InternationalVOLUME 17 ISSUE # 4

Fears from Afghan spillovers

The dollar has hit the highest level against the rupee and its rising demand for imports and smuggling to Afghanistan have created fears of further depreciation of the Pakistani currency and increase in price hikes.

In the absence of sufficient resources and without adequate international assistance, Afghanistan is heading towards a humanitarian crisis, where it faces shortages of food and medicines. If Afghans migrate to Pakistan, it will immensely add to the country’s problems. Pakistan’s currency has already depreciated by over 40pc and prices are their highest. The rising import bill has played a key role in increasing demand for the US currency recently. The fear of higher current account deficit in FY22 is also pushing importers to book more dollars for future imports. Market experts say it is after years that a black market of the dollar has emerged where the currency is being traded at a rate Rs3 to Rs5 higher than that in the open market. The weaker currency will add to inflation which would then require a tighter monetary policy and hike in interest rates, which could adversely affect GDP growth, experts warn.

Pakistan’s current account deficit has already widened to $1.5 billion in August 2021. The deficit soared close to the high monthly average seen in fiscal year 2018. The year saw the country hit an all-time high current account deficit of $20 billion and a drop in the foreign currency reserves to a critically low level of less than two months of the import cover, at $7.2 billion. The country witnessed a steep climb in the deficit for the second time in three months in August 2021. It had recorded a deficit of $1.8 billion in June. The central bank partially linked the rise in imports to the surge in demand for machinery and raw material for industrial and agricultural output in the wake of the government’s policy aimed at expanding the economy. Besides, high prices of commodities in the world market also contributed to the high import payments. Despite the robust growth in the import bill, the export earnings have remained sluggish.

Meanwhile, foreign direct investment (FDI) posted a negative growth during the first two months of the current fiscal year. The State Bank of Pakistan reported that Pakistan had fetched FDI amounting to $203 million in July-Aug of FY22 compared to $255 million in the same period last year (FY21), depicting a decline of 20pc or $52 million. During the period under review, FDI inflows stood at $359.5 million against the outflow of $156.4 million. An analysis revealed that despite some improvement, foreign investors are still withdrawing their investments from the stock market.

The State Bank of Pakistan (SBP) has also warned of “some greater uncertainty with respect to spillovers from the evolving situation in Afghanistan”. In its latest report, the central bank said the current account deficit had risen to $0.8 billion in July and $1.5b in August, reflecting both vigorous domestic demand and high global commodity prices. It added that remittances remained strong, growing by 10.4pc during July-August and exports also performed “reasonably well” (averaging $2.3b per month), as they were outstripped by imports. “As a result, the rupee depreciated by 4.1pc since July. However, many other currencies have also depreciated recently as expectations of tapering by the federal reserves have been brought forward,” it added. It observed that while the flexible exchange rate had appropriately played its role as a shock absorber, it was important that its role be complemented by strong exports, targeted measures to curb nonessential imports, and appropriate macroeconomic policy settings to contain import growth. The central bank noted that it would be important to support tax revenue growth and carefully monitor outturns through the year to ensure the budget remains on track. “Any unforeseen slippages in the fiscal stance would further bolster domestic demand, imports and inflation,” it warned.

In its report, Fitch Solutions noted that net exports would contribute negatively to headline growth as imports would outpace export growth. “On the external front, heightened security threats posed by radical groups such as the Taliban could lead to social instability and the destruction of infrastructure. This might weigh on the country’s gross fixed capital outlook and exporting capabilities as businesses become hesitant to invest in capacity building infrastructure,” it noted. It forecast imports to rebound more strongly than exports. “Finally, with petroleum products accounting for approximately 18pc of total imports value in FY21, elevated fuel prices will further increase Pakistan’s imports bill,” it warned.

According to the Asian development Bank, Pakistan’s fiscal deficit is projected to narrow to the equivalent of 6.9pc of the GDP in FY22, which is still higher than the target set earlier under a medium-term fiscal consolidation program supported by the IMF. Expenditure is also projected to rise in FY22 as the government has budgeted substantial increases in subsidies and in social and development spending to protect the vulnerable and fortify growth and economic recovery. “With primary and fiscal deficits, high borrowing costs, and currency depreciation, public external debt reached $95.2 billion in the fiscal year 2021. As domestic demand picks up and international oil prices rise, the current account deficit is seen widening to the equivalent of 1.5pc of GDP in the fiscal year 2022. Imports are expected to rise in the fiscal year 2022 in response to domestic economic recovery, higher international oil prices, and rationalisation of customs and regulatory duties in the budget of the fiscal year 2022-23, it noted.

Earlier, Standard and Poor’s said Pakistan’s economy was gradually recovering from its pre-pandemic nadir and the subsequent Covid-19 shock, but warned that vulnerabilities remain elevated. The agency said, “Multilateral and official funding will remain critical to Pakistan’s external debt sustainability.” It added that the ratings on Pakistan reflected its nascent economic recovery amid the enduring risk of the Covid-19 pandemic, stable but considerable external indebtedness and liquidity needs, and an elevated general government fiscal deficit and debt stock. “We expect Pakistan’s recent improvement in growth momentum to endure, bringing its long-term performance more in line with global peers. The government has adopted key reforms to stabilise its vulnerable fiscal position, however pandemic risks and political realities may temper further progress. The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which are elevated. Although the country’s security situation has gradually improved over recent years, ongoing vulnerabilities weaken the government’s effectiveness and weigh on the business climate,” it warned.

It observed that the humanitarian and security crisis in neighbouring Afghanistan could pose additional risks to Pakistan’s domestic security situation in the years ahead. “Domestic security, occasional tensions with India, and Pakistan’s extended land border with neighbouring Afghanistan pose challenges to its long-term economic outlook. These conditions, along with a shortfall in physical infrastructure, are additional bottlenecks to foreign direct investment,” it added.

The situation in Afghanistan is somewhat under control. However, there are reports of shortages of food and medicines in the country. If the situation worsens in Afghanistan and people migrate to Pakistan, it will also badly affect the country and its people. Pakistan will have to take measures to save itself from possible Afghan spillovers.