TEXT: The Pakistani economy is passing through a perfect storm due to troubling international and domestic dynamics. Globally, inflation has witnessed a spike following a series of unfortune events. Supply chain issues of the Post-Covid-19 era that resulted in elevated shipping rates and jump in commodity price have been exacerbated by the Ukraine war. As a result, an astronomical jump has been witnessed in the prices of essential commodities. Inflation for both advanced and developing economies reached multidecade high in recent months. For Pakistan, the situation has been aggravated by the IMF’s conditionality to eliminate subsidy on petroleum products and bring the end consumer electricity prices near the cost. Furthermore, the recent devastating floods has significantly impacted food basket. In Pakistan, after witnessing inflation reading of 12% during FY22, it has reached multidecade high level of 25% during the first five months of FY23.
Going forward, inflation is projected to remain elevated during the remaining months of this fiscal year with 1) gas price hike still remaining, 2) likely rupee devaluation, and 3) import constraints add another dimension to food prices such as lentils, tea, soybean, and poultry prices. Although some easing in commodities has been witnessed in recent months, on local level its impact is muted due to Rupee devaluation and rising levy on petroleum products. However, from next fiscal year FY24, inflation is projected to drop in single digit due to high base effect.
After keeping status quo Policy rate in last two meetings, SBP unexpectedly raised its key policy rate by 100 basis points to 16.0% in Nov-22 to ensure that the current high rate of headline inflation (25% in FYTD) doesn’t become entrenched and “risks to financial stability are contained”. During this calendar year, the policy rate has augmented by 6.25% while overall during this tightening cycle the policy rate has more than doubled from 7.0% in Aug-21 to current 16.0% in Dec-22.SBP has reaffirmed FY23 GDP growth of around 2% and a CAD of around 3% of GDP shared in the preceding monetary policy statement. However, higher food prices and core inflation are now expected to push average FY23 inflation up to 21-23%, from earlier projection of 18-20%. Apart from rising inflation as its primary concern, another reason for monetary tightening is likely to be exchange rate stability and external account vulnerabilities with hefty external debt payments due and need to further tame the current account deficit.
External account situation at critical juncture
The current account deficit continues to moderate in FY23 after clocking in at USD 17.4 billion during FY22. Cumulatively, the current account deficit during the first four months of FY23 fell to USD 2.8 billion, against USD 5.3 billion in the same period of last fiscal year. This improvement was mainly drivenby a broad-based 11.6% fall in imports to USD 20.6 billion, with exports increasing by 2.6% to USD 9.8 billion. On the other hand, remittances fell by 8.6% to USD 9.9 billion, reflecting a widening gap between the interbank and open market exchange rate and normalization of outside travel. The current account is coming under control due to lower commodity price and strict control over imports. However, the decline in exports and remittances is diluting the impact of falling imports. There is also a huge backlog of external payments including dividends toforeign shareholders of companies operating in Pakistan.
Foreign exchange reserves held by SBP during this calendar year have witnessed a substantial decline from USD 17.7 billion at Dec-21 to latest figure of USD 6.7 billion as of early Dec-22, which is a four-year low. Anxieties regarding Pakistan defaulting peaked in November as Credit Default Swap rates reached an all-time high. Amidst dwindling foreign exchange reserves, political uncertainty and recent floods, the Rupee depreciated by around 27% in this calendar year. Issuance of new international bonds (Eurobonds or Sukuk) in unlikely in the near term, due to astronomical rise in international bond yields, so the government will have to rely on multilateral agencies and friendly countries for meeting external financing. ADB and World Bank are envisaging increased financing to support Pakistan’s post-flood relief and rehabilitation activities. Weekly import cover is down to around 5 weeks only, compared to long term average weekly import cover of 13 weeks.
The issue for Pakistan is thedelay in meeting IMF’s conditionalities as the current government is reluctant to take further unpopular measures due to election year. IMF will continue its dialogue and engagement with Pakistan on policies and reforms needed to keep bailout programme’s targets on track and to complete the pending ninth review, which is likely to continue till Jan-23. In the meanwhile, the government is eyeing USD 3 billion from a friendly country, but this will only be a stop gap arrangement. Pakistan needs to undertake immediate credible steps that signal to the IMF and other lenders that the country will break out of its trajectory of perpetual crisis.
The current account deficit is now subdued significantly; but the financial account situation is now reaching alarmingly dangerous levels as external loan repayments are increasing, without injection of appropriate quantum of fresh loans. Pakistan’s external debt and liabilities has reached USD 130 billion (40% of GDP) in FY22, doubling in the last decade from USD 65 billion in FY12. While total debt or foreign debt when measured as a percentage of GDP is not that problematic when compared to other peer countries, the key issue for Pakistan is the annual debt repayment figure which ranges around USD 25 billion annually along with current account deficit of USD 5-15 billion which makes it an uphill task to arrange external financing. There is a dire need to reschedule and lengthen the maturity of annual external debt payment to a more practical number of USD10-15 billion. Overall, FY23 is likely to remain a tough year for country with sentiments likely to improve after election as new government will have a five-year mandate to implement much needed structural reforms. The country has a chequered history when it comes to actual structural reforms due to myriad power centres but that has now become imperative in order to turn the corner for the better.
Taha Khan Javed, CFA
Inflation and interest rate at multidecade high
Copyright Business Recorder, 2022