‘Virus, external woes, inflation top economic risks’

ISLAMABAD: The government has come clean on the fact economy is in doldrums as it is facing up to three major risks including virus’s fifth onrush, external sector frailties, and likely double-digit inflation in this fiscal year.

“Though … recovery is underway, the economy is also confronting new Covid-19 wave, inflation and external sector pressures,” noted ‘Monthly Economic Update and Outlook’ released by Ministry of Finance on Thursday.

It states that Pakistan’s economy continues to show healthy value-added creation and its cyclical position is largely balanced and the growth rate trend of potential output remains strong. Although this path is expected to continue, also a number of risk factors remain present at the horizon. A first risk factor concerns the surge of the omicron variant of the Covid-19 disease. Experience in other countries shows this variant is far more infectious than previous ones. On the other hand, its capacity to cause severe illness also looks to be impaired significantly. It is hoped that the SARS-CoV-2 virus that caused the Covid-19 pandemic may gradually converge to other known milder respiratory diseases that can be managed without causing too much damage to peoples’ personal health and their economic welfare.

Another risk is the stress on the external balance. Although current account deficit remains high, the baseline scenario remains that the excess of imports over exports will gradually ease in the coming months. This expected tendency is enforced by the government measures designed to stimulate exports and moderate import demand. The monetary policy decisions are also supportive in this respect.

Thirdly, according to Ministry of Finance states, inflation is high and year-on-year inflation is expected to be in double digits in the coming months.

In this regard it should be noted that year-on-year increase in the CPI index is to a large extent a backward-looking indicator. It is not only determined by current price movements, but also by what happened 12 months ago, when international commodity prices were at the lower areas of their current price cycles, whereas now they are at the upper levels. Forward looking, what matters most is monitoring future month-on-month price movements. Containing these price dynamics is the most relevant issue because they will determine further developments in the consumer’s cost of living. The government measures, accompanied by the support of monetary policy, are directed to protect consumer’s purchasing power in the future.

If these future MoM price movements can be stabilised, the year-on-year inflation will automatically fall back to levels that are suited for supporting Pakistan’s economic development. In that sense the current surge of the year-on-year inflation rate is a temporary phenomenon. The finance ministry states acceleration of inflation worldwide, as well as a significant increase in freight charges, are making international trade costlier.

Pakistan’s inflation rate is still under pressure like other countries due to rise in international commodity prices as wells as economic agents’ expectations. The government is making all-out efforts to improve the functioning of markets particularly in the food segment. The CPI (Consumer Price Index) inflation in December showed a monthly decline of 0.02 percent. Further, in January 2022, the CPI (Sensitive Price Indicator) shows a marginal decline, as a result of government efforts to dampen the pass-through of high international prices to domestic retail markets. But even if this would be reflected in the overall CPI index, year-on-year inflation in January 2022 may slightly increase, while a decline is expected on month-on-month basis. The availability of inputs will remain satisfactory for Rabi 2021-22 crops. The mechanisation and credit disbursement to agriculture show an increasing trend in FY2022, thus it is expected that in the absence of any adverse climate shock, the agriculture sector will perform better.

Industrial activity is measured by the LSM (Large-Scale Manufacturing), a sector which is the most exposed to external conditions. Its exposure to developments in international markets compares the cyclical component of LSM with the weighted average Composite Leading Indicators (CLI) in Pakistan’s main export markets.

Both these foreign and domestic cyclical indicators currently remain slightly above the 100 benchmarks, indicating positive to neutral output gaps. These cyclical stances, however, do not keep these economies from showing positive and healthy growth in their potential outputs. The LSM for November 2021 was better than expected. In December 2021, the expectation is that LSM will show strong growth as compared to its level attained in November. According to BOP data, exports and imports of goods and services increased in December 2021. Both exports and imports were supported by strong positive seasonal effects that usually affect these transactions in the month of December. Although the seasonal effects are stronger on imports, the increase in exports was somewhat more robust than the rise in imports, which explains, albeit modest, decline in the trade balance of goods and services. Usually in the month of January these seasonal effects typically disappear, which may soften the export proceeds, but also to a more important moderation in import payments. “It is therefore expected that the trade deficit will settle at lower levels in January and in the following months,” the Ministry of Finance claimed.

Although the trade balance improved somewhat, the current account balance slightly deteriorated. This was mainly due to an unusual increase in primary income payments to non-residents. It is expected that in January these payments would return to normal levels. Together with the expected improvement in the trade balance due to prudent government measures, the current account deficit may decline in January and onward.

During the first five months of the current fiscal year, the government increased its expenditures under grants and subsidies. In particular, under grants, government spending is focused on social protection (BISP & poverty alleviation) and Covid-19 (vaccine procurement). While subsidies to the power sector have also witnessed a sharp rise during the period under review. Thus, an increase in both grants and subsidies has been attributed to a significant rise in current expenditures.

With the start of the fifth Covid wave driven by the Omicron variant, the expenditure side may come under further pressure. However, the government will continue to follow a prudent expenditure management strategy while giving importance to the priority sectors so that the growth momentum may not be disrupted. On the revenue side, during the first half of current fiscal year, FBR (Federal Board of Revenue) exceeded its revenue target by 10.9 percent. In absolute terms, revenue amounting to Rs2,919.7 billion was collected against the target of Rs2,633.2 billion, which is Rs286.5 billion more than the six-monthly target. Collection during the first half of the current fiscal year was also higher by Rs715.6 billion in absolute and by 32.5 percent in percentage terms.

Moreover, FBR has been able to achieve more than 50 percent of its annual target during the first half of the fiscal year for the first time. The normal trend is that around 45 percent of the annual target is achieved during the first half of the financial year. The momentum in revenue collection generated by FBR during the first half of the current fiscal year indicates the FBR will not only be able to meet its annual revenue collection targets but will surpass it by a fair margin.