, 2018, also opined that an IMF bailout is likely on the cards for Pakistan, which raises expectations that this could trigger an import crunch and higher interest rates for the country.
External Accounts Near Breaking Point
On the external front, the report highlighted that Pakistan’s external position is in a precarious position with total foreign reserve holdings (including scheduled banks) standing at USD16.4bn in August, representing just barely over three months of import cover.
Additionally, the trade deficit remains wide at USD3.0bn in August, while the current account deficit came in at USD1.9bn in July (latest available).
“This shows that the country is still accumulating external debt, which already reached an all-time high of USD95.1bn in the second quarter of the year 2018.”
In the first quarter of the year 2018, Pakistan’s net international investment position stood at USD112bn (representing close to 40% of GDP), up by a staggering 50% from just two years ago.
If Pakistan receives a bailout from the IMF, which we expect them to come to an eventual agreement, this would boost investor confidence and provide some support to the external accounts.
“However, the IMF will likely push for the State Bank of Pakistan to impose higher interest rates and higher reserve targets, which would trigger a reduction in imports,” it said.
The ongoing deterioration in the country’s terms of trade will make the necessary reduction in imports (in one form or another) amid an increasingly precarious external debt position a painful economic rebalancing process.
Oil import prices have continued to rise, sending the petroleum import bill to a new all-time high of USD1.8bn in July, surpassing the previous peaks in 2008 and 2012.
“With no end in sight to Pakistan’s foreign energy dependence, it will likely take a sharp drop in non-energy import volumes to reassert the trade balance on a more sustainable footing,” said the research report.
Similar to what the research house has argued previously, import crunches tend to trigger recessions. In FY1993/94, FY1997/98, and FY2010/11, Pakistan saw a large current account correction as a result of lower imports, triggering a shock to the domestic economy and subsequently a ‘recession’.
With working-age population growth in excess of 2.0% during such periods, a recession can be deduced when real GDP per working age person contracts, even if the actual real GDP growth remains positive. Such high external imbalances leave the economy vulnerable to external shocks.
One Tail Risk Strike Off But Others Remain
While mentioning four risk factors for the country identified by the research house previously, it eliminated the risks of political instability following the smooth transition to power for the newly elected government but maintained the importance of the other three risk factors highlighted by them.
“Risks of a continued rise in oil prices, shocks to Chinese investment along the CPEC, or a global growth slowdown remain salient given the current fragile state of the Pakistani economy.”
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