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Monday December 09, 2024

Monetary tightening, weak rupee, inflation to haunt economy

The Ministry of Finance has highlighted three major risks facing Pakistan’s economy including the possibility of further hikes in interest rates

By Mehtab Haider
June 30, 2022
Miftah Ismail. Photo: The News/File
Miftah Ismail. Photo: The News/File

ISLAMABAD: The Ministry of Finance has highlighted three major risks facing Pakistan’s economy including the possibility of further hikes in interest rates, exchange rate depreciation, and consistent rise in domestic consumer prices.

“Economic growth in Pakistan is facing a challenging situation due to wider macroeconomic imbalances,” the Ministry of Finance stated in monthly report released here on Wednesday

“The current account deficit, which remained high during the first 3 quarters of CFY, may decelerate by the end of this fiscal and onwards.”

It said the delayed pass-through of international oil prices into domestic energy products might increase inflation. “Inflationary pressure may ease once international commodity prices start to decline and stabilise.”

Going forward, the report underscored that Pakistan’s growth prospects were expected to remain satisfactory, but the number of potential risks might diverge from optimal path.

First, the cyclical position of Pakistan’s main trading partners is somewhat deteriorating, the ministry report said, adding that their central banks were raising interest rates to counter inflation thus leading to possible recession in those countries.

Second, SBP may further raise domestic interest rates, it said.

The demand management policy of SBP may not be very effective as the current waves of inflation are largely caused by supply constraints and increasing international prices, especially commodity prices, according to the report, which also stressed that exchange rate depreciation was also a source of concern as it was causing the imported raw material to become more expensive.

Third, the report said, the persistent rise in domestic consumer prices was eroding real incomes, limiting the spending power of consumers and investors.

“These risk factors may challenge the macroeconomic environment and growth prospects, especially by negatively affecting the temporary cyclical output gap.”

The economy, as per the report, would tend back to potential output in the long run.

“Sound policy responses may lay the basis for a sustainable long-run growth trajectory. This should be accompanied by measures that aim to strengthen the growth of Pakistan’s potential output. These measures need to include the creation of a beneficial investment climate, confidence promotion and stimulus for promising economic initiatives with high growth potential.”

The current account balance may profit from sound demand management policies, it says adding that in the longer run, elevating the growth rate of potential output reinforces the supply side of the economy, accompanied by neutral demand management will bring the CAD on a long run sustainable path.

Despite achieving a real GDP growth of 5.97 percent in FY2022, the underlying macroeconomic imbalances and mounting international risks are depicting a challenging outlook especially pertaining to the external sector, the ministry explained.

“Inflation in Pakistan is driven by both external and internal factors. International commodity prices, especially oil and food prices are the main external drivers. Furthermore, domestic supply chain and market expectations also play an important role to determine inflation. It is mentionable that YoY inflation has been rising since September 2021.” This acceleration was expected to continue in June 2022, it added.

The government has withdrawn subsidies on fuel and energy products to control the mounting twin deficit and as a result, prices of all oil products sharply increased, it said.

“Further, the recent rise in international commodity prices, especially energy and food, will also be translated into domestic prices.”

The ministry said in the report that the government would continue to alleviate the burden of the poorest segment of the society through various programmes.

“In this scenario, YoY inflation is expected to accelerate in June and may remain within the range of 14.5 -15.5 percent.”

On the agriculture sector, it said the input situation for Kharif 2022 was satisfactory and it was expected that the agriculture sector would continue to augur well on account of continued government support.

Industrial activities, measured by the LSM index, were vulnerable to external conditions. It compares the cyclical component of LSM (large-scale manufacturing) with the weighted average Composite Leading Indicators in Pakistan’s main export markets (CLI).

“The CLI of some individual countries are constructed by the OECD to reflect the deviation of current GDP from its potential level. The cyclical component of Pakistan’s LSM output is obtained by extracting the stochastic trend from the seasonally adjusted LSM series. LSM index is published with a time lag of two months, whereas CLI with a one-month lag.” The LSM cycle was following the cyclical movements of the main trading partners.

“As expected, LSM output contracted in April as compared to March. In fact, LSM activity remained strong both in terms of underlying trend growth as in its cyclical position,” the report said.

Nevertheless, LSM may contract in May as compared to April mainly due to strong negative seasonal effects, but on YoY basis, LSM is expected to show continued solid growth, it added.

According to balance of payment data, in May 2022 exports of goods and services fell below their recent upward trend. “This may be due to a relatively strong negative seasonal effect this month. The imports of goods and services also went down. The balance on trade in goods and services, therefore, declined by around $ 300 million.”

It said in the month of June 2022 exports were generally affected by a negative seasonality, but it was expected that the downturn would be to a lesser degree compared to May 2022.

“Therefore, exports are expected to perform somewhat better in June 2022. On the basis of the continued declining trend in imports on account of measures taken by the government, it is expected that improvement will be observed in the trade balance in June 2022 compared to the one observed in May 2022.”

The remittances fell considerably in May 2022 mainly driven by its seasonal profile and this together with the deterioration of the trade balance widened the current account deficit significantly, the ministry said.

“However, in June 2022, remittances are expected to rebound. Together with the expected relative stability of the trade balance, a contraction in the current account deficit is expected, which may settle at around $ 1 billion.”

Furthermore, measures to offset the impact of higher international commodity and oil prices due to the Russia-Ukraine conflict took a significant toll on revenue and expenditures. Consequently, it said, the risk of fiscal slippages during the current fiscal year had increased.

On the revenue side, FBR tax collection maintained its growth momentum by posting a 28.4 percent increase during Jul-May FY2022.

“The growth momentum has been realised largely on the back of import-related taxes due to a sharp rise in import volumes.”

The government has announced measures to restrict imports in an effort to relieve external account pressures. With these measures in place, meeting the FBR tax collection target for FY2022 will be a daunting task.

“In the wake of these challenges, FBR is striving hard to improve domestic tax collection through various policy and operational level efforts,” the report added.