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Pak Economic Security – Multi Donor Dependency

As news filters in of the International Monetary Fund (IMF) likely to release tranche of Extended Fund Facility for Pakistan, here is a look at some fundamentals of the Pakistan economy.

Pakistan’s economy has been growing slowly over the past two decades. Annual per capita growth has averaged only 2 percent, partly due to inconsistent macroeconomic policies and an under-reliance on investment and exports to drive economic growth. In the regional update report titled ‘Shifting Gears: Digitization and Services-Led Development’ published in October 2021, the World Bank has indicated that despite repeated COVID-19 waves, Pakistan’s economy recovered in FY21amid effective targeted lockdowns and an accommodative monetary policy stance.

Economic growth is expected to ease in FY22 before strengthening again in FY23. However, potential delays in the IMF program with ongoing discussions with the World body, high demand-side pressures, potential negative spillovers from the evolving situation in Afghanistan and more severe and contagious COVID- 19 waves pose downside risks to the outlook said the World Bank’s latest report.

Due to low-base effects and recovering domestic demand, real GDP growth (at factor cost) is estimated to have rebounded to 3.5 percent in FY21 from a contraction of 0.5 percent in FY20 Buttressed with record-high official remittance inflows, received through formal banking channels, and an accommodative monetary policy, private consumption and investment are both estimated to have strengthened during the FY.

Government consumption is also estimated to have risen, but at a slower pace than in FY20 when the COVID-19 fiscal stimulus package was rolled out. In contrast, net exports are estimated to have contracted in FY21, as imports growth almost doubled that of exports due to strong domestic demand.

On the production side, supported by strong large-scale manufacturing, industrial activity is projected to have rebounded after contracting for two consecutive years. Similarly, the services sector that accounts for 60 percent of GDP, is estimated to have expanded, as generalized lockdown measures were increasingly lifted. In contrast, agriculture sector growth is expected to have slowed, partly due to a near 30 percent decline in cotton production on adverse weather conditions.

Despite slowing to 8.9 percent in FY21 from 10.7 percent in FY20, headline consumer price inflation remained elevated – mostly because of high food inflation, which is likely to disproportionately impact poorer households that spend a larger share of their income on food items compared to non-food items as per the World Bank.

In encouraging developments the current account deficit narrowed from 1.7 percent of GDP in FY20 to 0.6 percent in FY21 as robust remittance inflows offset a wider trade deficit. Foreign direct investment decreased, while portfolio inflows increased with the issuance of US$2.5 billion Eurobonds. Overall, the balance of payments surplus was 1.9 percent of GDP in FY21, and the official foreign exchange reserves rose to US$18.7 billion at end-FY21, the highest since January 2017 and equivalent to 3.4 months of total imports.

Accordingly, the Rupee appreciated by 5.8 percent against the U.S. dollar over the FY, while the real effective exchange rate rose by 10.4 percent. The current account deficit is projected to widen to 2.5 percent of GDP in FY23 as imports expand with higher economic growth and oil prices.

The World Bank estimates that Real GDP growth at factor cost declined from 1.9 percent y-o-y in FY19 to -1.5 percent in FY20 due to effects of the COVID-19 pandemic-related containment measures that followed the monetary and fiscal tightening associated with the IMF Extended Fund Facility (IMF-EFF).

The services sector is estimated to have contracted by over 1.0 percent, while industrial production is expected to have contracted by 5.0 percent, due to the high policy rates prior to the pandemic and plunging domestic and global demand thereafter. The agriculture sector, partially insulated from the effects of the containment measures, expanded modestly over the year.

To provide relief during the pandemic, the government postponed several administrative measures which would have otherwise put additional pressures on prices: it halted further planned increases in power tariffs over February through July 2020 as well as increases in taxes on motor vehicles and postal services, and granted tariff concessions on the import of several raw materials through FY21 as per the World Bank.

To preserve financial stability and support economic activity amid the COVID-19 crisis the SBP has maintained the policy rate at 7.0 percent, implying a negative real interest rate throughout the first six months of this fiscal year. The outlook entails a gradual post-COVID recovery, during which economic growth is expected to remain below potential, reaching 1.3 percent in FY21 and strengthening to 3.4 percent in FY23 as per the World Bank.

As per international financial institutions, major risks to the outlook include possibility of new waves of infections, emergence of new vaccine-resistant strains, and setbacks in mass vaccinations. In addition, more delays in the implementation of critical structural reforms could lead to further fiscal and macroeconomic imbalances.

IMF had stopped disbursement on the $6 billion program and most recently both IMF and World Bank, have stepped up their pressure on the government to increase power tariff at the very outset of the next calendar year 2022. “The IMF program of $6 billion is right now under suspension and there are clear indications that the Fund wants not less than the increase in power tariff from January 2022, which is one of the prerequisites to restore the program,” an official was quoted by the News International.

In a recent interaction, the World Bank mission was told, the official said, that the prime minister was very sensitive to this issue and he was the final authority to take a decision on it, thus no increase in power tariffs is likely.

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