Tuesday May 21, 2024

Rupee to stabilise, inflation to drop

The Ministry of Finance is expecting economic improvement despite the calamitous flood and is eyeing exchange rate stability with a stabilizing rupee and dropping inflation

By Mehtab Haider
October 31, 2022

ISLAMABAD: The Ministry of Finance is expecting economic improvement despite the calamitous flood and is eyeing exchange rate stability with a stabilizing rupee and dropping inflation.

This would be coupled with improving trade balance, remittances to rebound to $2.7bn and the current account balance is likely to show a surplus. In its outlook for November, the Ministry of Finance is looking at some positivity with improvement in the trade balance in the coming months on account of import contraction due to a deceleration in domestic economic activities and aggregate demand. However, the export scenario may improve due to the revival of infrastructure in flood areas of the country. Remittances are expected to revert back to around the level of US $ 2.7 billion. Therefore, in the baseline scenario, the current account balance is expected to move to equilibrium or even a slight surplus. This would accompany exchange rate stabilization and dropping inflation.

However, in view of the current month’s data, the Ministry of Finance mentioned Pakistan’s economy is facing challenges on account of slower growth, higher inflation, and managing external financing requirements and it could be tackled only with the help of pursuing a balanced policy approach.

The “growth prospects have weakened, along with contained economic activities and low demand will impact on resource mobilization. Thus, FY2023 is moving with challenges, seeking balance policy mix for stabilization,” Ministry of Finance stated in monthly economic outlook and update shared on Sunday.

The large-scale relief and rehabilitation requirements resulting from the catastrophic flood have posed significant challenges to fiscal consolidation efforts. Since government needs to allocate higher resources for the rescue and rehabilitation of flood victims and the rebuilding of infrastructure, there will be significant pressure on overall expenditures. On the revenue side, despite import compression, the zero rates of sales tax on POL items, and the flood situation, FBR tax collection in the first quarter of the current fiscal year has been remarkable on the back of an effective revenue mobilization strategy. However, an expected slowdown in economic activity and growth due to the devastation triggered by the floods may impact domestic resource mobilization efforts.

In the long run, Ministry of Finance argued that sound fundamentals and a healthy growing economy, a significant raise was required in gross fixed capital formation instead on consumption. “This will increase the National Income significantly. Further, there is need to enhance the productive capacity and productivity in each sector to substitute imports by domestic production and provide more supply capacity to the foreign markets” the report added.

The exchange rate stability, the report says, requires sound economic fundamentals. Besides inflation, also a manageable current account deficit and guaranteed financing of this deficit by healthy financial inflows are required. The report states that overall economic outlook shows an optimistic picture of the economic performance in the coming months. The CPI inflation is declining, rupee has gained stability, current account balance is on improving trend. These developments indicate that economic activity will remain positive and persistent in coming months, the report showed its optimism and added that for the future path of inflation, the exchange rate was of utmost importance. “Moderating inflation also contributes to exchange rate stability, which in the benign case may generate a virtuous inflation-exchange rate cycle” it added.

When markets get convinced about these prospects, speculative bubbles in the exchange market would be highly unlikely. In the baseline short to medium run, helped by sound domestic fiscal and monetary policies, the current account deficit is expected to reduce. A major risk factor, though, relates to the necessary imports to absorb the devastating consequences of the floods. However, downward revision of Pakistan’s main trading partners’ outlook may have a downside risk for exports in coming months. For fiscal sector, catastrophic flood requires rehabilitation and massive expenditures which will pose significant challenge for fiscal consolidation. In Pakistan, the economic environment is challenging due to damages caused by floods. The agriculture sector has been particularly hard hit by the destruction brought on by the floods, and due to forward linkages, this impact will also be transferred to other sectors of the economy, thus changing the overall economic outlook.

In October 2022, international oil prices continued to decline. Thus, it can be predicted that the current cycle means- reverting process has been extended. International food prices have been experiencing a decline during the previous three months. Furthermore, the broad money developments seem to be compatible with lower and stable inflation. On the other hand, the exchange rate in terms of Pakistani rupees to the US dollar has started appreciating. Thus, in the month under discussion, the local average prices of basic goods declined as compared to September which is likely to reduce CPI inflation. Moreover, the supply disruption in view of recent floods have resulted in a shortage of perishable food items which are posing risks of higher inflation. The inflationary risks have partially been alleviated due to timely decisions to import perishable items by waiving off the customs duties. Administrative measures are also being taken to control price speculation to ease out inflation.

In addition, the reversal of rupee depreciation after the government’s action against private banks involved in artificially jacking up dollars assisted in strengthening the rupee against the dollar. Moreover, the declining international commodity prices are expected to offset the inflation spikes that emerged due to domestic supply shocks. Nevertheless, it can be expected that YoY CPI inflation in the month of October will maintain its declining tendency observed in September. It is expected that CPI inflation will remain in the range of 21- 22.5%.

For Rabi crops 2022-23, certified seed availability will be 14 percent more compared to last year. According to Indus River System Authority, provinces have been allocated 30.25 MAF of water as compared to actual use of 27.42 MAF last year (average system usage of 36.69 MAF). The prevailing weather conditions are supportive and the shortage with average system usage seems manageable. However, flood water in cropping areas poses some risks to wheat production despite government efforts to facilitate the farmers.

In September, the continued deterioration in the cyclical position of the main trading partners and the recent devastating floods likely led to slightly slowing down industrial activities in Pakistan. Further, the slowdown in global economic growth along with higher commodity prices badly damaged the performance of Pakistan’s main trading partners. Higher than-expected inflation and the tight monetary policy stance of SBP also affected growth negatively. The slowdown in the LSM sector, after being positive in August, and higher production costs also contributed to negative consequences for growth in the next months. As expected, according to balance of payments data, the balance of trade in goods and services improved in September 2022.

This was mainly attributed to a decline in imports brought on by slower growth, government restrictions, and negative seasonal effects. Also, exports declined slightly due to sluggish foreign demand and domestic supply issues may have played a more important role.