GLOBAL financial markets have been roiled the past week by extreme panic-induced volatility. Lower locks/circuit breakers have been activated in stock exchanges around the world, oil prices have dropped the most in a single day since 1991, while the yield on the US 30-Year Treasury bond has sunk to below one per cent for the first time in history.
An estimated $9 trillion has been wiped off the market capitalisation of global stocks in the past two weeks, with the S&P 500 index plunging 20pc since its peak on Feb19. The Pakistan Stock Exchange’s KSE-100 index has fallen 10pc since. Not surprisingly, traders have dubbed the price action on March 9 as Black Monday and the recent carnage more generally as a ‘bloodbath’.
The two immediate catalysts for the collapse witnessed on global financial markets are the rapid, contagious spread across the world of the novel coronavirus (COVID-19), and the start of an oil price war between Saudi Arabia and Russia after the dramatic collapse of the OPEC+ agreement on production cuts.
The two seemingly unrelated developments — the COVID-19 pandemic and the oil price war — are not as unrelated as they may seem at first. The first development has amplified pre-existing worries about the health of the global economy. These concerns have played into oil market fears about weak demand. The second development (collapse of OPEC+ agreement) has added a supply shock to the disquiet of oil exporting nations. Since the demand for oil — and in a second-hand way, its international price — is an important indicator of the health of the global economy, the sharp fall in oil benchmarks has reinforced the prevailing sentiment of gloom and doom.
The global economy has hit severe turbulence.
The categorisation by WHO of COVID-19 as a pandemic will fuel the panic. Given that over 103 countries were reported affected as of March 9, including hard-hit advanced economies such as Italy, compared to around 26 each at the time of SARS or MERS, and the extreme containment measures that countries around the world are having to take, the scale of potential economic disruption is unprecedented. Huge losses are being incurred by airlines, hotels, and the wider tourism/hospitality and recreation industries, among others.
The fact that China was at the epicentre of this virus is leading to fears about the economic contagion spreading far and wide. While China absorbs around 11pc of the world’s exports, almost 40pc of its own exports, or nearly $1tr, are supplied to global companies as part of the latter’s supply chains. (This number is down from around 80pc at its peak in the early 2000s.) The closure of factories and all means of transportation between December and end-February would have imposed colossal losses that are unlikely to be recouped with a global economy tipping into a ‘recession’.
According to an estimate by Bloomberg Economics, the COVID-19 pandemic can cost as much as $2.7tr to the global economy in the worst case, with the loss to China’s economy estimated at 2.4pc of GDP.
The more relevant question for us of course is what will be the economic impact on Pakistan? The most visible number that commentators are focused on is the international price of oil. With every decline of $10 per barrel, Pakistan’s oil import bill drops by approximately $1.3 billion. With benchmark Brent crude trading at $59 on Feb 20, and having lost almost $25 per barrel as of March 11, the import bill can fall by over $3.2bn over the next 12 months if current levels are sustained. Since a fall in the international price of oil is linked to other important energy products that Pakistan imports, such as LNG, the potential savings are likely to be larger.
Lower imported energy prices should translate into a sharp fall in inflation, with the magnitude depending on how much of the fall in international prices is passed on to domestic consumers by the government. The prospect of sharply lower inflation should spur an interest rate-cutting cycle by the central bank, which will ease budgetary pressure on the one hand, and lower the burden of financial charges for businesses. Cheaper imported energy prices will also potentially translate into lower energy costs for businesses and households via a reduction in electricity and gas tariffs. This should also ease the pace of accumulation of circular debt.
These are substantial positives. However, the impact is not unambiguously positive. The upside from lower oil prices will be limited to an extent by the growth-diminishing effects of fiscal consolidation. Global recessionary conditions will also provide headwinds for Pakistan’s exports. The lower demand and price of oil could at some stage impact Saudi Arabia’s willingness to continue with the generous oil facility it has granted to Pakistan. The enormous impact on the global economy, with the oil export-dependent Gulf economies hardest hit, could spill over into the country’s flow of worker remittances.
In addition, lower oil prices will negatively affect the government’s main revenue spinner. However, lower revenue from the import and sale of petroleum will be offset to some extent by raising the petroleum levy, as well as via lower debt servicing costs. Finally, conditions in the global financial markets have prompted significant outflows from the stock of foreign portfolio investment in government securities. Between March 9 and 11, around $400 million has flown out from the ‘hot money’ book, or roughly 12pc of the total invested stock in a space of three days. This is possibly the start of the worst case scenario readers will recall I have been warning against since July last year.
An even bigger risk that stalks Pakistan’s outlook than all the foregoing near-term ones, however, is that the economic reprieve from falling oil prices could engender complacency in the already fairly underwhelming reform effort this government is undertaking. If so, that would take us back to where we started — square one.
The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.
Published in Dawn, March 13th, 2020