With domestic energy tax hikes planned in October 2021 and increased oil and commodity prices, the World Bank forecasted that inflation will rise in FY22 before cooling down in FY23.
According to a national daily, World Bank stated in its report ‘Pakistan Development Update: Reviving Exports’ that headline consumer price inflation remained elevated – primarily due to high food inflation, which is likely to have disproportionately affected poorer households who spend a larger share of their income on food than on non-food items. Real interest rates were negative during FY21, thanks to the policy rate being at 7.0 percent. This aided the recovery.
GDP Growth & Inflation
The Bank explained that Pakistan’s real GDP growth (at factor cost) is estimated to have risen to 3.5 percent in FY21 from a decline of 0.5 percent in FY20, thanks to low base effects and recovering domestic demand, according to the research. Government consumption is expected to have increased, although at a slower rate than in FY20 when the COVID-19 fiscal stimulus package was implemented. Net exports, on the other hand, are expected to fall in FY21, since import growth nearly doubled that of exports due to strong domestic demand.
On the production side, industrial activity is expected to have rebounded after two years of contraction, thanks to large-scale manufacturing. Similarly, once lockdown measures were gradually relaxed, the services sector, which contributes for 60 percent of GDP, is predicted to have expanded. The agriculture sector, on the other hand, is likely to have slowed, partially due to a 30 percent drop in cotton production due to unfavorable weather conditions.
The report remarked that Inflation is expected to rise in FY22 as a result of domestic electricity price hikes, which were announced in October 2021, as well as rising oil and commodity prices, before moderating in FY23.
The World Bank report adds that on May 7, 2021, the Pakistani Rupee (PKR) hit well above a two-year high of PKR 152.2 versus the US dollar (USD). But due to global shifts that remain unspecified, the Rupee has shredded a lot of value as well, losing more than 10 percent value against the US dollar in just over five months to a record low of PKR 171.1 on October 14, 2021. The Rupee’s recent steep dip can be ascribed to a number of key global, regional, and Pakistan-specific occurrences, explained the report.
With a constructive monetary policy, record-high remittance inflows, and expectations of an expansionary fiscal policy set forth in the FY22 fiscal budget, imports increased in April-June 2021, coinciding with the reversal in the Rupee exchange rate’s trend. Total imports increased 85.8 percent year over year in August 2021, resulting in a monthly trade deficit of $4.0 billion, somewhat less than the previous high of $4.1 billion in June 2021.
The widening trade deficit, and hence the current account deficit, has increased demand for the dollar, causing the PKR to depreciate.
In the calendar year 2020, Pakistan’s goods exports to Afghanistan were valued at $870.5 million (4 percent of total goods exports). However, as a result of the Afghanistan conflict, supplies through the Pak-Afghan supply chain have plummeted, falling by nearly 40% year on year in July and August 2021. In contrast, the value of commodities imported from Afghanistan to Pakistan in August 2021 increased by almost 30% year over year. As a result of these changes, Pakistan’s dollar earnings have decreased and outflows of dollars have grown, contributing to the dollar’s scarcity in relation to the PKR.
Fiscal Reforms & Forecast
With greater economic growth and oil prices, the current account deficit is expected to widen to 2.5 percent of GDP in FY23. After tapering in FY22, exports are likely to rebound sharply as tariff reform initiatives gain pace, boosting export competitiveness. Furthermore, after benefiting from a COVID-19-induced transfer to formal channels in FY21, the increase of official remittance inflows is likely to slow.
According to the World Bank, fiscal and monetary tightening will resume in FY22, in accordance with the 25-basis-point policy rate hike in September 2021, as the government refocuses on moderating increasing external pressures and handling long-standing fiscal issues.
With the promulgation of major reforms, such as those targeted at sustaining macroeconomic stability, increasing competitiveness, and improving the financial viability of the energy sector, output growth is expected to moderate to 3.4 percent in FY22 before strengthening to 4.0 percent in FY23. Poverty is predicted to continue to decline, with a 4.0 percent unemployment rate by FY23.
World Bank expects the deficit (excluding grants) to remain high at 7.1 percent in FY22 and grow to 7.2 percent in FY23 despite fiscal efforts. The implementation of essential revenue-enhancing changes, particularly the harmonization of the General Sales Tax, would contribute to a gradual reduction in the deficit.
Major downside risks include delays or stalling of the IMF-EFF program, which would result in external financing difficulties; excessively high domestic demand, which would lead to unsustainable external pressures; more contagious COVID-19 strains, which would necessitate widespread lockdowns; and worsening regional and domestic security conditions, including those stemming from the situation in Afghanistan. All of these factors could cause crucial structural reforms to be postponed.