ISLAMABAD: The World Bank has projected Pakistan’s GDP growth to slow from 6 percent in the fiscal year 2022 to around 2 percent in the fiscal year 2023, while inflation will rise to 23 percent from 12.2 percent.
The bank’s “October 2022 Pakistan Development Update: Inflation and the Poor” noted that preliminary estimates suggest that as a direct consequence of the floods, the national poverty rate for Pakistan can increase by 2.5 to 4 percentage points, pushing between 5.8 and 10 million people into poverty.
The macroeconomic outlook is predicated on the International Monetary Fund (IMF)-Extended Fund Facility (EFF) programme remaining on track, the bank added.
Pakistan remains exposed to external conditions, with the macroeconomic outlook sensitive to global commodity prices and financing conditions. Higher international interest rates, deteriorations in market sentiment, and tighter global financing conditions would pose challenges to accessing affordable external financing. Pakistan’s economic outlook faces substantial risks from further potential increases in world energy and food prices due to ongoing Ukraine–Russia conflict and slower global growth due to rising inflation, it added.
The floods are expected to have a substantial negative impact on Pakistan’s economy. Prior to the floods, the economy was already facing a difficult adjustment to regain macroeconomic and fiscal stability. Implementation of government plans for fiscal consolidation is likely to become more challenging, given extensive relief and recovery spending needs, and slower growth of tax bases due to weaker economic activity.
While relief measures are needed to cushion the human and economic impacts of flooding, delays in fiscal consolidation will heighten risks to macroeconomic and fiscal stability, in the context of high inflation and fiscal and current account deficits.
The report stated that the slower growth will reflect damages and disruptions caused by catastrophic floods, a tight monetary stance, high inflation, and a less conducive global environment. Recovery will be gradual, with real GDP growth projected to reach 3.2 per cent in the fiscal year 2024.
The report noted that macroeconomic risks also remain high as Pakistan faces challenges associated with a large current account deficit, high public debt, and lower demand from its traditional export markets amid subdued global growth.
In line with fiscal consolidation efforts and lower subsidy expenditures as a share of GDP, the primary deficit (excluding grants) is forecast to narrow from 3.1 per cent of GDP in the fiscal year 2022 to three per cent in the fiscal year 2023, despite negative impacts to revenue bases and increased expenditure needs due to the floods.
The fiscal deficit is projected to contract by one percentage point to 6.9 per cent of GDP in 2023 and expected to gradually narrow over the medium term as revenue mobilization measures take hold, particularly GST harmonization and personal income tax reform. In the context of high inflation and rapid nominal GDP growth, public debt as a share of GDP is projected to gradually decline over the forecast period, despite continued primary deficits. Flooding is expected to lead to higher goods imports, reflecting domestic demand for food and cotton, while exports, particularly rice and textiles, are expected to decrease.
Despite flood-associated effects, the CAD is expected to narrow slightly to around 4.3 per cent of GDP in 2023 from 4.6 per cent in 2022, in line with stronger remittance inflows. The CAD is projected to shrink further in the fiscal year 2024 as exports recover from flood impacts. Primary Balance (excluding grants) is projected at -3 per cent the current fiscal year compared to -3.1 in 2022. Agriculture sector is projected to grow by -1.1 per cent in the current fiscal year compared to 4.4 per cent in 2022.
To manage short-term risks, the government needs to strike a delicate balance between progressing on the required fiscal consolidation and meeting relief and recovery needs. In the context of high domestic and external financing needs, ongoing political uncertainties, and upcoming elections, maintaining market confidence will be critical.
Clearly articulating and effectively implementing an economic recovery could help manage market perceptions. It will be critical to maintain a tight monetary policy stance; pursue fiscal consolidation to the extent possible, including through the tight targeting and prioritization of any new expenditures; and proceed with planned structural reforms, including in the energy sector.
Bank recommended that consider opening trade routes with India to source key food products and cotton, to reduce the excess demand the floods will likely generate. India could be a low-cost supplier of these goods given its production patterns and proximity. The report noted that devastating floods will have adverse effects on poverty reduction.
The floods will impact households through at least four channels that include: (i) reduced income due to lost harvests and livestock, or loss of livelihood; (ii) loss of assets, such as homes, livestock, productive equipment, and household durables; (iii) shortages of food due to lost food stocks, poor harvests and rising food prices; and (iv) loss of human capital, due to disease, food shortages and prolonged school closures.
