Deep in choppy waters

Published November 2, 2020

The economy is in one of the most critical phases. Confronted with a public health challenge caused by a global pandemic, the country has just had a fiscal year with economic contraction.

The current fiscal year remains under a cloud. Global economic conditions are still precarious. Hence, there are doubts about inflows from external sources, such as exports, remittances and foreign investment. Equally unsure are inflows from bilateral and multilateral creditors amid uncertainties over the International Monetary Fund (IMF) programme since early this year.

On top of that, the 11-party opposition alliance is leading the country into political uncertainty. More worryingly, the government is unwilling to engage its political rivals when prices of essential commodities are skyrocketing.

This is happening at a time when the economy is in its third year of a low-growth-high-inflation cycle. In simple terms, that means the purchasing power of a vast majority of people is in continuous decline. One estimate says more than 14 million people have lost jobs in last six months. The number of people on stipends and subsidies has been going up drastically, which is adding to the budgetary pressures.

Economists describe such a combination as stagflation. It’s the worst of both worlds: when inflation goes up, growth decelerates and unemployment stays high. Policymakers have been extending support to businesses and individuals, but have been struggling with capacity constraints. That leaves policymakers with a limited number of options. That is what the economic managers are faced with at the moment.

The IMF has forecast a subdued economic growth rate coupled with higher inflation and rising unemployment

They want to stimulate industrial activity through cheaper energy tariffs, but the IMF programme doesn’t support it. In fact, a proposed package of Rs400 billion for increased electricity consumption and the stubborn IMF programme are keeping each other in limbo — yet another uncertainty.

The irony is that the low-growth-high-inflation cycle usually takes time to recede. This is perhaps the worst thing for an economy, especially when it requires a growth rate of over seven per cent to absorb a large youth bulge. Low growth means no more job creation and wage improvement — thus, unemployment on the one hand and inflation on the other. People lose jobs and face pay cuts, leading families to poverty.

Most global institutions forecast that Pakistan will stay in the deadly cycle of low-growth-high-inflation. The IMF has forecast a subdued economic growth rate for Pakistan coupled with an elevated rate of inflation and rising unemployment during the current fiscal year. In its World Economic Outlook released two weeks ago, the Fund projected Pakistan’s growth rate at 1pc, inflation at 8.8pc, current account deficit at 2.5pc of GDP and unemployment rising by 0.6 percentage points to 5.1pc during the current fiscal year. This is in sharp contrast to the government’s targets of 2.1pc GDP growth rate, 6.5pc inflation and 1.5pc current account deficit.

Going forward, the IMF estimates the economic growth rate will recover to 5pc by 2025. It says inflation will peak at 10.2pc at the end of 2020-21 and the current account will be in deficit of 2.5pc for the same year, eventually going up to 2.7pc of GDP in 2024-25. The recent celebrations by authorities over a quarterly current account surplus can turn negative even with a minor oil price shock or decline in remittances.

The estimates from the World Bank are even worse. It expects an increase in poverty coupled with muted and uncertain economic recovery over the next two years. “In Pakistan, economic growth is projected to remain below potential, at 0.5pc for 2020-21 compared to over 4pc annual average in the three years to 2018-19” — the first contraction in decades, reflecting the effects of Covid-19 containment measures that followed monetary and fiscal tightening prior to the outbreak, the global bank said two weeks ago.

Economic growth is projected to remain below potential, averaging 1.3pc for 2020-21 and 2021-22. Even this projection is highly uncertain, and is predicated on the absence of significant infection flare-ups or subsequent waves that will require further widespread lockdowns. Growth is expected to gradually recover, but remain muted, given heightened uncertainty and the resumption of demand compression measures. A possible resurgence of the infection, widespread crop damage owing to locusts and heavy monsoon rains pose major risks to the outlook.

The World Bank also estimates the current account deficit will widen to an average of 1.5pc of GDP over 2020-21 and 2021-22, with imports and exports gradually picking up as domestic demand and global conditions improve. The fiscal deficit is projected to narrow to 7.4pc in 2021-22, with the resumption of fiscal consolidation and stronger revenues driven by recovering economic activity and critical structural reforms.

Expenditures will remain substantial due to sizable interest payments, rising salary and pension bills and absorption of energy state-owned enterprises–guaranteed debt by the government. “Given anaemic growth projections in the near term, poverty is expected to worsen. Vulnerable households rely heavily on jobs in the services sector, and the projected weak services growth is likely to be insufficient to reverse the higher poverty rates precipitated by the pandemic.”

Asian Development Bank has taken an optimistic view though. It expects Pakistan to post broad economic recovery of about 2pc and estimates inflation at 7.5pc during the current fiscal year (2020-21) subject to a subsiding coronavirus by the end of 2020 and the resumption of structural reforms under the IMF programme.

On the supply side, agriculture is expected to continue to lend impetus to GDP growth. Growth in industry is forecast to improve in 2020-21, led predominantly by construction and small-scale manufacturing. Spurred by improved growth in agriculture and industry, coupled with an expected improvement in domestic demand, overall services should also contribute to growth in 2020-21, ADB said.

An upside risk to the inflation forecast is global oil prices rising higher than currently projected. A greater risk will be electricity tariff increases currently under consideration to improve cost recovery and help bring down government subsidies. ADB estimates the current account deficit at 2.4pc of GDP in 2020-21.

Published in Dawn, The Business and Finance Weekly, November 2nd, 2020


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