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Sunday April 02, 2023

‘High inflation, low forex reserves main challenges to economy’

February 01, 2023

ISLAMABAD: Amid ongoing parleys with IMF for breaking the deadlock for reviving the programme, the Ministry of Finance has conceded three major challenges being confronted by country’s economy. These challenges include stagflation, low foreign currency reserves and immense pressures on fiscal fronts.

“Pakistan is currently confronted with challenges like high inflation, low growth (stagflation) and low levels of official foreign exchange reserves”, the Ministry of Finance stated in its monthly report released on Tuesday.

Further, the month-on-month (MoM) increases in consumer prices may be countered by a further mean reverting international commodity prices and some exchange rate stability due to decreased pace of depreciation, it said.

The overall money supply growth remains compatible with a return to low and stable inflation. But, the outlook of M2 is broadly dependent on fiscal accounts which are under immense pressure on account of heavy interest payments and rehabilitation spending.

Nonetheless, the first five months of CFY have ended with some developments; containing fiscal deficit and surplus in primary balance due to effective fiscal management. Fiscal consolidation is the key to saving official reserves and exchange rate stability.

This may temporarily be costly in terms of growth prospects in the short-term. Long-run prosperity and growth can only be achieved by augmenting the country’s long-term equilibrium growth path by expanding production capacities and productivity. This is a shared responsibility of both the private and public sectors, it added.

In Pakistan, economic activity is following a lower growth path since the start of current fiscal year. This is also reflected by the negative growth of several high frequency variables such as cement dispatches, oil sales, industrial production etc.

Furthermore, slowdown in global growth, especially in main export markets, along with tight monetary policy stance by central banks (17 percent policy rate in January 2023) and low export growth also affected economic growth in Pakistan negatively. The average monthly economic indicator (MEI) points to slightly positive growth during the first half of the current FY. But, it deteriorated somewhat during the second quarter of current FY.

According to Balance of Payment data, export of goods decreased by 21.6 percent on YoY basis in the month of December 2022, while export of services declined by 3.2 percent. As a result, exports of goods and services declined by 18.1 percent in Dec. Usually, the month of December observes a strong positive seasonal effect which has played some role and total exports increased by 2.3 percent on MoM basis.

On the other hand, import of goods decreased by 34.4 percent on YoY basis and 2.7 percent on MoM basis in Dec 2022. Similarly, import of services declined by 44.5 percent on YoY basis. As the imports fell more than decline in exports, the trade balance of goods and services improved by 52.3 percent.

Exports are constrained by domestic production issues related to the slowdown of demand in the main export markets and high domestic production costs. Imports are currently constrained by sluggish domestic demand and administrative measures to protect the official foreign reserves level. Since no immediate reversal of these developments is envisaged, the trade balance may further stabilise or improve somewhat in the upcoming month.

The current account balance slightly deteriorated in the month of December. This was mainly due to an increase in primary income payments and a decrease in remittances. It is expected these payments would return to normal levels. Together with expected improvement in the trade balance due to prudent government measures, the current account deficit may decline in January and stabilise during second half of FY2023.

Geopolitical tension, tightening financial conditions and rising inflation have all had a considerable negative influence on growth expectations, creating severe challenges for the global economic environment. Pakistan is no exception.

The government has adopted tight fiscal and monetary policies to combat the economic problems brought on by both internal and external forces. Currently, it is facing difficult task of supporting vulnerable segments of society and meeting other public spending needs, particularly rising interest servicing.

However, due to prudent spending management and effective domestic resource mobilisation, the fiscal deficit was not only confined to the same level of 1.4 percent of GDP as last year, but primary balance surplus was also maintained during the first five months. Nonetheless, rising interest payments due to increase in domestic and foreign interest rates as well as flood-related spending can put extensive pressure on overall spending.

Furthermore, despite massive import compression, FBR tax collection has increased by more than 17 percent, yet it registered a shortfall of Rs217 billion in the first half of current fiscal year. In light of current global and domestic economic conditions, FBR facing a difficult task in meeting the full-year target.

In the absence of adequate fiscal space to mitigate the impact of various economic shocks, the government’s option would be to reallocate expenditures towards critical areas, while improving spending efficiency. Raising revenue by broadening tax base, making tax system more progressive and reducing tax avoidance and evasion is the other option, the report concluded.