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Thursday March 28, 2024

Current account, inflation vulnerable to world commodity shocks

By Erum Zaidi
March 18, 2022

KARACHI: Pakistan’s external current account and inflation face vulnerabilities due to soaring global commodity prices and its limited export base, the central bank said in a first quarterly report for FY2022 released on Thursday.

“The developments in the first quarter of the current fiscal year clearly highlight Pakistan’s susceptibility to global commodity price shocks, partly due to the country’s limited export base,” the State Bank of Pakistan (SBP) said report on State of Pakistan’s Economy.

“While textile exports benefitted from rising global cotton prices, Pakistan could not capitalise on the surging global prices of items that it used to export –wheat and sugar – and instead had to import them to stabilise domestic prices and ensure local market availability,” it added.

“On the other hand, higher prices of energy commodities, edible oil and steel, have contributed significantly to widening import payments. As a result, the commodity price pressures had a largely negative impact on the trade balance, as evident by the worsening in Pakistan’s terms of trade during the quarter,” it noted.

The SBP called for consistent policies at the sectoral level to address this issue.

“One industry that requires a long-term policy focus is edible oil. Around 86 percent of the country’s edible oil consumption comes from imports,” the report said.

The country ran a large current account deficit of $11.6 billion in the seven months of this fiscal year versus the deficit of $1.028 billion a year earlier. The surging deficit was attributed to the spike in global oil and other commodity prices, which significantly pushed up import payments.

The SBP, in its last monetary policy statement (MPS) said the Russian’s war on Ukraine introduced uncertainty in commodity outlook. So, the price and the current account deficit outlooks are threatened by uncertainty in the international commodity costs.

The SBP projects the real gross domestic growth in the range of 4-5 percent in FY2022. However, in the March MPS, it expects the country's GDP growth to be between 4 and 5 percent this year.

The analysis and economic outlook of the report are based on data for the July-September 2021 period, and were finalised in November 2021, using data available as of then. As such, the report did not incorporate the rebasing of the large-scale manufacturing and GDP in January 2022.

The government is targeting to reduce the fiscal deficit to 6.3 percent in FY22 from 7.1 percent in FY21, by increasing revenues via expansion in the tax net and the ongoing growth momentum, which would contribute to tax collection.

Meanwhile, downside risks to the fiscal outlook include a slowdown in economic activity, which would impact tax revenues.

The SBP expects inflation to average between 9-11 percent this fiscal year before declining toward the medium-term target range of 5-7 percent in FY2023 as global commodity prices normalize, according to the March Monetary Policy Statement.

But at the same time, it said this baseline outlook is subject to risks from the path of global prices, domestic wage developments, and the fiscal policy stance, it said.

However, as per the first quarter report, for the full-year FY2022, the SBP is projecting headline CPI inflation to remain higher than FY2021’s reading of 8.9 percent. The risks are tilted towards the upside, mainly due to the higher-than-expected increase in global prices of commodities imported by Pakistan, including energy (oil, coal and LNG) and non-energy items (edible oil, cotton and steel, among others).

Further impetus has come from the likely upward adjustments in administered prices, including power tariffs and taxes on transport fuels (GST and petroleum development levy), as well as the pass-through of rupee depreciation so far.

In contrast, prominent downside risks to the inflation outlook include a sharp drop in oil prices and higher-than-expected moderation in industrial activity amidst normalization of monetary and fiscal policies, according to the SBP’s report.

The report noted that during the first quarter economy maintained the growth momentum that had begun during FY2021. Both the supply and demand sides contributed to this momentum.

However, the substantial increase in global commodity prices contributed to in a build-up in inflationary pressures and a widening current account deficit.