Growth acceleration for Pakistan will depend on the implementation of structural reforms in energy and taxation, and implementation of the China Pakistan Economic Corridor (CPEC), says the World Bank (WB). The WB report "Pakistan Development Update", launched on Thursday, projected that Pakistan's Gross Domestic Product (GDP) growth will accelerate to 5 percent in fiscal year 2017 and 5.4 percent in fiscal year 2018. There is a need to continue efforts to strengthen and diversify the financial sector and improve its governance and transparency, according to the report.
The gradual growth trend is underpinned by increased public investment through CPEC. If CPEC is not implemented as expected in fiscal year 2017, this will reduce the growth outlook. Failure to follow through with the fiscal consolidation agenda would also affect growth in a number of ways. Reduced fiscal space may reduce public investment and the resultant increase in government borrowing may crowd out private investment, as witnessed in the recent past, the WB report added.
It further states that slippages in fiscal consolidation would undermine confidence in the reform momentum and Pakistan's ability to absorb future shocks. External and internal balances could be affected by large increases in oil prices and Pakistan's external and fiscal balances continue to benefit from low global oil prices, but a sudden increase in oil prices could disrupt this stability. On the other hand, low oil prices will curtail public spending in GCC economies, which are a key source of remittances for Pakistani foreign workers. This would reduce remittances growth and widen the current account deficit.
According to the WB report, the European Union (EU) is a major and growing market for Pakistan's exports, accounting for 30.8 percent, of which the UK's share was 7.4 percent in FY16. An economic slowdown in the EU and the UK as a result of 'Brexit' would likely slow the demand for Pakistani exports, particularly textile exports. Also, a potential appreciation of the Pakistani Rupee against the British Pound and Euro would increase the price of Pakistan's exports, thereby reducing their competitiveness.
Pakistan's growth is expected to continue to accelerate, reaching 5 percent in fiscal year 2017 and 5.4 percent in fiscal year 2018. On the demand side, growth is expected to be primarily driven by public and private consumption, supported somewhat by a moderate increase in investment. Pakistan's low investment to GDP ratio is expected to increase due to infrastructure projects under CPEC and other public investment. These projects, if delivered on schedule, are expected to accelerate growth in the domestic construction industry and expand electricity generation. Improved electricity availability would, in turn, support growth in the industry and services sectors.
On the supply side, the services sector, which comprises more than half of the economy, is expected to be the primary source of growth. The sector is expected to grow by 5.6 percent in fiscal year 2017. After a lean performance in fiscal year 2016, the agriculture sector is expected to recover sufficiently to grow at 2.7 percent in fiscal year 2017, while the industrial sector is forecast to grow at 5.7 percent.
The report further states that current account deficit is expected to widen from 1.1 percent of GDP in fiscal year 2016 to 1.7 percent in 2017. The key contributor to this will be a widening of the trade deficit due to moderate growth in exports (because of weak global demand and appreciation of the real exchange rate) and likely higher growth in imports (due to increased economic activity and a marginal rise in international oil prices). However, ongoing remittance inflows will support the current account. It is also expected that FDI flows will strengthen due to the accelerated implementation of CPEC projects. Therefore, like previous years, foreign exchange reserves are projected to increase.
The fiscal deficit is projected at 4.2 percent in fiscal year 2017, 0.4 percentage point lower than the revised estimates of 2016, which already represented the lowest deficit in nine years. This decline in consolidated fiscal deficit is primarily driven by an increase in government tax revenues and a further rationalisation of government current expenditures including subsidies. The provinces are also expected to supply a small surplus to support this effort. Federal and provincial governments are, however, expected to continue increasing their development expenditures. Inflation is expected to rise moderately and has already bottomed out. Projected increases in economic activity and an expected marginal rise in global oil prices will push up domestic prices. Inflation is projected to grow from 2.9 percent in fiscal year 2016 to 4.6 percent in fiscal year 2017 and 5 percent in 2018.
Energy reforms have reduced load shedding, losses and subsidies but delays in the privatization of distribution companies may affect the sustainability of these results, says the WB, adding that energy subsidies and the accumulation of arrears in the energy sector pose fiscal costs and risks, while insufficient amounts of energy limit the ability of the economy to prosper.
Delays in the sale of three of the best-performing distribution companies in Faisalabad, Lahore and Islamabad, and the government's preference to sell shares through Initial Public Offerings (IPOs), means that a different approach will have to be adopted. Investment in distribution to reduce technical losses and improve metering, billing and collection is badly needed and is now likely to fall on the public purse. Pakistan is also implementing a far reaching reform of its financial sector.
Several weaknesses in basic financial sector infrastructure and in the legal and judicial framework have constrained lending to the private sector, including the absence of an appropriate insolvency framework; deficiencies in credit information; the lack of a secured transactions framework and electronic collateral registry for moveable collateral; and difficulties in enforcing collateral outside of the judicial system.
The provinces' contribution to tax revenues remains limited, with several taxes under the responsibility of the provinces (agricultural income tax, urban property taxes) significantly underperforming. Improved co-ordination between the federal government and the provinces (and among provinces) will be necessary to deal with double taxation and increasing tax compliance costs.
Despite strong growth, private investment in the South Asia region remains relatively low. Pakistan's export performance has also been poor over the past few years, caused by both a weak external environment and significant supply-side constraints that affect the country's competitiveness. Pakistan's much lower rate of investment is driven by its volatile security situation, energy shortages and poor business regulatory environment. The implementation of the federal and provincial governments' joint action plan to improve the investment climate will be one important step towards reversing this long-term trend.
Exports continued to fall highlighting Pakistan's worrying decline in export competitiveness; 2016 saw the continuation of a longstanding decline in Pakistan's share in global trade. This trend is a combined reflection of Pakistan's weakening export competitiveness and soft global demand in key sectors. Food and textiles, in particular, are key contributors to Pakistan's exports and continue to suffer from a decline in international prices and demand. More generally, Pakistan's decline in competitiveness has been driven by poor trade facilitation, infrastructure gaps, inefficient logistics and a poor investment climate. Pakistan has also lagged behind its competitors in trade openness, reducing its prospects of regaining export momentum.
The government's next challenge will be to invest in health, education and nutrition; Pakistan's staggering fall in poverty over the last 14 years has not been accompanied by a similar improvement in wellbeing. The government recently set a new national poverty line that identifies 29.5 percent of Pakistanis as poor. By back casting this line, the poverty rate in fiscal year 2002 would have been about 64.3 percent. This means that poverty has more than halved between 2002 and 2014, even according to this new and higher metric. The new poverty line was introduced in April 2016 precisely because of Pakistan's success in reducing poverty over the last decade and a half. Using the old national poverty line, set in 2001, the percentage of people living in poverty fell from 34.7 percent in 2002 to 9.3 percent in fiscal year 2014-a fall of more than 75 percent.
Since fiscal year 2010, Pakistan has seen little progress across a number of key human development indicators. Literacy has remained between 58 and 60 percent since 2010.
Stunting remains very high and the related problems of water quality and poor sanitation are either failing to improve or worsening. These disadvantages are far more concentrated in rural areas than in urban areas, and vary widely between provinces. Malnutrition is a particular concern, with Pakistan experiencing the third highest stunting rate in the world at 43.7 percent.
"Pakistan continues to make good progress in restoring macroeconomic stability. Building on this Pakistan needs to push forward with deeper structural reforms that spread benefits more widely, and the World Bank stands ready to support the reforms agenda," said Illango Patchamuthu, World Bank Country Director for Pakistan.