FeaturedNationalVOLUME 17 ISSUE # 45

Rising uncertainties, declining growth

The economy is at a great risk after devastating floods. The rupee is continuously losing its value against the US dollar. Prices are at a historic high. Exports are projected to decline in the coming months, which will put pressure on foreign reserves and aggravate the country’s balance of payment problem.

The country hopes to receive international aid to mitigate flood losses but it could still face huge economic costs at a time when it badly needs to improve its growth to meet the needs of the country and a rapidly growing population. International estimates say Pakistan’s GDP will slow down considerably in the current fiscal year against a healthy 6pc growth last year. A declining growth means more people losing their jobs and adding to the poverty quagmire of the country.

According to the Asian Development Bank, Pakistan’s economy will slow down to 3.5pc in the current fiscal year amid devastating floods, policy tightening, and critical efforts to tackle sizable fiscal and external imbalances. In its latest report, the ADB said GDP growth in Pakistan in FY2022 was propelled by higher private consumption and an expansion in agriculture, services, and industry – particularly large-scale manufacturing. According to the update, private consumption expanded by 10pc in FY2022 resulting in improved employment conditions and higher household incomes. Agriculture output increased by 4.4pc in FY2022 supported by strong performances in crops and livestock. “Agriculture growth is expected to moderate due to flood damage and high input costs next year, which may diminish services growth, particularly wholesale and retail trade. In FY2023, fiscal adjustments and monetary tightening are expected to suppress domestic demand. A contraction in demand, together with capacity and input constraints created by higher import prices from the rupee’s depreciation, will reduce industry output,” it added.

On the other hand, Fitch Solutions revised Pakistan’s real GDP growth forecast for the current fiscal year down to mere 0.2pc, from 0.6pc previously, while stating that the severe floods in Pakistan would weigh on agricultural production and exacerbate the country’s external imbalances. “Fitch Solutions expects floods in Pakistan to exacerbate the already weak economic outlook and political situation. We have lowered our real GDP growth forecast for Pakistan to 0.2pc for 2022-23 (July – June), from 0.6pc previously, as adverse weather conditions will not only reduce agricultural production which accounts for 19pc of GDP but also weigh on exports and exacerbate Pakistan’s external imbalances,” it noted. The report observed that Pakistan was already facing a potential balance of payments crisis even before the floods hit. “A widening trade deficit would further weigh on the dwindling foreign exchange reserves and the Pakistani rupee. We see the current account deficit to widen to 4pc in the current fiscal year, as foreign reserves are also falling.”

The International Monetary Fund also highlighted risks to Pakistan’s economy. In its latest report, it said high inflation and tighter global financial conditions because of the war in Ukraine would continue to weigh on Pakistan’s economy, pressuring its exchange rate and external stability. The report said risks to the outlook and programme implementation remain high and tilted to the downside given the very complex domestic and external environment. “Policy slippages remain a risk, as evident in FY22, amplified by weak capacity and powerful vested interests, with the timing of elections uncertain given the complex political setting,” the global money lender said.

The report said socio-political pressures are expected to remain high and could also affect policy and reform implementation, especially because of the tenuous political coalition in office and its slim majority in parliament. “All this could affect policy decisions and undermine the programme’s fiscal adjustment strategy, jeopardising macro-financial and external stability and debt sustainability,” it stated. The global lender also warned that high food and fuel prices could trigger protests and instability, which could in turn jeopardise macro financial and external stability and debt sustainability. Moreover, higher interest rates, a larger-than-expected growth slowdown, pressures on the exchange rate, renewed policy reversals, weaker medium-term growth, contingent liabilities related to state-owned enterprises and climate change were described as major risks.

The finance ministry has also admitted that the economic outlook is surrounded by global and domestic uncertainties, including lower growth, especially in the wake of recent heavy rains and floods affecting Kharif crops as well as elevated inflation. It also warned that recessionary tendencies may hurt Pakistan’s export markets in the coming months. “The economic outlook is surrounded by global and domestic uncertainties. Geopolitical tensions remain unabated, worldwide inflation remains high, interest rates show tendencies to rise, and the US dollar strengthens. Pakistan’s external environment is therefore facing increasing challenges,” the ministry stated in its monthly economic update.

Pakistan needs to grow at 7-9pc for 30 years to reduce public debt and create jobs by bringing a radical shift in functioning of the state and redefining the government role as a facilitator, according to the Pakistan Institute of Development Economics. There should be a maximum of two terms for the prime minister and all the legislators to break the monopoly of political families that will lead to a stable democracy, according to the think tank. The reform agenda emphasizes achieving a 7-9pc economic growth rate annually for next 30 years to create two million jobs per annum and reduce the public debt, which it said had already become “unsustainable”.

Another think tank, the Institute of Policy Reforms, says Pakistan’s economy will stay in the low growth, low export and close to default position despite the apparent short-term control over the current account deficit. It also advised the government to slow down foreign borrowing. It anticipates further devaluation of the rupee or a more restrictive monetary policy and even more increase in administered prices. “If all of that happens, the cure may turn out to be worse than the disease. The people of Pakistan are paying a huge cost for years of poor economic management,” it noted.

The most critical problem faced by Pakistan’s economy is repayment and servicing of external debt and years of ill-advised financial management. New external loans, often at high commercial rates, are taken to service past debt, a solution fraught with risks, but one that has become especially acute in recent years. In essence, the economy is in a debt trap. Besides, Pakistan remits over 0.5pc of GDP in foreign direct investment (FDI) profits annually. While this is a necessary part of FDI, these are not export-oriented investments. Remittance of profits adds to foreign exchange squeeze.

In the last twenty years, Pakistan has paid external creditors more than it has received from them. Yet its external debt grew by over 200pc from $37.2b in FY01 to $112.9b in FY20. We may have paid back the original loan more than once and still owe it to the creditor. Between FY01 and FY20, external debt disbursed to Pakistan was $112.6b. During the period, it has paid foreign creditors a sum of $117.9b in principal and interest. Thus, it has paid back $5.2b more than it received. Of the $117.9b paid, $90.6b was principal, and $27.2b was interest. Average annual interest paid was US $1.4b. It is the result of borrowing to service past debt and the effect of compounding, which makes even concessional credit expensive. As a result, most solvency and liquidity indicators have worsened in recent years.

Taking another measure, the government of Pakistan spends the bulk of its revenue on paying interest on public debt. In the last ten years, it has spent annually an average of 60pc of federal net revenue receipts on interest payment (on both domestic and external debt). In FY19, interest payment was 103pc of net revenue receipts. It means every government expense other than interest payment was met from loans.

As a result, most macroeconomic or GDP growth indicators have worsened during the last twenty years. Seen over 20 years, the fiscal and current account deficits have stayed high, inflation has resisted a tight monetary policy, and the rupee has weakened consistently. Many times, we have put controls on imports and have repeatedly sought IMF help.

The ground realities show Pakistan faces serious economic challenges and it will have to increase its exports, revenue and decrease expenditure to meet the growing needs of its people. It also badly needs political stability to achieve its economic targets.