Global economic headwinds and Pakistan

November 1, 2020

The key to success will lie with improved tax collection and build-up of exports, both of which are challenging in this economic climate

The Covid shock has brought the global economy to its knees. Many countries are evaluating not only their economic models but also their social and political imperatives. In these times of once-in-a-generation shifts, it is important to assess both its short- and long-term implications for the national economy.

The USA, EU, and China, the three largest economies in the world, represent almost 60 percent of the world GDP. The EU and the USA have experienced unprecedented economic contraction in living memory. This sharp decline has manifested itself in a devastating manner. Europe, for example, is world’s number one tourist destination with tourism contributing more than $550 billion to the economy.

At the peak of the Covid hotel revenues alone were down more than 60 percent compared to 2019. Think not just of empty hotels but also bars, restaurants, car rentals, tourist sites, tour operators, airports, duty free shops etc. These are service sectors in which unemployment hits middle class the hardest. The prospects for recovery range from two to five years.

However, the stock markets, especially the US markets, present a completely different story. S&P 500, a popular stock index, fell more than 30 percent to recover at nearly 10 percent above December 2019 levels. This is stunning performance given the catastrophic impact Covid has had in nearly every other sector. So, is this a positive sign?

A deeper read into these numbers presents a grim reality. These rosy returns are heavily skewed by the tech giants (collectively known as FAANGS: Facebook, Apple, Amazon, Netflix, and Google plus Microsoft). They have risen more than 30 percent this year while the other stocks have remained close to their March lows. Together these five stocks are 22 percent of the S&P 500 Index and the US tech sector is now worth more than the sum of all European stock markets.

The consensus is that these stocks, and other asset prices, have been inflated by the sustained low intertest rates and pumping of trillions of dollars by the Fed. A bubble waiting to burst? The question is not if, but when.

In these bleak times China is the shinning story. The country first hit by Covid has recovered spectacularly and during Q3 2020, the economy is expected to grow by nearly 5 percent. If Covid was an unmitigated disaster then Chinese recovery is nothing short of a miracle. China has outpaced other investor-favourite emerging economies, known as BRICS (Brazil, Russia, India, China, and South Africa). In fact, Covid has been disastrous for India and Brazil, setting their economies back by several years.

It is in this recovery that Pakistan’s best hopes to navigate the crisis lie, at least for the next two to three years.

Due to its relatively isolated nature, from mainstream global commerce, Pakistan’s economy has escaped the calamitous ruins faced by many others. Fortunately, and due to some proactive measures by the government, the Covid impact has been tempered. This has been helped by some prescient policies of the State Bank, which slashed rates aggressively, and fiscal discipline leading to a lower current account deficit.

The strong Chinese recovery means that China will continue to have the wherewithal to support CPEC projects. Given the tensions with the US, it is also likely that Chinese reserves, that were normally pumped into US treasuries, may find home in other projects. China should remain focal to our economic development.

This time the policy makers should aim to make it different. It is time to set the economy on a footing that is sustainable for decades to come. The markets and investors value stability over all other factors.

If the government continues with prudent fiscal and monetary actions, the rupee-dollar exchange rate should remain stable. Due to Fed’s policies, dollar is already showing signs of weakness against other major currencies. Whatever happens in the US elections, the new president will not seek a strong dollar.

The all-time low interest rate environments offer a once in a lifetime opportunity to manage the country’s debt. Where possible the loans should be renegotiated, and aggressive marketing done to open debt capital markets to Pakistan. Now is the time to break the shackles of dependence on the IMF.

For the medium term, rich economies are expected to look inwards as they recover from the ravages of Covid. The propensity to invest outside, particularly in developing countries like Pakistan will be low. The competition between countries to attract foreign capital will be intense. Pakistan should aim to build strong domestic capacity and resilience. The implementation of house building schemes, etc will set the precedent.

With rising global unemployment, there is a risk of foreign remittances, our mainstay for decades, stagnating or even falling. Schemes such as Roshan Pakistan Accounts should be pushed aggressively to allow expats to park dollar savings with flexibility within the Pakistani banking sector.

With all the possible opportunities, there is also a minefield of risks. For a start, the second wave of Covid is alarming. If left unchecked, it could push the economy into a vicious downward spiral. Also, the debt level has now reached 90 percent of the GDP. This debt will have to be repaid and needs to be brought down to controllable levels as soon as practicably possible.

The key to success will lie with improved tax collection and build-up of exports, both of which are challenging tasks in this economic climate. On the political side, if the current tensions with the opposition escalate then the signal to the markets will be a negative one.

External factors such as geo-politics starting with US-China trade wars, India/FATF issues and US elections can become relevant at any time. But then again, it is not for the first time Pakistan has had to navigate turbulent waters to survive.

But this time, the policy makers should aim to make it different. It is time to set the economy on a footing that is sustainable for decades to come. The markets and investors value stability over all other factors.

Pakistan is starting from such a low base that any well-executed action will only lead to improvements.

Let us remember that if we increase our GDP per capita (from current levels of less than $1,500) to, say, $5,000, we will still be below South Africa. Even at $5,000 per capita, a country of 200 million plus population will have a trillion-dollar economy. That is not an unreasonable target to aim for.

The writer is a finance professional based in Dubai. He tweets @Travelutionary1

Global economic headwinds and Pakistan