The World Economic Outlook issue of April 2023 by the IMF contains detailed macroeconomic [AN1] projections at the individual country level from 2022-23 to 2027-28. The objective of this article is to analyze the projections for 2023-24. An earlier article had reviewed the IMF projections for 2022-23. The principal finding was that the GDP growth rate and the rate of inflation estimates were somewhat on the optimistic side.
The IMF projections for the next three years are of importance because of the likelihood that given the extremely fragile financial situation, Pakistan will need the umbrella of another IMF Extended Fund Facility to be able to attract enough new funding to be able to honour its external debt repayment obligations.
The focus here is on the IMF projections for 2023-24. At this stage, given the considerable uncertainty about the prospects for the world economy and even more so for the economy of Pakistan, it is difficult to make projections beyond the next year. IMF projections after 2023-24 must be seen as generally an extrapolation of trends.
However, if Pakistan goes for another IMF programme, then three-year projections from 2023-24 to 2025-26 assume importance. These projections will determine the magnitude of the performance criteria, indicative targets and structural benchmarks in a future programme.
The first key projection by the IMF for 2023-24 is of the GDP growth rate at 3.5%. This is predicated partly on a low base effect of near zero or even negative growth rate in 2022-23. The agricultural sector which was badly hit by the floods should show some significant recovery, especially in the case of output of cotton and rice.
The concern relates to the prospects for growth in the large-scale manufacturing sector. Already, in February 2023, the QIM has shown a big decline of 11.5% and cumulatively from July 2022 to February 2023 the fall has been 5.5%. One of the major factors contributing to this debacle has been the severe constraint imposed on the import of raw materials and industrial inputs so as to strongly restrict the size of the current account deficit. Further, big declines are also likely to be observed in the construction, transport and wholesale and retail trade sectors.
The fundamental question is whether there will be some revival in these sectors, especially by industry. The foreign exchange reserves remain currently at a precariously low level of $4.4 billion, enough to provide import cover for only one month. Therefore, unless the reserves’ position improves significantly by end-June 2023, there will continue to be need to strongly curtail imports and the manufacturing sector will not have the space for significant positive growth.
Therefore, at this point it is difficult to accept the GDP growth rate projection of 3.5% for 2023-24. It may be significantly lower.
Turning to the rate of inflation projection for 2023-24, the IMF expects it to fall significantly to 21.9% from 27.1% in 2022-23. The latter estimate is already understated and the year, 2022-23, is likely to close with an average rate of inflation of above 29%. Further, one of the critical determinants of the rate of inflation is the extent of depreciation in the value of rupee over the year. This is likely to be close to 38% in 2022-23. Unless there is a significant build-up of foreign exchange reserves early in 2023-24, there will be the same or even greater pressure on the rupee.
Fortunately, there is one positive factor. Given the slowdown in the global economy and trade, the IMF rightly expects that international commodity prices will fall significantly in 2023-24. Overall, considering both the negative and positive factors, it is likely that the rate of inflation will be close to 25%, somewhat higher than the IMF projection of almost 22%.
The two critical projections with regard to a future IMF programme are the size of the budget deficit and the current account deficit, respectively. Here we see a truly startling projection of the former by the IMF in 2023-24. The IMF projects that the budget deficit will rise exponentially from 6.8% of the GDP to the extraordinarily high level of 8.3% of the GDP in 2023-24. However, the primary deficit is likely to remain at 0.5% of the GDP in 2023-24.
The implication is that there will be a quantum jump in the magnitude of debt servicing. The IMF projects it to increase from Rs 5407 billion in 2022-23 to as much as Rs 8557 billion in 2023-24, an unbelievable increase of over 58% in one year. This clearly implies that the IMF expects the SBP policy rate to remain at a very high level of 21% or even more.
The rise in interest rates is leading to a fundamental worsening in the budgetary position of the federal government. From 2021-22 to 2023-24, the level of debt servicing is likely to rise cumulatively by a massive 176%. This has never happened before and if the projection of a budget deficit of 8.3% of the GDP actually materializes then this will be the largest ever deficit.
There is need also to realize that such a large deficit will be inevitable even if the IMF projection of a high 30% growth in revenues is achieved, which is also unlikely if the import tax base remains restricted. If the extremely high level of interest rates continues in the presence of high inflation, then Pakistan is entering a period of very high budget deficits. Fortunately, the IMF expects that the budget deficit will fall to 7.1% in 2024-25, implying some moderation in interest rates.
There are a number of negative implications of the colossal rise in the size of the budget deficit by 54% in 2023-24. There will inevitably be a, more or less, complete ‘crowding out’ of the access of the private sector to bank credit. Also, since bulk of the deficit financing will be through domestic borrowing, this will lead to an acceleration in rate of expansion of money supply and put greater pressure on the price level. It is not clear if the IMF has factored this in the rate of inflation projection for 2023-24. Also, the huge budget deficit will inevitably put pressure on the current account deficit.
We come now to the projection of the current account position in 2023-24 by the IMF. The current account deficit is expected to be 2.4% of the GDP, close to 2.3% of the GDP this year.
One favourable factor is that with the slowdown in the world economy, the growth rate of world trade could be less than 3% and the all-commodity international price index in dollars could fall significantly. This will facilitate imports and physical measures to restrict imports will be needed less. Consequently, the IMF expects that there will be an almost 10% increase in the volume of imports in 2023-24, as compared to a contraction of 20.8% in 2022-23.
However, the big problem is the IMF projection of the level of exports in 2023-24. Exports of goods are expected to show a handsome growth of 18.3%, compared to a fall of 6.5% in 2022-23. The problem is that with falling international prices and continuing high domestic inflation, exports from Pakistan are likely to become increasingly less competitive in international markets.
The fundamental question is whether the IMF is anticipating substantial continuing devaluation of the rupee in 2023-24 to sustain the export competitiveness? If so, then the rate of inflation projection will be significantly on the low side.
Also, a 2.4% current account deficit, equivalent of almost $8 billion may not be sustainable in light of the difficulties in meeting the external financing requirements in 2023-24. It may have to be pitched lower and achieved through even more intensive resort to the instruments of monetary and fiscal policies.
Overall, the projections by the IMF of the GDP growth rate, rate of inflation and current account deficit in 2023-23 appear to be somewhat optimistic. However, the anticipated size of the budget deficit at 8.3% of the GDP is extremely large and unprecedented.
Copyright Business Recorder, 2023