Growth has improved, but the government of Pakistan needs to address fiscal and external sector vulnerabilities that have reappeared with the wider current account deficit, falling foreign exchange reserves, rising debt obligations, and consequently greater external financing needs, says the Asian Development Bank (ADB).
“Political uncertainty heightened following the Supreme Court decision in August to disqualify for office the Prime Minister elected in 2013. Calm has returned, and his party will continue to lead the government until new Parliamentary elections due by the third quarter of 2018. Still, possible loss of momentum for making policy decisions may hamper growth prospects”, said ADB in its latest report “Asian Development Outlook 2017”.
GDP Growth & Inflation
The report states that GDP growth is expected to accelerate to 5.5 percent. Rising domestic demand fueled by economic expansion is expected to stoke inflation during fiscal year 2018.
However, the ADO 2017 projection for 4.8% inflation could stand with continued central bank policy vigilance, a muted increase in global oil prices and some expected easing of global food prices. The general government budget for fiscal year 2018 sets the target deficit at 4.1% of GDP, significantly narrower than the 5.8% of GDP deficit of a year earlier.
Govt Financing & Deficit
The federal budget for fiscal year 2018 assumes two-thirds of deficit financing will come from domestic bank and non-bank sources with no borrowing from the central bank. Achieving such a large reduction in the general government budget deficit and this ambitious financing target appears to be very difficult, but a continued large deficit would again require very substantial foreign financing.
There was a significant increase in government borrowing from the central bank in fiscal year 2017 to retire debt from commercial banks and non-bank sources such as Pakistan Investment Bonds.
The report states that government borrowing from the central bank helped increase commercial bank liquidity and extension of credit to the private sector, but further large borrowing risks could create inflationary pressure.
Accordingly, the central bank needs to vigilantly shape monetary policy to emerging circumstances in fiscal year 2018.
The current account deficit is expected to remain high in fiscal year 2018, projected at 4.2% of GDP, with rising imports, declining remittances, and stagnant exports.
Tax Collection & Revenues
An 18% increase in tax collection and larger non-tax revenues would boost total revenue to 17.2% of GDP. Further rationalization of current expenditure to the equivalent of 15% of GDP is envisioned to support a projected expansion in capital expenditures.
Total expenditures are projected at 21.3% of GDP, reflecting an increase of 18% on significantly higher budgetary allocations for development.
The Bank report states that development expenditures are forecast to reach 6.3% of GDP after public sector development program allocations increased by half in fiscal year 2017, the year before election.
Notable areas for allocations are security, road transport, aid for less-developed areas and internally displaced people, health, and education.
Imports are expected to continue to increase as growth spurs domestic demand that domestic production cannot meet. July 2017 imports were, though 8% less than the peak in June – 50.9% higher year over year. Petroleum accounted for a quarter of the increase, while imports doubled for power generation machinery and construction, much of it apparently related to the CPEC.
Trade & Current Account Deficit
A key challenge will be to finance Pakistan’s burgeoning trade deficit as remittance inflows, however substantial, continue to fall.
The share of exports in GDP nearly halved from 13% in fiscal year 2006 to a dismal 7.1% in fiscal year 2017. Exports fell annually by 2.5% on average from fiscal year 2013 to fiscal year 2017 due to lack of competitiveness and bad conditions for modernizing investment, leaving persistently low value addition to fetch low unit prices.
The continued large trade and current account deficits in July 2017 exceeded capital and financial account net inflows to create a gap that again was covered by drawing on foreign exchange reserves, which fell by $1.5 billion to $14.6 billion at the end of that month.
The capital and financial account surplus increased sharply by just over 40% to $10 billion in fiscal year 2017, mainly reflecting increased borrowing by the government, the private sector, and commercial banks as debt-free foreign direct investment stagnated from a year earlier at $2.3 billion.
With the current account deficit at $12.1 billion, the gap was financed by a $2 billion draw on official foreign reserves, which declined to $16.1 billion at the end of fiscal year 2017 but still provided 3.7 months of cover for imported goods and services.
External debt and liabilities have increased by an estimated $8.9 billion, with the government accounting for $4.8 billion of the rise, to bring Pakistan’s estimated external debt, excluding currency valuation adjustments, to $82.8 billion in June 2017, or 27.2% of GDP, up from 26.4% a year earlier.
Worker remittances have shown some unexpected improvement, however, in the first 2 months of fiscal year 2018, increasing by 13.2% from the same period in fiscal year 2017. If this rebound can be sustained for the rest of fiscal year 2018, it may ameliorate the projected deficit.
The authorities may need to consider rapid currency depreciation at some point to rein in import growth, or increase foreign borrowing to finance the external gap or to prevent an undue weakening of foreign exchange reserves.
Pakistani rupee remained largely stable in fiscal year 2017, buoyed by central bank open market operations, but depreciated by 0.6%, from Rs. 104.8, to the US dollar in June, to Rs. 105.4 in July.
In recent years, the currency has been on a rising trend in real effective exchange terms, eroding Pakistani competitiveness with appreciation by 3.6% in fiscal year 2017 on a widening inflation differential.
“Pakistan’s positive economic outlook shows its strong resilience, but the country needs to better protect itself against the emerging risks and works towards improving its competitiveness, revenue collection, energy supply, revitalizing public sector enterprises, and leveraging greater public-private partnerships to maintain the growth momentum, boost infrastructure spending and improve overall service deliveries” said Xiaohong Yang, ADB’s Country Director for Pakistan.
In the near future, the government of Pakistan must carefully manage external debt, the balance of payments and their financing requirements, while instituting macroeconomic and structural reforms to support economic stability and expansion as well as to make Pakistan more competitive and for fiscal sustainability. This has become increasingly important given the increasing government and CPEC-related repayment obligations.