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There is growing perception that the economy has turned the corner and that the growth rate is picking up while the imbalances are increasingly under control. The only negative factor apparently is the recent perking up of the rate of inflation.

The State Bank of Pakistan (SBP) has projected that the GDP growth rate in 2020-21 will now approach 3 percent. This is in contrast with the significantly lower projections by the International Monetary Fund (IMF) and the World Bank. However, the agricultural sector is likely to see negative growth due to a big drop in cotton output and marginal increase in other crops.

The third wave of Covid-19 is going to impact once again sectors like manufacturing, wholesale and retail trade and transport and communications like last year for almost the same period. The public administration and defense sector will show less growth due to limited increase in expenditure. Economic activity in services in the private sector is also now being adversely affected due to the third wave.

Therefore, the optimism shown recently by the SBP may have to be made more realistic. The GDP growth rate scenario is back again to less than 2 percent.

Turning to the rate of inflation there are some negative developments. The perking up of the CPI from 5.7 percent in January to 8.7 percent in February is partly attributable to higher inflation in non-food and non-energy prices. For the first time since July, the core rate of inflation has risen to above 7 percent.

A seldom highlighted cause of inflation is the rate of monetary expansion. M2 (money supply) has been growing at almost 18 percent. This is significantly higher than the average annual increase of 13 percent over the last five years. The faster monetary expansion is, of course, due to the large financing packages of Rs 2.3 trillion put in place by the SBP after the first attack of Covid-19 and because of high level of domestic borrowing to finance the budget deficit.

A significant negative development is that the rate of increase in the WPI (weighted price index) has begun to outpace the rise in the CPI (consumer price index). This was not the case from July to December 2020 and a large part of inflation was due to the rise in retail prices. Clearly, intermediate inputs and raw materials prices are rising and this implies more cost push inflation, which could, sooner or later, take the rate of inflation in the CPI to a double-digit.

There are also some negative developments on the external trade front. The rate of growth in imports is rising significantly. It was only 1 percent in the first quarter of 2020-21 rising to over 10 percent in the second quarter. During the last two months, imports have risen by as much as 14 percent. The big jump in agricultural imports and rise in import prices due to the process of recovery in the world economy following the widespread use of vaccines are the two major factors.

Unfortunately, exports are showing an opposite trend. They had achieved a healthy growth rate of 11 percent in the second quarter of the ongoing financial year but now it is tapering off. During the last two months it has been only 3 percent. Consequently, with fast growing imports and near stagnant exports the trade deficit has spiraled up by as much as 26 percent. How long will remittances continue to bail out the current account?

While the current account is still in surplus, the continued deterioration in the financial account of the balance of payments has also seldom been highlighted. This account has been barely in surplus of $129 million as compared to $7,623 million in the corresponding period of 2019-20.

There are many reasons for the severe deterioration in the financial account. First, foreign direct investment is down by almost 30 percent. $406 million of equity funds have left the country while last year there was a big inflow of $2,249 million. Second, net foreign assistance to the government has declined by 24 percent. Third, SBP has made large repayments.

Overall, the balance of payments is in surplus of only $764 million as compared to $5,842 million last year. This is the knife edge and any further rise in the large trade deficit, reduced inflow of home remittances and foreign investment and/or assistance could lead to pressure on the foreign exchange reserves.

However, they will now be propped up by receipt of $550 million from the IMF following the resumption of the IMF Extended Fund Facility. What are the prospects for the economy after the return of the IMF? On the positive side, foreign inflows are likely to increase significantly. There is now even the prospect that Pakistan will be able to float a Euro/Sukuk bond of $2 billion.

But what is the outlook for the people of Pakistan? As happened after the initiation of the Programme in 2019, the tax burden is going to rise substantially. The budget of 2021-22 is expected to include additional taxes of Rs 700 billion. Inevitably, this will have to be achieved mostly by enhancement in indirect tax rates. Further, the budget deficit will have to be reduced by up to 1.5 percent of the GDP. This will mean cut in spending on development, social sectors or social protection. This will imply more cost-push inflation and reduced demand for labour, thereby aggravating the already bad employment situation.

The draconian measures agreed to for reducing the circular debt in the form of a quantum jump in electricity tariffs and other measures will contribute to more cost-push inflation and damage competitiveness of exports. Further, a newly autonomous SBP will most likely limit support to financing the budget deficit, thereby putting pressure on interest rates and impacting negatively on investment in the economy.

Therefore, the next year is likely to witness a significant build-up of foreign exchange reserves following the return of the IMF umbrella. But this will come at the cost of persistent high rate of inflation and lower employment and GDP growth, especially if COVID-19 keeps coming back to haunt the people.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2021

Dr Hafiz A Pasha

The writer is Professor Emeritus at BNU and former Federal Minister


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