Washington, D.C September 7 2021: Growth will remain around 4% in FY 2021/22 supported by an accommodative monetary policy and a significant increase in public investment says International Finance Corporation in its detail note on Pakistan.
Preliminary official estimates show a strong recovery in FY 2021 (ending in June), with growth of 3.9%, driven by the recovery in manufacturing and services. Growth in agriculture may improve to 4% in 2022 under the assumption of recovery in cotton production, which will be supported by adequate availability of irrigation and credit facilities. Adjusted for population, fewer cases and deaths of COVID-19 have been recorded in Pakistan than in other developing and emerging economies. While the rate of new cases has recently declined, the pandemic still puts considerable stress on Pakistan’s public health system.
The authorities have deployed a comprehensive set of policy responses that have helped to limit the contraction in real GDP to 0.5% in FY 2019/20. The crisis-mitigating measures included emergency health spending, a food security program, temporary tax deferrals, subsidized loans to households, and deferrals of loan payments. In early August, the government tightened restrictions on mobility in major cities, including Islamabad and Karachi, amid rising number of COVID-19 cases related to the Delta variant.
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Risks are broadly balanced. On the upside, faster vaccination rates and further progress in reforms could boost growth to 4.7%. The downside risks stem from a resurgence of COVID-19 and the still-low vaccination rate in Pakistan (Exhibit 1). Security concerns from cross-border terrorist activities is an additional downside risk following the Taliban’s swift seizure of power in Afghanistan. Continued exodus of refugees from Afghanistan to Pakistan could also strain the finances of the government.
The current accommodative monetary stance remains appropriate. The policy rate remained unchanged at 7% from July 2020 to August 2021 and supported the recovery. Urban core inflation remained broadly stable at 6.9% in July 2021 (yoy) as compared with headline inflation of 8.7%, which was driven by the upward adjustment in electricity tariffs in the context of higher global oil prices (Exhibit 2). The SBP noted in its recent MPC that the recent price pressures were “largely supply-driven and transient”. We expect average CPI inflation to decline to slightly below 8% in FY 2021/22 as compared with 10.7% in FY 2019/20.
Exchange rate flexibility is helping. The sharp depreciation of the rupee since 2017 has reduced external vulnerability. Pakistan’s exchange rate is market-determined and has depreciated by 17% in real effective terms since 2016 (Exhibit 3). The Pakistani rupee remained stable at around 160 per USD from end 2020 to June 2021. Improved policies and the progress in structural reforms have helped to build confidence in the rupee.
The external position has strengthened supported by the continued surge in worker’s remittances. The deterioration in the trade deficit, on the back of the sharp increase in imports, has more than been offset by the continued surge in workers’ remittances. Remittances increased by 29% in FY 2020/21 driven by both domestic and international factors. Domestically, the authorities reduced the threshold for eligible transactions from $200 to $100 under the Reimbursement of Telegraphic Transfer (TT) Charges Scheme, promoted usage of formal and digital channels, and restricted cross border travel in the wake of COVID-19. Internationally, fiscal stimulus in developed and emerging economies enabled Pakistanis living abroad to send more money home. Saudi Arabia, the UAE, USA, and the UK are the main source of remittance inflows.
The current account deficit narrowed from by one percentage points of GDP to 0.7% of GDP in fiscal year 2020/21 (Exhibit 4). Net capital inflows were again well above the current account deficit, leading to a substantial increase in official reserves to the equivalent of 3.3 months of import coverage, the highest since 2016. We expect growth in volume of exports to accelerate in FY 2021/22 supported by recovery in cotton production and tariff reforms. Nonetheless, the current account deficit may widen slightly to 1.6% of GDP due to higher imports of petroleum products and slightly lower remittances. However, the projected increase in net capital inflows would lead to a further significant rise in official reserves, to around $22 billion in June 2022 (equivalent to 3.8 months of import coverage). In this context, the SBP received $2.75 billion from the IMF as part of its new SDRs allocation.
Significant easing of external debt vulnerabilities. Pakistan’s external debt, while rising, remain modest at 43% of GDP. The increase in the debt in FY 2020/21 was driven mainly by the government’s $2.5 billion Eurobond in March. Official borrowing from multilateral institutions and commercial banks in the amount of $1.1 billion and $ 0.54 billion, respectively, also contributed to higher external debt. Public debt service payments fell by $3 billion to $7.2 billion in FY 2020/21 as the government’s external debt was rescheduled due to the Debt Service Suspension Initiative (DSSI).
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Fiscal consolidation is underway. The narrowing of the deficit in FY 2020/21 to 7.1% of GDP was supported by continued recovery in tax revenues and prudent spending, which fell by 2% in real terms (Exhibit 6). The budget for the FY 2021/22 envisages further narrowing of the overall fiscal deficit to 6.3% of GDP and a primary deficit of 0.7%, supported by revenue-enhancing reforms and further expenditure rationalization. Public debt, while declining, will remain elevated at 88% of GDP by June 2022.
Sustained rapid growth hinges on further progress in reforming the economy. The current IMF program (EFF) and underlying reforms serve as anchors of macroeconomic stability. However, achieving rapid, sustained, and inclusive growth will require Pakistan to remain committed to seeing through bold and comprehensive reforms to eradicate corruption and rent-seeking behaviors, improve the business environment, stabilize finances, and effectively communicate the need for change to the public. Efforts to remove structural impediments will improve total factor productivity, raise confidence, and encourage stronger private sector investment. The current gross investment to GDP ratio remains low at around 15% of GDP. Experience from most emerging and developing economies show that raising growth to at least 5% would require much higher investment to GDP ratio.