Forecasting a 3-4 percent GDP growth with higher inflation outlook for this fiscal year (FY20), the State Bank of Pakistan has said that though early signs of recovery are already visible, the real GDP growth is likely to remain subdued.
According to the SBP's Annual Report on the State of Pakistan's Economy for the fiscal year 2018-19 issued on Monday, macroeconomic stabilization will continue to be the cornerstone of economic policies during FY20 and development spending may play a pivotal role, since there has been an observed tendency that Pakistan's GDP growth and Public Sector Development Program (PSDP) spending move in the same direction, and similar has been the case in FY19.
"The government has allocated a greater outlay for PSDP during the year compared to the actual spending in FY19. In addition, an improvement in market sentiments vis-à-vis the IMF program, a better performance of agriculture sector compared to last year and further improvement in the current account balance, may also improve the final outcome," the report said.
SBP mentioned that though real GDP growth picked up during FY17 and FY18, the sharp downturn in FY19 highlighted the fact that the economic expansion in these years had not been based on a sustainable strategy and was susceptible to various stabilization measures, such as the cut in development expenditure. This has exposed the structural deficiencies faced by the economy yet again, requiring immediate policy attention. For example, a steadily rising tax to GDP ratio is imperative for fiscal sector sustainability.
Growth in real GDP decelerated to 3.3 percent in FY19, compared to 5.5 percent in FY18 and all the sectors of the economy contributed towards this lacklustre performance, the major drag came from the commodity-producing sector. The slowdown was broadly attributed to contractionary economic policies and inflationary pressures in the aftermath of exchange rate depreciation.
SBP has urged domestic investors to tap underserved markets and segments as it is especially encouraging that proactive, technology-driven domestic startups have already ushered in a positive disruption in industries ranging from banking (fintechs) to transportation (ride hailing apps) and consumer goods and food (delivery app).
"Such examples may inspire those investors who have been sitting on the fence for some time now to abandon the "wait and see" mode and take positions sooner rather than later. In the grand scheme of things, a collective shift in sentiment and more optimism could prove to be a much needed catalyst for the revival of economic activities," SBP said.
The report said that inflation, meanwhile, is expected to exceed its annual projection by the Planning Commission of Pakistan for FY20 and may be 11-12 percent by end of FY20 as against the target of 8.5 percent. While, demand pressures have generally subsided, cost-related impact may be more pronounced in the first half of the fiscal year, taking the cue from oneoff adjustment in prices of utilities and other FY20 budget-related measures.
By the second half, further supported by the end of deficit monetization by the government, price pressures may begin to recede, setting the tone for considerably lower inflation in FY21.
However, SBP has warned that cross border tensions, which have flared up intermittently since Q3-FY19 and worsened during Q1-FY20, represent an upside risk to this outlook, given their tendency to drive up food inflation. At the same time, the global slowdown may pose a downside risk to the outlook, especially if international oil prices fall more sharply than anticipated.
According to SBP, the external sector's outlook is positive on the whole, albeit being subject to both upside and downside risks. The current account deficit, after shrinking on YoY basis during FY19, is anticipated to subside further 2.5-3.5 percent of GDP in FY20 compared to 4.8 percent in FY19.
The FTA-II with China and preferential trade agreement with Indonesia may also give a boost to exports and exports are projected to pick up during the year, conditional on demand conditions among the country's major trading partners and buoyancy in commodity markets. In particular, the onset of fiscal stimulus and successful resolution of trade negotiations involving major economies would be instrumental in supporting global consumer demand, which would in turn bode well for exporting partners, including Pakistan, along with improved prospects of foreign investments.
On the other side, decline in imports would be instrumental in improving the current account as the policy induced import compression would continue on top of subdued prices, barring any adverse shock from international oil prices.
Moreover, workers' remittances are expected to remain robust in FY20 on the back of measures taken and incentives given to overseas Pakistanis remitting under the Pakistan Remittance Initiative (PRI). SBP estimated home remittances amounted up to $25.6 billion for this fiscal year compared to $21.8 billion in last fiscal year.
SBP said that the outlook for the fiscal sector, by contrast, is not straightforward and fiscal deficit may be 6.5-7.5 percent of GDP by end of FY20 down from 8.9 percent in FY19. However, the government is expected to make a concerted effort to meet the IMF's quarterly targets, implying a measure of fiscal discipline.
The FY20 budget looks to fix the deficiencies of the tax system and represents an earnest effort to increase documentation. It envisages a sizeable reduction in the deficit, by enhancing revenues and squeezing expenditures. However, SBP mentioned that achieving the ambitious tax collection target in the middle of a broader economic slowdown may present a challenge.
Indeed more concerted efforts are needed to improve the tax system; beyond the federal level, provinces should also aim at enhancing their own revenue base, it suggested.
The economy rebalances and there is reduced demand in some sectors, however new opportunities for private sector are simultaneously opening up in other areas. For example, imports of many consumer items and finished goods are shrinking due to a combination of regulatory duties and exchange rate depreciation. This generates an opportunity for domestic companies to step in and fill in this demand in the short to medium-term, SBP said.
Moreover, alignment of the exchange rate represents improved prospects for export-oriented enterprises and the government's commitment to foster the ease of doing business and pursue investor-friendly policies is also welcome, the report said.
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