SBP's economic outlook

The latest Monetary Policy Statement of the SBP was released a few days ago. The Statement is positive in nature. Apparently, 'business confidence and the outlook for growth have improved'. This, it says, 'reflects the decline in COVID-19 cases in Pakistan and the easing of the lockdowns, as well as the timely stimulus provided by the Government and the SBP'.

Based on this relatively optimistic statement, the SBP expects GDP growth to recover to slightly above 2 percent in FY-21, after falling to -0.4 percent last year. The recovery is expected to be driven mainly by the manufacturing sector and construction. However, the SBP does highlight some downside risks, including a potential second wave of COVID-19 infections, a sharp increase in infections in the winter months in Pakistan's major export markets in Europe and the US and the threat to agriculture from locust attacks. On the upside, a faster global recovery could lift exports further.

One of the primary reasons for the relative optimism is the 5 percent growth achieved by the large-scale manufacturing sector in July 2020. But it needs to be recognized, first, that production was depressed in July 2019 with a fall of almost 6 percent. Second, the growth is concentrated in only a few industries. For example, the production of cigarettes has jumped up by 76 percent, accounting for one-fourth of the 5 percent growth. This is clearly unlikely to be sustained. If other industries with fast growth like wheat and grain milling, cement and medicines are included with cigarettes, they account for the entire growth of 5 percent in the large-scale manufacturing sector. The remaining 90 percent of the sector has shown zero growth.

There is need also to realize that the GDP growth rate in 2019-20 has, in fact, been overstated at -0.4 percent. There are three factors that have contributed to an even lower growth rate. First, the fall in the manufacturing sector was over 10 percent as compared to the 8 percent estimate by PBS for 2019-20. Second, the outputs of wheat and sugarcane are significantly lower than the estimates by PBS. The major crop sector is shown as having achieved a growth rate of 2 percent in 2019-20. It is actually closer to zero. Third, there is a consequential negative impact on the level of economic activity in the wholesale and retail trade sector of over 1.5 percent. Therefore, the GDP growth rate in 2019-20 is likely to have been closer to -1.5 percent rather than -0.4%.

The 2 percent GDP growth rate projection for 2020-21 also runs counter to estimates by multilateral agencies. The World Bank expects it to be 0.9 percent while the IMF has projected it at 1 percent. The performance will hinge crucially on agriculture. The floods and the locust attack are likely to lead to big losses in crop output. Further, Karachi, the economic hub of the country, contributing almost 18 percent of the national GDP, is being hit badly by power load-shedding. The impending gas shortage in winter months could also lead to a contraction nationally in industrial output. If COVID-19 cases start rising, economic activity could be adversely affected again. Therefore, there are many risk factors and it is far too early to show optimism about the GDP growth rate in 2020-21.

The second macroeconomic projection for 2020-21 by the SBP is now more cautious in character. This relates to the rate of inflation. The SBP now expects it to be in the range of 7 to 9 percent. Currently, it is operating at just above 8 percent. Here again, there is a degree of uncertainty? The electricity tariff has been raised a few days ago by NEPRA. Wheat flour and sugar prices continue to rise rapidly at 23 percent and 28 percent, respectively. Other food items likely pulses, potato and milk are also showing high double-digit price increases. Fortunately, non-food prices have provided a modicum of stability.

However, many of the non-food items are sensitive to changes in international prices. A key price is the price of oil. It has fluctuated between $40 and $43 per barrel. This has implied lower domestic prices of POL products and containment of the oil import bill. Of course, there is the downside risk that if in early 2021, the world economy begins to show a faster recovery than the oil price could start rising once again. Further, the path of the exchange rate in coming months will also have significant implications on the inflation rate. Will the Rupee continue to remain relatively stable?

Therefore, the outlook for the external balance of payments for 2020-21 is of crucial importance. Here again, the SBP has demonstrated a degree of optimism. The Monetary Policy Statement highlights the surplus in the current account in the last two months and the resilience of the external sector since the COVID-19 outbreak. The exceptional performance of home remittances has been a major positive factor. As a result, the foreign exchange reserves are close to adequacy. The SBP expects the current account deficit to remain bounded at 2 percent of the GDP and together with expected private and official inflows to keep Pakistan's external position stable in FY21.

There is, however, a need to look at the different parts of the balance of payments. No doubt the current account has improved substantially by over $2 billion in months of July and August as compared to the position in the corresponding months of 2019. However, what has not been highlighted is the severe deterioration in the financial account of the balance of payments. It has turned negative in the first two months of 2020-21 from a positive net inflow of over $2 billion in 2019-20 to a negative inflow of $408 million.

The deterioration in the financial account is due, first, to a fall in foreign investment by 43 percent. Second, the net inflow of foreign assistance, including by the IMF, to the Government from traditional sources has declined by 20 percent. Third, external debt repayment has increased by 13 percent. Fourth, there has been an unanticipated repayment of the Saudi deposit of $1 billion. However, this has been compensated for an equal inflow from China. Overall, the balance of payments had a surplus of $248 million in the first two months of FY21 as compared to a surplus of $1281 million in the first two months of FY20.

The over $1 billion increase in home remittances in the last two months is also contrary to expectations. The World Bank has projected that globally the inflow of remittances to developing countries will fall by $100 billion from the pre-COVID level of $350 billion. Fortunately, this is not the case with Pakistan and remittances from virtually all sources have increased.

There is need to study further the causes of the 4 percent decline in the value of exports in the first two months of FY21. This is due entirely to a big fall in the volume of exports accompanied by a big jump in export prices. Textile exports, in particular, have seen a quantity decline of over 23 percent. Fortunately, prices have increased on average by 22 percent, leading thereby to a fall in the value of exports of only 1 percent. The big question is whether export prices will remain high when consumer spending in importing countries is depressed?

Overall, there is need to avoid a somewhat premature and optimistic assessment of the projections for the economy of Pakistan in FY21. There are too many factors which could operate either positively or negatively at this point. Among the imponderables is the possible adverse impact on economic activity by demonstrations and rallies by the opposition parties in coming weeks. We will have to keep our fingers crossed and pray that Pakistan emerges successfully in FY21 from the negative impact of COVID-19.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2020