Problem with IMF projections

An IMF delegation has probably arrived in Pakistan to conduct a ‘stock-taking’ as indicated by the Finance Minister. This is, therefore, the appropriate time for comments on the IMF Staff Report of September, 10, 2024, on the new Extended Fund Facility of the IMF to Pakistan. This programme is for 37 months and the total disbursement of the loan by the IMF is expected to be $7 billion.

The Staff Report contains an assessment of the current economic situation in Pakistan along with medium-term projections of the key macroeconomic indicators. The report also projects the external financing requirements of Pakistan up to 2027-28 and identifies how these can be fulfilled.

Further, from the viewpoint of successful implementation of the Programme, the Staff Report contains quarterly performance criteria, indicative targets and structural benchmarks for 2024-25. Attainment of these will signify successful performance by Pakistan and enable continuation of the Programme.

The objective of this article is to present an assessment of the macroeconomic projections in the IMF Staff Report.

We first look at the IMF assessment of the growth of the economy in 2024-25. The GDP growth rate is expected to rise from 2.4 percent in 2023-24 to 3.2 percent in 2024-25, and further to 4 percent in 2025-26 and to 4.1 percent in 2026-27.

The basic problem is that the sources of growth have not been identified. This would have required estimates of growth rates by sector and/or by components of expenditure. Consequently, the growth rate projections appear to be very subjective in character.

Current indications are that achievement of the GDP growth rate of 3.2 percent 2024-25 may not be possible. First, there is a ‘high base’ effect of the 17 percent growth in major crops in 2023-24. Already, it is clear that there has been a big decline in cotton output this year of over 21 percent and only a marginal increase in rice production. Further, wheat cultivation may decline in the absence of a proper procurement price.

Production in the large-manufacturing sector is continuing to show a lack of buoyancy. In fact, in the first two months of 2024-25 the Quantum Index of Manufacturing has fallen by 0.2 percent.

Overall, it is unlikely that the IMF-projected GDP growth rate of 3.2 percent will be achieved in 2024-25. Already, the World Bank has lowered its growth expectation for the economy of Pakistan to 2.6 percent in 2024-25.

The IMF Staff Report also expects a strong revival of the level of investment in Pakistan. The level of gross capital formation is projected to rise from 13.1 percent of the GDP in 2023-24 to 13.6 percent of the GDP in 2024-25 and to a peak level of 15.7 percent of the GDP by 2026-27. Presumably, this reflects the potentially favourable impact of successful implementation of the Programme over the next three years.

The first problem is that IMF staff projection includes in the gross capital formation the change in the level of inventories of 1.7 percent of the GDP. Therefore, the projected level of gross capital formation in 2024-25 is 11.9 percent of the GDP and not 13.6 percent of the GDP.

There is need to acknowledge that there has been a big investment slump in Pakistan in recent years, both of private and public investment. The level of investment in Pakistan as a percentage of the GDP has been at a historically low level. Private investment has floundered because of the poor state of the economy, very high interest rates, a quantum jump in energy costs and in capital costs due to rupee depreciation. Public investment has floundered due to the diversion of revenues to cover the big increase in the debt servicing burden.

Initial indications about investment prospects are not very promising. Bank credit to the private sector has expanded by only 4.6 percent up to the end of October. For the year as a whole the IMF Staff projection requires a growth rate of at least 10 percent. The recent drop in interest rates may help somewhat.

The level of government investment is projected in the IMF Staff Report to rise sharply in nominal terms by almost 39 percent. During the first quarter of 2024-25 there has actually been a drop in the level of development expenditure by the federal and the provincial governments combined of 2 percent. The decline will persist and may even become bigger in the presence of a large shortfall in FBR revenues in 2024-25.

Therefore, the IMF Staff projections of the level of investment in Pakistan in 2024-25 are optimistic. Also, a rise to above 15 percent of the GDP in 2025-26 is possible only if there is a quantum decline in interest rates and access to bank credit improves substantially for the private sector.

The next set of estimates relates to the rate of unemployment in Pakistan from FY 2022-23 to FY 2024-25. Believe it or not, the IMF projection in Table 1 of the Staff Report is that the overall rate of unemployment in Pakistan will decline from 8.0 percent in 2023-24 to 7.5 percent in 2024-25. Earlier, it is reported that the unemployment rate fell from 8.5 percent in 2022-23 to 8.0 percent in 2023-24.

The IMF staff report not only indicates that the unemployment rate is lower than expected but that is declining. For example, the estimation is that the unemployment rate fell in 2023-24, despite a very low GDP growth rate of 2.4 percent. Such labour-intensive growth in Pakistan would be truly exceptional among developing countries.

A careful exercise based on historical sectoral employment–to-growth elasticities reveals that there is likely to have been an increase in the number of employed workers of just under 1 million in 2023-24. However, the labour force expanded during the year by 1.7 million. Therefore, the unemployment rate is likely to have increased by 0.6 percentage points in 2023-24, rather than fall by 0.5 percentage points. It is estimated at over 10 percent in 2023-24.

Similarly, if a GDP growth rate of 3.2 percent is achieved in 2024-25, there will still be a small increase in the unemployment rate. A decline in the unemployment rate is only likely to happen in Pakistan when the GDP growth rate exceeds 4 percent.

Turning next to the projected rate of inflation the IMF Staff Report expects it to be 9.5 percent in 2024-25 and fall further to 6.5 percent by 2026-27. This is in comparison to the inflation rate in 2023-24 of 23.2 percent. However, there was a precipitous fall in the rate of inflation in the last quarter of 2023-24 to 13.7 percent.

The return to single-digit inflation in 2024-25 will, of course, be welcome. Already, in the first four months, the rate of inflation has fallen to 8.7 percent. Sustaining the single-digit rate will require, first, continued stability in the nominal exchange rate. However, the IMF Staff expects the rupee to depreciate by almost 8 percent in 2024-25.

Second, the fall in agricultural output, especially of wheat, could lead to a return to higher food prices. Third, the issue is the likely rate of escalation in electricity and gas tariffs in the second half of 2024-25. Fourth, any resort to indirect taxation in a forthcoming mini-budget will raise prices.

Overall, the likelihood is that the rate of inflation may remain at a double-digit rate, especially from February 2025 onwards when a ‘low base’ effect will lead to an upsurge in the rate of inflation. As such, the IMF Staff projection of a 9.4 percent rate of inflation in 2024-25 may be somewhat on the low side.

Overall, there is the likelihood that in relation to the IMF Staff Report projections for 2024-25 of the GDP growth rate and the level of investment may be lower, while the level of unemployment and the rate of inflation are likely to be higher.

The next article will focus on the fiscal and balance of payments projections in the IMF Staff Report, as well as on the Programme targets for 2024-25.

Copyright Business Recorder, 2024