‘Fiscal deficit, public indebtedness pose risks to Pakistan’s economy’

ISLAMABAD: Pakistan is expected to post a modest growth during the current fiscal year as widening fiscal deficit and growing debt pose risks to its economic outlook, an international policy institute said.

“We expect Pakistan to experience modest growth in FY2020/21 following a small contraction in FY2019/20,” Institute of International Finance (IFF) said in a latest report.

“However, risks to the economic outlook are tilted to the downside. Recurrent outbreaks of Covid-19, a large fiscal deficit, and high public indebtedness remain major challenges.”

The Washington-based global association of financial institutions said the economy could grow by 1.8 percent in FY2020/21 driven by some recovery in private consumption.

The country’s exchange rate was market-determined and depreciated by 22 percent in real effective terms since 2017.

“The effects of currency depreciation and weaker domestic demand are visible, as imports dropped by 18 percent in nominal dollar terms, more than offsetting the decline in exports of 7 percent in FY2020,” the institute said in the report, “Pakistan: Commitment to Reform Faces a Test”.

The pandemic led to a contraction in output of 0.7 percent in FY2020. Domestic demand declined two percent, while exports of goods and services increased 1.6 percent as compared with a decline of 7.3 percent in imports of goods and services. Adjusted for population, fewer cases and deaths of Covid-19 have been recorded in Pakistan than in other developing and emerging economies. These results are subject to a large degree of uncertainty, as data quality, testing capacity, and transparency vary.

The IIF said lockdown restrictions have been lifted across the country. The response measures have been adequate, supported by the IMF’s emergency financing in the amount of $1.4 billion, provided in April. Expansion of social programs has rightly focused on tackling the health emergency and supporting the most vulnerable, while stimulating economic activity.

The State Bank of Pakistan’s (SBP) proactive liquidity initiatives and lower policy rates are propping up economic activity and safeguarding financial stability, according to the IIF.

The policy rate has been lowered 5 times since February, a cumulative reduction of 625 basis points. The authorities have also introduced a fiscal stimulus package in the amount of $5.1 billion (1.9% of GDP), which included direct transfers to wage workers and poor families, financial support to SMEs and the agricultural sector, higher subsidies for basic goods, and various tax incentives.

One-third of this amount has been implemented already, and the remaining $3.4 billion will be used in the current FY 2020-21 budget.

“We expect the policy rate to remain the same in the next monetary policy committee meeting, thus dampening inflationary expectations,” the IIF said. “Although rising food prices continue to exert upward pressure on inflation, weak demand is likely to keep inflation in upper single digit levels.”

Workers’ remittances, which slightly exceeded exports of goods, continued their increase, supported by a more depreciated exchange rate and appropriate policy steps implemented by the authorities, including reducing the threshold for eligible transactions from $200 to $100 under the reimbursement of telegraphic transfer charges scheme, an increased use of digital channels, and targeted marketing campaigns to promote usage of formal channels. Resistance to tax reforms and cost-recovery in the energy sector from entrenched elites could undermine the fiscal consolidation strategy and put public debt sustainability at risk. The completion of the second extended fund facility by the International Monetary Fund review has been delayed pending implementation of key reforms.

The budget for the FY 2021 envisages cuts in subsidies, freezing salaries and pensions, and increases in petroleum levies. However, rising defence spending, higher interest payments (6.3 percent of GDP), and rollover of fiscal stimulus from FY2020 could widen the deficit to 8.7 percent of GDP, compared with a budgeted deficit of 7 percent, which is based on growth of 2.1 percent.

Public debt could rise to 86 percent of GDP by June 2021, compared with 70 percent in 2018. The external funding picture warrants caution as debt amortization remains high in years to come. However, improvement in the current account, rollover of short-term debt, and debt service suspension initiative have eased Pakistan’s external financing needs and shored up its official reserves, which could increase further to $15.4 billion (excluding gold) by June 2021 (3.3 months of imports of goods and services).