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Ouster of Nawaz has enhanced political risks: WB

By Mehtab Haider
October 10, 2017

ISLAMABAD: The World Bank (WB) has warned Pakistan over increasing macroeconomic risks substantially especially on external account, projecting that these risks might affect the country’s dwindling foreign reserves.

“The quitting of ex-prime minister Nawaz Sharif has enhanced political risks and created some policy uncertainty. The upcoming national election in 2018 may affect the reform momentum and macroeconomic policy. Slower progress in much-needed structural reforms would weaken growth prospects and discourage private investment,” a WB’s report titled “South Asia Economic Focus Fall 2017” states on Monday.

Macroeconomic risks for Pakistan, the WB report says, have increased substantially during FY2017. The external balance is particularly vulnerable given the persistent current account deficit, affecting the country’s reserve position. The WB suggested that improving the external balance hinges upon a revival in exports, a slowdown in imports, and stable remittance flows.

“In absence of any of these factors, the persistent current account deficit will put further pressure on already dwindling reserves. The fiscal position is also expected to deteriorate during the election cycle, which would affect debt trends and maintain debt at the current high level,” it added.

The WB projected the outlook until FY2019 as moderately higher growth. This outlook is contingent upon continued macroeconomic and political stability, as well as steady progress in implementing the main pillars of the government’s medium-term reform programme, which tackles key constraints to growth. The WB says tackles key constraints to growth. The WB says that the outlook assumes that oil prices will increase moderately but remain low. On the supply side, impetus to growth is projected to come from the services and the industrial sectors. On the demand side, acceleration would be driven by public and private consumption, aided by a moderate increase in investment. The pressure on the current account is expected to persist as the trade deficit will remain elevated during FY2018 and FY2019.

This situation can potentially become unsustainable in absence of corrective policy measures. However, exports are expected to recover during FY2018 and FY2019 due to an easing of supply side factors. Imports, after strong growth of 17.7 percent in FY2017, are expected to grow at a slower pace in FY2018 and FY2019. Remittances will continue to partly finance the current account deficit. It is also expected that FDI flows will strengthen due to the accelerated implementation of CPEC projects. 

However, capital and financial flows during FY2018 and FY2019 will only partly finance the current account deficit, which will result in a drawdown of reserves during these two years. Fiscal slippages are expected to continue through the election cycle, which will result in a widening of the fiscal deficit during FY2018. This increase in the fiscal deficit is primarily driven by a slower increase in government tax revenues (both federal and provincial) and a sharper increase in expenditures. An adjustment in the fiscal position in FY2019 after the election will help in curtailing the fiscal deficit. Inflation, after remaining moderate during FY2017, is expected to rise in FY2018 and FY2019. Inflation is expected to rise due to higher domestic demand pressures and a slight increase in international oil prices.

Pakistan’s growth outlook continues to improve and inflation remains contained. However, growing fiscal and external imbalances pose an immediate challenge to this outlook. Efforts to reverse the current imbalances and continued implementation of structural reforms will be needed for sustaining and accelerating growth and improving welfare of masses.

Pakistan’s GDP growth continued to increase and was 5.3 percent in FY2017. This performance fell short of the government’s growth target of 5.7 percent for FY2017 as the industrial sector performed worse than expected. After a weak performance in FY2016, the agricultural sector picked up during FY2017 and grew at 3.5 percent due to better cotton, sugarcane, and maize crops. The services sector, which accounts for approximately 60 percent of the economy, grew 6.0 percent in FY2017 surpassing the target of 5.7 percent. On the demand side, growth was again dominated by domestic consumption, which accounted for an overwhelming 92 percent of GDP in FY2017, and contributed 8.4 percentage points towards GDP growth (moderated by a negative contribution of 3.7 percent from net exports). 

Strong aggregate demand and improving business sentiments were evident in private sector credit growth of 18.2 percent, expanding by PKR748 billion in FY2017 compared to PKR446.5 billion in FY2016. Low inflation and low interest rates also contributed to higher credit growth. An increase in foreign investment flows from China (to fund CPEC projects) has also contributed to growth. Pakistan’s external account and international reserves came under stress at the end of FY2017 because of a high and widening current account deficit. The current account deficit for FY2017 has swelled to 4 percent of GDP (USD 12.1 billion), compared to 1.7 percent of GDP in FY2016. 

The key driver is a very large trade deficit, which swelled to USD 26.9 billion (8.9 percent of GDP) due to declining exports and high import growth. Imports have grown partly because of CPEC related projects. External borrowing helped keep reserves at relatively comfortable levels in FY2017, despite the large trade deficit. The external account pressure has persisted in FY2018, but despite this pressure the PKR has remained stable against the USD. The current external situation can become unsustainable in absence of adequate policy response. The fiscal deficit widened significantly in FY2017. Provisional data for FY2017 shows that the fiscal deficit stood at 5.6 percent of GDP, 2.1 percentage points higher than the budgeted estimate for FY2017. 

Lower-than-expected revenue, falling Coalition Support Funds (recorded as non-tax revenues), and an inability of provinces to generate surpluses drove this deterioration. As a result, the public debt to GDP ratio is expected to stay close to last year’s level of around 68.6 percent, the report concluded.