ADB projects slower growth, higher inflation

Inflation will rise to 7.5 percent and the GDP growth rate will further decelerate to 3.9 percent in FY 2019, with macroeconomic challenges continuing despite steps to tighten fiscal and monetary policies to rein in high and unsustainable twin deficits. This was stated in the Asian Development Bank's latest report titled "Asian Development Outlook 2019, Strengthening Disaster Resilience" arguing that growth decelerated in fiscal year 2018 despite revived agriculture. The expansionary fiscal policy markedly widened the budget and current account deficits and drained foreign exchange.
"Until macroeconomic imbalances are alleviated, the outlook is for slower growth, higher inflation, pressure on the currency, and heavy external financing needed to maintain even a minimal cushion of foreign exchange reserves. Recurrent crises in the balance of payments require that firms become more export competitive," the report stated.
Pakistan's outlook is for a sharp drop in growth as, following a pronounced widening of its balance of payments deficit in 2018, it likely embarks on austerity measures supported by the International Monetary Fund (IMF).
To meet its large financing needs, the government is discussing a macroeconomic stabilization program with the IMF in addition to arranging financial assistance and oil credit facilities from bilateral sources.
Continued fiscal consolidation in fiscal year 2020 will keep growth subdued at 3.6 percent. The supply side is already showing signs of slowdown. Agriculture is expected to under-perform the 3.8 percent growth target for fiscal year 2019 after water shortages struck as wet season crops were being sown.
Large-scale manufacturing reversed 6.6 percent growth in the first half of fiscal year 2018 to decline by 1.5 percent in the same period of fiscal year 2019 as domestic demand contracted and rising world prices crimped demand for raw materials.
The report further argues that contraction hit all key categories, including a 0.2 percent decline in textiles. A slowdown in agriculture and industry as domestic demand shrinks will keep growth in services subdued. A government structural reform package announced in January 2019 is expected to support agriculture, facilitate new business openings, and continue to expand capacity in some industries to the forecast horizon.
Stabilization policies and rising inflation are likely to contain growth in private consumption and investment, while public sector development spending has already slackened. With exchange rate flexibility and declining imports, net exports are expected to contribute to growth.
Average inflation accelerated sharply from 3.8 percent in the first 8 months of fiscal year 2018 to 6.5 percent in the same period of fiscal year 2019, led by a surge in nonfood inflation to 9.1 percent that reflected currency depreciation and a significant increase in gas tariffs for consumers and industry in the first half of the year. Food inflation remains relatively moderate at 2.6 percent thanks to sufficient stocks of food staples. In response to intensifying inflationary pressures, the central bank gradually raised, in four rounds from July 2018 to January 2019, its policy rate by 375 basis points to 10.25 percent.
Despite tighter monetary policy and lower international oil prices, inflation is expected to rise sharply to average 7.5 percent in fiscal year 2019, driven up by continued heavy government borrowing from the central bank, hikes to domestic gas and electricity tariffs, further increases in regulatory duties on luxury imports, and the lagged impact of currency depreciation by more than 10.7 percent since July 2018. Inflation will remain elevated at 7 percent in fiscal year 2020.
A supplementary consolidated government budget for fiscal year 2019, adopted in September 2018, envisages a decline in the budget deficit to 5.1 percent of GDP in fiscal year 2019, mainly by cutting the development expenditure excluding CPEC projects, but including measures to enhance revenue and extend relief to the poor. Growth in tax collection weakened from a robust 16.4 percent in the first half of fiscal year fiscal year 2018 to only 2.7 percent a year later.
The Federal Board of Revenue targets tax collection equal to only 11.6 percent of GDP in fiscal year 2019 taking into account reduced sales taxes on major petroleum products, drag on the collection of withholding tax from contracts, contraction in general sales tax revenue as imports slow, and the overall slowdown in the economy.
Including non-tax revenue, total revenue declined by nearly 2.4 percent in the first half of fiscal year 2019. Budget expenditure increased by 5.5 percent in the first half of fiscal year 2019 over the same period a year earlier as current spending rose for interest payments and defense. Lower revenue collection and higher current expenditure pushed the budget deficit from the equivalent of 2.3 percent of GDP in the first half of fiscal year 2018 to 2.7 percent a year later.