The report noted that inflation matters for growth and investment and has a direct impact on household welfare. The impact of inflation on firms and households discourages investment decisions, leads to investments in less efficient or unproductive assets, erodes external competitiveness, decline of purchasing power and decreasing real incomes effects on asset prices.
Rising energy prices have also been a major contributor to inflation, reflecting higher global energy prices, a weaker Rupee, as well as much-needed upward adjustments to government-administered energy prices. With hikes in fuel prices and tariff adjustment on electricity pricing, energy price inflation surged in August 2022 to 80.7 per cent in urban areas and 67.8 per cent in rural areas.
It further stated that in the context of Pakistan’s economy, expansionary fiscal policies and the delayed monetary policy response led to economic overheating, further contributing to inflationary pressures. Global financial market tightening as well as rising imbalances also contributed to a marked depreciation of the Rupee, which further exacerbated inflationary pressures. More recently, energy prices increased rapidly as the government phased out subsidies and reduced energy tax exemptions, in an effort to contain the associated fiscal costs and curtail the further accumulation of energy sector debt.
The report noted that inflation has a particularly negative welfare impact on poorer households in Pakistan. However, previous policy responses to rising inflation have emphasized reducing energy prices through delays in energy price adjustment and introduction of energy tax exemptions and direct government interventions in agricultural markets. This has been suboptimal for several reasons. Firstly, subsidies and tax exemptions have contributed to pro-cyclical fiscal expansion, fueling inflation, and feeding into medium-term fiscal sustainability challenges. Secondly, providing subsidies and tax relief on fuel and electricity have been heavily regressive, with better-off households benefiting disproportionately. Lastly, distortionary agricultural and energy policies (including subsidies, public procurement, and price caps for agricultural goods and high import duties) have undermined efficient resource allocation and price signals. Policy measures could instead focus on managing overall inflationary pressures, while protecting the poor and most vulnerable.
Going forward, maintaining an appropriate monetary policy stance and minimizing interest rate volatility, guided by the primary goal of safeguarding price stability, can help reduce inflationary pressures, anchor inflationary expectations, and address external imbalances. To this end, implementation of the amendments to the Central Bank Act from earlier in the year, combined with proactive and data-driven monetary policymaking can further strengthen the SBP’s independence, governance, and mandate to support price stability objectives.
On the expenditure side, progress should be maintained towards achieving cost recovery in energy prices and removing tax exemptions on energy prices. This will curtail a highly regressive drain on fiscal resources, while supporting the effective management of aggregate demand and reducing inflationary pressures. On the revenue side, broad-based reductions in taxes—such as on fuel—should be avoided. Provision of such exemptions implies providing relief to all including the most affluent households, and results in the loss of significant fiscal resources that could be better used to provide targeted support to those most in need.
Reducing import duties on sensitive food products can help reduce food prices at a relatively low cost. This is especially relevant in the current context where higher food prices are driven by flood-related disruptions. Removing distortions that artificially increase the prices of goods that are heavily consumed by poorer households can help to mitigate short-term impact while supporting medium-term growth. The import duties can add up to 18 per cent on the price of sensitive food items. The foregone import duty revenue associated with a six-month elimination of import duties on selected sensitive food items is relatively minor, estimated at Rs7 billion (less than 0.06 per cent of the estimated total expenditure in fiscal year 2022).
The bank also recommended policy measures which include maintaining macroeconomic policies that contain inflationary pressures and maintaining the independence of the State Bank of Pakistan (SBP), combined with proactive and data-driven monetary policymaking to support price stability objectives.
“The recent floods are expected to have a substantial negative impact on Pakistan’s economy and on the poor, mostly through the disruption of agricultural production,” said Najy Benhassine, the World Bank’s Country Director for Pakistan. “The Government must strike a balance in meeting extensive relief and recovery needs, while staying on track with overdue macroeconomic reforms. It will be more important than ever to carefully target relief to the poor, constrain the fiscal deficit within sustainable limits, maintain a tight monetary policy stance, ensure continued exchange rate flexibility, and make progress on critical structural reforms, especially those in the energy sector.”
Copyright Business Recorder, 2022