After a very disappointing and disorderly year end, the global market is probably heading for another difficult period. With very few potential opportunities in the pipeline, it is more likely that the global economy will continue to remain under stress until the first two quarters of the new calendar year.
Tighter global stance will exert more pressure on their economies as the tone of central banks around the world will remain aggressive to fight stubbornly high inflation.
With different reasoning most of them are faced with similar problems.
It won’t be wrong to say that it is the central banks’ own dilemma caused by policy weaknesses that led to the crisis.
The overheating of the US economy for a longer duration could still force the Fed to opt for quantitative tightening. Market will therefore be watchful whether or not it maintains its aggressive monetary policy stance, though the US economic data released in recent months drops a hint that the interest rate tightening cycle may probably slow down or eventually discontinue after the 3rdquarter.
To tame inflation, which is at 40-year high, prolongation of aggressive Fed policy stance is not ruled out in the 1st half of 2023. Tighter conditions will support USD and it should not be exposed to further selling.
The greenback is likely to maintain its strength until the first half of 2023. USD has another advantage: it will continue to enjoy its safe haven status. If there is economic or geopolitical unrest, it will encourage dollars inflows that should give strength to the American currency.
The Chinese economy still poses few risks that can delay global recovery. The market will closely look at the progress in other countries. More importantly, developments in Europe, the Russia/Ukraine conflict, pressure on supply and energy prices could give some feel about the market sentiment, as the US economy is not the only growth-driving factor.
However, if oil prices remain subdued, then by the later quarters of 2023, inflation will significantly decline and we could eventually see the beginning of interest rate cuts.
Euro @ 1.0705
Recently, the ECB (European Central Bank) boss has cautioned about the
possibility of a further series of rate hikes if necessary to tame inflation. Aggressive and hawkish posture will help the European currency to make some more gains. But tightening risks a recession, as the economy is still struggling that could even deteriorate the outlook.
Initially, Euro may hold 1.0220 levels for the upside move. A clear break of 1.0880 is required for further gains, which looks difficult. Major resistance is around 1.1390 that should not surrender for resumption of downward move. On the downside, Euro’s fall below parity against US Dollar will be the challenge. If it surrenders, we could see new lows in 2023. Else 1.1920.
GBP @ 1.2091 in 2022: Investor’s confidence was shattered due to poor economic conditions and political uncertainty. The UK’s political unrest was one of the major causes of a weak Pound that can still pop up.
As economic conditions deteriorated Britain’s mortgage issuance and pension funds were severely dented. The Bank of England (BoE) had to step in to bring stability. While on the rate hike issue, BoE was slow to act.
The challenge for BoE will be to keep up with the pace. British economy is faced with several difficulties. Its large deficit is a big problem, lingering supply chain and energy issues could still be the growth hindering factors.
Therefore, sterling is likely to struggle in the coming days/months. On the upside unless resistance at 1.2480 surrenders, Sterling will struggle to move much beyond. Hence, see risk for a drop, a move below 1.1150 is required to test 1.0840. Strong support is at 1.0320. Else an upside break of resistance will encourage a move towards 1.2890.
GOLD @ $ 1823.66: All odds favour buying of gold on dips. Potentially, it is expected to move up in the later quarters of 2023 to test new highs. Higher interest rates, stagflation, recession fear, and global political and economic unrest favour metal purchase. Central bank’s buying interest will be “cherry on top”.
The only hindering factor is ongoing quantitative tightening that could temporarily delay the up move. This means that in the first two quarters of 2023, we could witness whipsaw patterns in gold. While in the latter half, conditions are likely to favour the yellow metal.
The key support level on the downside is $ 1620 that should not surrender. However, on the up, a clear break of $ 1997 is required that could pave the way for a test of $ 2078-98 area. It is a major resistance level, only break would push for possible further highs of $ 2240-60 zones. Else $ 1550 before up again.
At macro level, Pakistan’s economy is shrouded in thick fog due to political and economic uncertainty. Since the last 4-decades the system has been lacking structural reformation; the uneven functioning of the economy is badly hurting. Floods have wreaked massive havoc in Pakistan. The size of damage is beyond imagination as the crisis is unprecedented.
This humanitarian disaster has caused so much misery that it has left countless people without food and shelter. Under such circumstances it is extremely difficult for any developing country to single- handedly operate, manage/rescue and to rehabilitate the sufferers without foreign assistance. The IMF and other lending must be considerate.
