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Thursday March 28, 2024

Pak economy to be under pressure: WB

The other day Asian Development Bank (ADB) had projected further deceleration of Pakistan’s GDP growth to 3.9 percent and rising inflation pressures on average at 7.5 percent for the ongoing financial year 2018-19.

By Mehtab Haider
April 08, 2019

ISLAMABAD: The World Bank (WB) has projected a bleak picture of Pakistan’s economy with deceleration of growth rate and rising inflationary as well as debt burden over the next two years.

The other day Asian Development Bank (ADB) had projected further deceleration of Pakistan’s GDP growth to 3.9 percent and rising inflation pressures on average at 7.5 percent for the ongoing financial year 2018-19.

“GDP growth is forecast to decelerate further to 3.9% in FY2019 as macroeconomic challenges continue and despite steps to tighten fiscal and monetary policies to rein in high and unsustainable twin deficits,” the Asian Development Outlook (ADO) 2019 released by the ADB on Wednesday noted. Continued fiscal consolidation in FY2020 will keep growth subdued at 3.6%, the ADB report further stated.

But the World Bank portrayed a gloomier picture and stated that Pakistan’s public debt to GDP is expected to cross 80 percent in FY-19 and to remain elevated in the next two years, increasing Pakistan’s exposure to debt-related shocks.

“The pace of poverty reduction is expected to continue to slow-down in FY-19 and FY-20, following the projected growth deceleration and higher inflation rates,” the WB’s regional update report on South Asia titled ‘Exports Wanted’ released on Sunday.

The report states that Pakistan’s growth is projected to decelerate to 3.4 percent in FY-19 and to 2.7 percent in FY-20, as the government tightens fiscal and monetary policies.

While domestic demand growth will slow down immediately, net exports will only increase gradually. As macroeconomic conditions improve, and a package of structural reforms in fiscal management and competitiveness is implemented, growth is expected to recover to 4.0 percent in FY21.

This baseline scenario assumes stable international oil prices and reduced political and security risks. Inflation is expected to rise to 7.1 percent (average) in FY-19 and projected to reach 13.5 percent in FY-20 as a result of further exchange rate depreciation pass-through.

The trade deficit is projected to remain elevated during FY-19, but to narrow in FY-20 and FY-21 as the impacts of currency depreciation, domestic demand compression, andother regulatory measures to curb imports set in.

Remittances are projected to finance over 70 percent of the trade deficit. FDI, multilateral and bilateral debt-creating flows as well as financing from international markets are expected to be the main financing sources of the current account in the near to medium term. The fiscal deficit is projected to increase to 6.9 percent in FY-19 and to remain high during FY-20-21, a result of large interest payments and a slow increase in domestic revenues.

Together with the macroeconomic adjustment expected over the next two years, the WB states that there is an urgent need to implement structural reforms to support the growth rebound from FY-21 onwards. Economic uncertainty has increased due to protracted negotiations with the IMF. In addition, recent regional tensions have had an impact on risk perceptions. The low reserves position and high debt-ratios limit the buffers that Pakistan could use to absorb external shocks (such as an increase in US interest rates) and may negatively impact the government’s ability to access international markets. Reforms to put the country on a stable growth path include increased exchange rate flexibility, improved competitiveness and lower cost of doing business. On the revenue front, reforms to improve tax administration, widen the tax base and facilitate tax compliance are critical.

“Higher inflation rates may jeopardise recent gains in poverty reduction, since poor households in urban areas are particularly affected by increases in prices, as shown by the most recent inflation hike during the 2007-08 food price crisis,” it added.

In Pakistan the current account deficit continued to widen but stabilised over the course of last year and it stood at 5.2 percent of GDP in the fourth quarter of 2018. The current account deficit reached $8.8 billion (3.3 percent of GDP) at the end of February 2019, compared to $11.4 billion (3.7 percent of GDP) the year before.

“Pakistan’s currency has continued to depreciate against its trading partners over the last six months, while India’s has not,” it states.

Pakistan’s real effective exchange rate, which is the average of its currency in relation to an index of other major: Currencies depreciated against the USD, mostly in the first half of 2018, currencies weighted by their relative trade shares and adjusted for inflation differentials, depreciated by nearly 5.5 percent from October 2018 to March of this year. The depreciation against its trading partners increases the price competitiveness of Pakistan’s exports in international markets and makes imports more expensive. Over time, such an adjustment of relative prices is needed if policies are put in place to improve the trade balance.

