WHILE there is no single definition of recession, it is generally defined as a significant decline in economic activity that lasts for months or even years. Most experts declare a recession when a nation’s economy experiences negative GDP, rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.
In Pakistan’s case, the dangerously fragile currency, high-risk premium in international financial markets, a high debt burden and the recent shock of the devastating floods add to our sad story of economic downturn. Expensive imports and a softening in global demand for exports as well as China’s slowdown will add further pressure on Pakistan and the region. Prima facie, all of these negative economic indicators point towards a looming recession in Pakistan.
The global economic outlook is also looking grim. Since the beginning of the year, a rapid deterioration of growth prospects coupled with rising inflation and tightening financing conditions, has ignited a debate about the possibility of a global recession in 2023. According to the IMF, the main drivers of this pessimistic outlook are downturns in China and Russia, weak consumer spending in the US and tight financial conditions due to higher-than-expected inflation worldwide. Moreover, the fallout from the Ukraine war is further complicating the economic picture. In July 2022, the IMF downgraded their 2022 global growth forecast to 3.2 per cent from 6.1pc of last year — 0.4pc lower than forecast in the last outlook update in April. The expected global slowdown could potentially inflict worse damage than the financial crisis in 2008, warned the UNCTAD in its Trade and Development Report 2022.
With higher-than-expected inflation — especially in the US and the largest European economies — global financial conditions are becoming tighter. The recent interest rate hikes in the US will cut an estimated $360 billion of future income for developing nations excluding China, while net capital flows to developing countries have turned negative. As a matter of fact, developing countries are now financing developed ones, the report said. Interest rate hikes by advanced economies are hitting the most vulnerable the hardest. Some 90 developing countries have seen massive devaluation in their currencies against the dollar this year.
So, what will happen in a recession that may last over a year, if not longer? In Pakistan’s case, the impact is likely to be harsh as the country is dealing with one of its most challenging balance-of-payments crises. The foreign exchange reserves have sharply declined to a meagre $6bn, hardly sufficient to cover the import bill for a month. This has led to a sharp deterioration in Pakistan’s credit rating and investor confidence indices. Continued political instability and rising militancy threats add to the already negative economic outlook. So, what kind of realistic policy response is required and expected from the government to deal with recession?
Prima facie, the negative economic indicators point towards a looming recession in Pakistan.
Firstly, the government must understand the dynamics of a global slowdown and its potential impact on Pakistan’s macroeconomic fault lines. There hasn’t been any relaxation in the IMF programme or a sympathetic response to cover the damages from the devastating floods. Pakistan is left with no choice but to complete the Fund programme that will end in June 2023. It is very likely that Pakistan will need another IMF programme to complete the adjustment process during the next three years. The GDP growth forecast for 2023 has already been slashed downwards to 2-3pc and it will continue to remain low in the adjustment period as the IMF will push for monetary tightening and demand compression till the easing of inflationary pressure. There will be a high political cost for any government to fulfil prior actions linked to cutting down subsidies, power sector reforms and removal of several distortions. The predictability of continued bailout support from Saudi Arabia and China is also linked to an endorsement from the Fund. China’s slowdown has been worse than anticipated amid Covid-19 outbreaks and lockdowns. Moreover, further lockdowns and a deepening real estate crisis in China has pushed growth down to 3.3pc this year — the slowest in more than four decades, excluding the pandemic.
Secondly, pressures on exports are going to rise due to the higher cost of doing business, slowing down of demand in our traditional trading partners and the lack of competitiveness in the manufacturing sector. Remittances and traditional FDI flows are already showing a downward trend. Some of the large multinationals may decide to cut down their operations in Pakistan as Eurozone growth has been revised down to less than 3pc this year and 1.2pc in 2023.
Thirdly, job cuts are imminent in a recessionary period and pressures of non-performing loans will be high on the banking sector. With 2.5 million new entrants in the labour market every year, there is no way that the current structure of the economy can provide decent employment opportunities for the youth. Pakistan must prioritise and invest in knowledge-based skills such as IT and nursing, and devise a strategy to export human resources to aging countries like Japan and Germany. This will not only ease the pressure on jobs but will lead to a higher level of remittances.
More losses are expected in the stock market and real estate sector but both these sectors are linked to the richer segments of society. Since a large portion of Pakistan’s economy relies on informal transactions, it could shield small and medium enterprises from some of the recessionary shocks due to lower reliance on bank loans.
Among the limited options, the only practical way forward in the recession period will be to cut down on non-essential imports and reliance on oil, energy conservation and selling strategic stakes in profitable state-owned enterprises to raise foreign exchange. Incentives will have to be created for increased production of essential food items and productivity in the manufacturing sector. The ruling elite should consider shifting their policy focus from populist infrastructure projects to targeted subsidies and delegated institutional models for the implementation of key reforms to diversify the structure of the economy in order to build a resilient economy.
The writer is a senior development and economic policy expert. He is currently advising the UN and governments as a leading expert on financing for development.
Published in Dawn, December 25th, 2022