It is worrisome that nearly 40% of the crop (wheat-rice-maize-lentils, etc.) was/is damaged. Cotton shortfall due to floods will further add to the ongoing misery, which means production in this year will be well below the projected target.
It is the backbone of Pakistan’s exports. After floods there is a risk of root disease due to wet soil. Hopefully, with better management, it is expected that in the first half of FY24, the overall crop situation due to wet soil conditions will improve and that should lead to an increase in production in the latter half.
Livestock & Dairy, which is a large contributor to our economy, suffered immensely. Total estimated losses could be well over Rs 5 trillion. And to meet essential crop/commodities shortages and for infrastructure, flood related foreign exchange funding requirements could range between $ 15-25 billion.
Meanwhile, there is already a severe liquidity crunch (external and domestic), which is causing a lot of stress. In recent times, the fiscal and monetary policy mix has not been very supportive for the economic fundamentals, which is key to recovery. Pakistan is faced with a daunting task to arrange its future funding (external and domestic), which is almost clogged.
Growth - inflation – rate
At macro level the economy was/is already underperforming, and the impact of floods is severe. Agriculture sector, which is nearly 23 percent of the GDP, is the second best contributor. It has suffered immensely due to floods and will contract sharply.
In future, to achieve agriculture surplus, high income status and for food security, there is urgent need for structural transformation. A rough estimate is that in the last 10 years, based on rupee depreciation and inflation impact, bank credit to the agriculture sector was short by nearly Rs 12-15 trillion that could have helped in modernization.
Manufacturing, which is the third largest sector that roughly contributes 13% of the GDP and is nearly 16% of the labor force, is suffering exceedingly due to economic slowdown and liquidity constraints. It is because, instead of providing credit to the private sector, 80% of the bank’s liquidity is deployed in government securities, as collateral due to low tax collection and high deficit caused by large trade gaps.
Out of Rs 20.97 trillion bank deposits, Rs 16.88 trillion of the bank’s investments are in government paper, through SBP open market operation (OMO), injection amount is 34 % while Advance/Deposit ratio has declined to 48.40% versus 77% plus global average lending to the private sector.
At this pace the manufacturing sector will never flourish unless bank lending is sharply increased to a minimum advance to deposit ratio of 60%. As per an estimate based on the impact of depreciation and inflation, in the last one decade the private sector has been deprived of nearly Rs 25 trillion funding that could have improved the job market and helped in raising tax collection.
Services sector, which is the engine of growth, is the highest contributor of over 60 percent of the GDP. Despite the services sector’s better performance, tax to GDP ratio is pathetically low, which often surges beyond 10% when Pakistan’s GDP dips down in dollar terms after depreciation of rupee.
Hence, such gains are temporary and meaningless as they do not provide enough cushion to reduce the size of debt and its financing. The problem is because the major portion of the economy is undocumented that leads to an extraordinarily high level of currency in circulation, which is currently Rs 7.795 trillion that supports the writer’s viewpoint.
Predicting inflation is extremely difficult. Weather, supply chain and geo political conditions are unforeseeable. Government and private sector spending policies, external funding/inflows, remittances, exports, trade gap, balance of payment position, international oil and commodity/food prices, domestic crop position, exchange rate, budget and IMF and donors response will all matter most.
It is difficult to walk on a thin line. Hence, on average it could range between 15-22%.
Conditions are not conducive. The economy desperately needs the IMF and other donors’ stimulus packages on a regular basis. Whereas, keeping in view the international borrowers pattern and target given to them to obtain funding, the trend suggests that based on inflation, lenders could demand further sharp hikes of policy rate by somewhere between 200 and 400 basis point.
USD/PKR @ 226.43
It is expected that once the IMF gives a verbal nod some adjustment is possible that should help to narrow the gap between interbank and parallel market rate. In such a situation, the ailing Rupee should get some breathing space.
Do watch for the inflows, which should give confidence to the market. To bring some stability, SBP forex reserves should touch $ 8-10 billion mark. Market will get jittery and nervous if SBP forex reserves plunge below $ 3.5 billion.
It is hard to make a call, with SBP forex reserves already hovering around $ 5.82 billion, as factors such as oil and trade gap/ balance of payment will be the key to determining the next direction. Volatile conditions will prevail until the delay and lack of clarity about talks with the IMF.