After the Pulwama incident, India has withdrawn the most favoured nation (MFN) status for Pakistan and raised custom duties on all goods imported from Pakistan to 200 percent. This may lead to a significant drop in Pakistani exports to India. However, Pakistan’s exports to India are worth only $560 million. Pakistan may still impose retaliatory tariffs on Indian goods or expand its negative list prohibiting specific imports from India. Such retaliatory tariffs could jeopardise Indian exports, which are worth $1.8 billion. But since the bilateral trade between the two countries barely reaches $2.4 billion, the negative effects from an escalation of trade tensions are limited. However, they would prevent the two countries from moving closer to their high trade potential.

In Pakistan, external account pressure reduced international reserves to $6.6 billion (1.3 months of goods and services import coverage) by mid-January 2019. With short-term financing from the Kingdom of Saudi Arabia, the United Arab Emirates and China, international reserves increased to $10.5 billion (two months of goods and services import coverage) at the end of March. Meanwhile, the government continues to negotiate a support package with the IMF, the report added.

Core inflation is rising fast in Pakistan and Bangladesh and recently picked up in Sri Lanka. In Pakistan, inflation increased owing to exchange rate depreciation, demand side pressures and higher fuel prices. Consumer prices rose by 8.2 percent from February 2018 to February 2019, the highest rate in South Asia.

The last fiscal year showed a record-high trade deficit in Pakistan, at $31.1 billion, contributing to a current account deficit of 6.1 percent of GDP. The observed trade deficit resulted from the combination of consumption-led growth that fuelled demand for imports, and mounting constraints to export competitiveness.

Between 2005 and 2018, Pakistan’s merchandise exports rose from $16 billion to $23 billion, an increase of only 47 percent compared to an increase of 286 percent in Bangladesh, 563 percent in Vietnam or 193 percent in India. Its exports have been concentrated in a few products with little sophistication like textiles, apparel and rice. Its exporting firms remain small, when compared to those in peer countries, and there is little entry into and exit out of export activities.

Many factors affect competitiveness in Pakistan. These include, among others, high costs of doing business, electricity availability at affordable costs, or access to finance. However, there are three constraints that directly affect exporters. These are the anti-export bias of its trade policy, the inadequate export promotion infrastructure, and an ambiguous regulatory framework around FDI.

Domestic demand is expected to contract while at the same time export growth will be gradual. On the supply side, services growth, which has been leading growth in the past, is projected to decline to 4.4 percent in FY-19 compared to 6.4 percent in FY-18. The agriculture and industrial sectors will also grow significantly lower in FY-19 and FY-20.

Growth is expected to recover to 4 percent in FY-21 as structural reforms take effect and macroeconomic conditions improve. Remittances flows are likely to support the current account balance next year. A more stable external environment will also support a pickup in economic activity starting from FY-21.

“Pakistan’s growth must be driven by investment and productivity, which will put an end to the boom and bust cycles that affect the country every few years,” said Illango Patchamuthu, World Bank Country Director for Pakistan.

“It is entirely possible for Pakistan to transform its regulatory environment and reduce the cost of doing business. On the revenue front, reforms to improve tax administration and widen the tax base are critical. Over the adjustment period and beyond, actions outlined in the recently announced Ehsaas Programme can protect the poor and vulnerable through social safety nets and safeguarding public spending on health and education,” Illango said.

Across South Asia, imports grew much stronger than exports in the last two years, reversing the region’s exports dynamics of the early 2000s. Strong domestic demand, fuelled by a consumption and investment boom, resulted in high import growth of 14.9 percent in 2017 and 15.6 percent in 2018, which is nearly twice as high as the region’s export growth. In comparison, exports grew by only 4.6 percent in 2017 and 9.7 percent in 2018.

“There’s no single solution that can unleash South Asia’s export potential and policymakers need to implement an ambitious range of reforms that can turn the region into the world’s next export powerhouse,” said Hans Timmer, World Bank Chief Economist for the South Asia Region.

“Efforts should include trade liberalisation, spurring entrepreneurship, and equipping citizens with the skills they need to compete on the global market. It would be good to be creative and relentless in all these efforts,” he said.