- Major downside risk to overall growth outlook for FY22 is the ongoing third and potentially additional waves of Covid-19
- While remaining bounded, the current account deficit is expected to rise, mainly due to a further widening in the trade deficit
KARACHI: Identifying certain structural vulnerabilities, the State Bank of Pakistan (SBP) is expecting surge in inflation and current account deficit in the future.
According to the SBP's Third Quarterly Report on The State of Pakistan’s Economy for the fiscal year 2020-21, going forward, in FY22, the economic momentum that became evident during FY21 is expected to strengthen further. The ongoing rollout of vaccines, coupled with the continuation of economic activities during the virus' second wave and most of the third wave, offers some optimism.
However, the report said a major downside risk to the overall growth outlook for FY22 is the ongoing third and potentially additional waves of Covid-19, which might necessitate the imposition of mobility restrictions and therefore disrupt the ongoing economic momentum.
In addition, in the external sector, while remaining bounded, the current account deficit is expected to rise, mainly due to a further widening in the trade deficit on account of likely rise in import payments. The increase in imports reflects higher oil prices, which are now projected to add to the pressures coming from consistently growing import volumes of energy commodities.
The State Bank said while the economy made an encouraging recovery during FY21, certain structural vulnerabilities continue to merit attention.
First, in the agriculture sector, the secular decline in cotton production needs to be addressed. Timely availability of pest-resistant seed varieties and further support from agriculture extension departments, particularly to promote the adoption of climate-smart farming practices, could enable better outcomes.
Second, in the external sector, the widening of the merchandize deficit needs to be contained to a sustainable level. Greater self-sufficiency in agriculture, through adoption of better farming and crop management practices, and maintenance of adequate stocks can reduce the need to import commodities (such as wheat, sugarcane and cotton) to bridge domestic shortfalls or counter temporary price pressures. Discouraging the import of luxury consumer items and promoting greater diversification of exports, in terms of value-added items and destinations, could also help.
Third, efforts are required to mitigate food inflation, triggered largely by supply-side issues in the management of agriculture commodities. This may be achieved through better coordination among federal and provincial food departments, provision of reliable data, vigilant monitoring of stocks and food prices, and timely import of commodities.
Fourth, the twin burdens of debt servicing and a narrow revenue base are leaving less fiscal room for public investment. This calls for an acceleration of efforts to broaden the tax base, increase documentation in the economy, improve public financial management, restructure loss-making public sector enterprises, and reduce circular debt of the power sector.
The report said recent CPI outturns have indicated a consistent YoY increase in inflation in February, March and April 2021 primarily originating from the supply side, with the output gap still estimated to be negative.
The current uptick is concentrated among food items and utility (electricity) prices, whereas wage pressures are judged to be stable at this point. Furthermore, better commodity management, including by building strategic reserves of staple food items, is likely to alleviate supply-side pressures from food items. As a result, second-round effects of the supply-driven shocks to inflation are currently muted and inflationary expectations continue to remain well-anchored.
However, the report said there are multiple upside risks to the inflation expectations. First, the ongoing rising trend in international commodity prices is broad-based, with prices of oil, food and metals, all rising significantly. Second, upward adjustment in administered utility tariffs (electricity, gas, and fuel) could further feed into inflation as well as inflationary expectations. Third, wage pressures will need to be watched carefully, particularly in the context of any increases in the minimum wage and public sector pay. Fourth, the withdrawal of sales tax exemptions and other potential revenue generating measures in the FY22 budget may also lead to an increase in inflation during the fiscal year.
In addition, in the fiscal sector, a decent growth in revenues has been noted so far in FY21, with collections until April 2021 being higher than the target. Furthermore, the growth in expenditures is lower than last year (FY20), mainly due to lower development spending and restraint on non-interest current spending. On this basis, SBP is expecting that the fiscal deficit for FY21 is expected to be 6.5-7.5 percent of GDP.
However, an upside risk to this projection are higher payments on account of circular debt settlements. For FY22, while the budget is awaited, an improvement in the fiscal deficit is expected amid a continuation of the current growth trends in revenue collection into FY22, as well as the acceptance of the proposal to remove corporate tax exemptions. Lastly, the higher growth outcome in FY22 would further boost revenue collection, while PSDP spending is expected to increase.
On the agricultural side, the impetus is likely to come from a further improvement in output, with the government emphasizing the use of better seed varieties and modern technology. In particular, cotton production is expected to recover from the multi-year low recorded in FY21.
The government's Kharif and Rabi packages, which typically include subsidies on fertilizers and other inputs, are also anticipated to support growth in the agriculture sector.
Further impetus to economic growth is likely to come from expected investments under TERP and the policy-driven boost in construction activities.
Furthermore, the government has indicated its intention to increase PSDP spending, which would also be a major contributing factor to the higher growth outcome. These favorable trends across agriculture and industry would also spill over to the services sector.
On the other hand, the growth in export receipts is mainly projected to come from the continued strong momentum in high value textile items (that is, apparel and home textiles), as well as a rebound in rice exports amid better crop expectations (which would allow exporters to offer more competitive prices).
However, potential downside risks to the export growth include continually rising international prices of textile inputs (including cotton yarn), which might impact exporters' competitiveness; as well as the resumption in economic activity in key competitors (especially India and Bangladesh) amid vaccinations and a subsiding in Covid cases.
Finally, workers' remittances are projected to remain buoyant, as the main factors (switch to formal channels, incentives for banks and MTOs, etc.) will still be in place. In addition to this, progress on the IMF program would help the continuation of foreign exchange inflows from external sources, while promoting further stability in the balance of payments.
Copyright Business Recorder, 2021