This situation will make it a challenge for the government to achieve the reduction in the budget deficit it targets for fiscal year 2019. A second supplementary budget, adopted on 6 March 2019 without information on the projected deficit, focuses on an economic reform package envisaging incentives and measures to encourage investment and exports, enhance the ease of doing business, and strengthen export-oriented activities.
In the first 8 months of fiscal year 2019, the government borrowed more from the central bank and less from commercial banks, freeing up liquidity with which commercial banks boosted credit to the private sector by 18.9 percent over the same period of fiscal year 2018.
This sharply increased net domestic assets and nearly doubled broad money growth to 2.8 percent. The current account deficit is expected to ease in fiscal year 2019 but will remain high at the equivalent of 5 percent of GDP because of the large trade deficit. It will narrow further to 3 percent in fiscal year 2020 with easing macroeconomic pressures on the external accounts.
Export growth plunged from double digits in the first 7 months of fiscal year 2018 to 1.6 percent in the same period of fiscal year 2019. It is expected, however, to strengthen in the remaining months of this fiscal year and further in fiscal year 2020 as the lagged impact of currency depreciation kicks in, along with the incentive package for export-oriented industries announced in January 2019.
Imports fell by 0.8 percent in the first 7 months of fiscal year 2019 from the same period of fiscal year 2018, with imports other than oil 5.7 percent lower because of slower domestic economic activity, currency depreciation, and an increase in import duties for nonessential items.
Remittances are expected to revive-having already risen by 10 percent in the first 7 months of fiscal year 2019 over the same period of fiscal year 2018-as the Pakistan rupee depreciates further, economic activity in the Middle-eastern oil exporting countries (major destination of Pakistani migrants) holds broadly steady, and the government takes measures to facilitate remittances through official channels.
The government's diaspora bonds-issued in January 2019 with terms of 3 and 5 years and an attractive return of over 6 percent-aim to tap resources from overseas Pakistanis. Inflows that do not incur debt, such as foreign direct investment, are expected to be lower in fiscal year 2019 as several CPEC energy projects are near completion.
Financing a high current account deficit in fiscal year 2019 will require substantial borrowing, as in the first 7 months of the year, and use much of the bilateral lending support announced in the early months of 2019 to finance the deficit in the balance of payments. Foreign exchange reserves, depleted to $8.1 billion in February 2019, will likely remain stressed at the end of fiscal year 2019.
The report further states that Pakistan ranks 107 out of 140 economies on the Global Competitiveness Index 2018. It is classified as inhabiting the first stage of development among 35 factor-driven economies- that is, economies heavily reliant on unskilled labor and natural resources.
The country's persistently low score and ranking on the index is reflected in its companies' struggles to compete in international markets and in weak export opportunities, which spark recurring crises in the balance of payment.
Pakistan lags behind the South Asia regional average on most index indicators. Business competitiveness in Pakistan suffers under a challenging macroeconomic environment and adverse terms of trade, significantly eroding production and exports.
Pakistan's exports, such as they are, remain largely primary products whose lack of sophistication and diversification condemn them to declining shares in world markets. Agricultural commodities and textiles and other manufactures with little value added, comprise over 80% of exports. The high cost of doing business is a key factor limiting firms' ability to compete. Access to affordable capital is constrained by a shallow and underdeveloped capital market.
Manufacturing firms face high corporate tax rates, taxes on dividends and retained earnings, cascading taxes levied on inter corporate dividends, and a super tax levied on retained reserves. The effective corporate tax rate of up to 49% is significantly higher than taxes on international competitors. High custom duties on machinery imports raise the cost of investment, and high tariffs on raw materials and intermediate inputs erode the price competitiveness of both exporters and domestic industries facing stiff competition from imports. High tariffs and undependable electric power add to production costs.
Pakistan's cumbersome customs and clearance procedures and poor quality of logistics and infrastructure remain a constraint for the ability for just-in-time supply chain management. Investing in infrastructure and improving trade facilitation could boost participation in world markets, but the absence of industry-wide facilities to test and certify compliance would still leave many exporters disadvantaged.
The report further states that macroeconomic stability is needed to create an environment that inspires business confidence and is conducive to investment and trade. Facing twin deficits in fiscal and current accounts, the government has long been bedeviled by difficult policy choices that pit improved tax revenues against enhanced competitiveness.
Moreover, with anti-export bias in tax and exchange rate policies, and high government borrowing that crowds out private investment, firm competitiveness erodes, even though recent currency depreciation have supported exports, the report states.