During this period, the market should not be surprised if PKR trades in a wide range between 2% -10%. With delay or IMF agreeing to fund, both side moves are a good possibility. In the short to medium term, speculators should consider winding their position.
However, since it’s a quarterly IMF target agreed and set by the previous government, market players should keep in mind that it’s not a one-time issue that will be resolved. To get funding regularly, the economy is required to meet all its targets in an agreed time-frame. Or, will have to obtain a waiver for smooth inflows.
Indeed, widening the gap between interbank and parallel market rate is not helping. But in recent times, comparatively fewer Pakistanis got job opportunities abroad. Pakistan is heavily dependent on remittances; the government will have to come up with a planned strategy to send highly skilled workers on a regular basis by setting up technical training centers in major cities.
With 1.4 billion people, India tops the list of migrants and could end up with $ 100 billion remittances. But Bangladesh, which has a population of 166.3 million, overtook Pakistani migrants in numbers. A drop in remittances could be temporary and with some more extra SPB efforts in coordination with fiscal authorities, they can come up with a better strategy along with some sort of incentive that could once again help to push the inflows higher to new highs.
Despite the above facts, on an average basis, with a population of 230 billion, Pakistan still leads the list of top receivers of funds from overseas Pakistanis and is expected to close around $ 30 billion, as remittances are likely to pick up in the last quarter of FY23.
Pakistan is currently faced with incredibly high systemic financial risk. In simple terms, the probability has arisen because of insufficient liquid assets or cash squeeze that hinders paying back the borrowed money.
Hence, there is a probability that a crisis can be triggered. On an average, Pakistan roughly requires $ 35 billion for its annual funding that will gradually inch up every year due to higher borrowing cost, as global interest rates have risen sharply.
The reason is obvious: in recent years, successive governments kept on concentrating on micro level issues and were either too slow or complacent to address the core problem. Over the years the economic managers did not comprehend the possible impact of surging debt and its servicing ratios.
The economy had never generated enough income to meet the expenses, as focus remained on micromanagement, while the country was faced with bigger challenges. Hence, economic conditions deteriorated.
Private sector credit expansion has reached extremely low levels. Further, due to depreciation of rupee when converting PKR into USD, it is almost half the value of what it was a few years ago, whereas, global prices of goods/commodity skyrocketed due to inflation. Same applies to agriculture sector lending.
Banks’ advance/deposit ratio of 48.40% versus 77% plus global average is the real cause of misery, which was/is never addressed. IMF’s insistence to increase tax collection and simultaneously asking to reduce deficit and ask banks to invest in government securities instead of increasing the size of bank credit constitute the real cause of liquidity constraints and increase in domestic debt.
The question is why on its list of priorities and conditionality the IMF does not put a condition and insist to attain, tax to GDP ratio target of 15% and to 20% in the next 5 years’ Why are they so friendly on this issue?
Currency in circulation is Rs 7.795 trillion. It is a clear indication of tax evasion and undocumented economy, which remains unchecked for decades. The figure also confirms a very high level of corruption. Taxing all the income will prove to be a blessing for the economy.
Economic burden (estimated)
SBP FX Reserves $ 5.82 Billion (very low)
External Debt $ 115.23 Billion (Risk of sharp increase)
Int’l Reserves/Foreign Currency Liquidity (Derivatives) $ 4.17 Billion (worrying)
Domestic Debt Rs 33.18 Trillion (hinders bank lending)
Currency in Circulation Rs 7.79 Trillion (Exceptionally high due to tax evasion & undocumented economy)
Open Market Operation (OMO-injection) Rs 5.18 Trillion (liquidity comfort zone)
Circular Debt Rs 4.2 Trillion (need to be funded)
Unfunded Debt Rs 3.11 Trillion (exposed)
Tax-to-GDP hovers around 10% or below (tax all income)
Net government sector borrowings Rs 19.62 Trillion (stock- discourages bank lending)
Credit to private sector Rs 9.24 Trillion (stock-extremely low-reason for low industrial & manufacturing sector growth)
Copyright Business Recorder, 2023
(The writer is former Country Treasurer of Chase Manhattan Bank. The views expressed in this article are not necessarily those of the newspaper)
He tweets @asadcmka
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