World Bank says inflation in Pakistan to edge up in FY22

ISLAMABAD: The World Bank projected on Thursday that inflation would edge up in FY22 with domestic electricity tariff hike announced in October 2021, and higher oil and commodity prices before moderating in FY23.

The Bank, in its report Pakistan "Reviving Exports" stated that despite inflation slowing to 8.9 percent in FY21 from 10.7 percent in FY20, headline consumer price inflation remained elevated - mostly because of high food inflation, which is likely to disproportionately impact on poorer households that spend a larger share of their income on food than on non-food items. With the policy rate being held at 7.0 percent throughout FY21, real interest rates were negative, supporting the recovery.

A team of World Bank experts, Gonzalo J. Varela (Senior Economist) Aroub Farooq (Research Analyst), Federico Ganz (Consultant), and Abid Hussain Chaudhry (Program Assistant), briefed the media over economic position of Pakistan and its overall trade performance.

The report states that Pakistani Rupee (PKR) reached a more than two-year high of PKR 152.2 against the U.S. dollar (USD) on May 7, 2021. However, the Rupee has subsequently been depreciating, losing more than 10 percent of its value against the greenback in just under five months, to a record low of PKR171.1 on October 14, 2021. The relatively sharp decline in the Rupee can be attributed to a few significant global, regional, and Pakistan-specific developments that have occurred in recent months.

With domestic demand continuing to be supported by the accommodative monetary policy, record-high remittance inflows, and the expectations of an expansionary fiscal policy set out in FY22 fiscal budget, imports surged over April-June 2021, coinciding with the turnaround in the trajectory of the Rupee exchange rate. The strength in imports has carried over to the first quarter of the current fiscal year. Total imports in August 2021 jumped 85.8 percent y-o-y, leading to a monthly trade deficit of $ 4.0 billion, slightly lower than the record-high trade deficit of $ 4.1 billion in June 2021. The growing trade deficit, and consequently wider current account deficit, has increased the demand for the dollar, contributing to the depreciating PKR.

Pakistan's goods export values to Afghanistan have been sizeable, amounting to $ 870.5 million (4 percent of total Pakistan goods exports) in calendar year 2020. However, with the Afghanistan crisis, shipments from Pakistan to Afghanistan have declined significantly, by around 40 percent y-o-y in July and August 2021. In sharp contrast, goods import values from Afghanistan to Pakistan in August 2021 have jumped by about 30 percent y-o-y. These developments have reduced Pakistan's dollar earnings and led to an increased outflow of dollars, contributing to the dollar's scarcity relative to the PKR.

World Bank lowers GDP forecast, projects higher inflation in FY22

According to the report, due to low base effects and recovering domestic demand, Pakistan's real GDP growth (at factor cost) is estimated to have rebounded to 3.5 percent in FY21 from a contraction of 0.5 percent in FY20. With effective micro-lockdowns curbing the spread of the pandemic, record-high official remittance inflows, the expansion of the Government's cash transfer program, and an accommodative monetary policy, private consumption and investment are both estimated to have strengthened during FY21, driving the economic recovery. Government consumption is also estimated to have risen, but at a slower pace than in FY20, when the COVID-19 fiscal stimulus package was rolled out. In contrast, net exports are estimated to have contracted in FY21, as imports growth almost doubled that of exports due to strong domestic demand.

On the production side, supported by strong large-scale manufacturing, industrial activity is estimated to have bounced back after contracting for two consecutive years. Similarly, the services sector, which accounts for 60 percent of GDP, is estimated to have expanded, as generalized lockdown measures were increasingly lifted. In contrast, agriculture sector growth is expected to have slowed, partly due to an approximate decline of 30 percent in cotton production on account of adverse weather conditions.

The report says that Current Account Deficit (CAD) narrowed from 1.7 percent of GDP in FY20 to 0.6 percent in FY21 as robust remittance inflows offset a wider trade deficit. Foreign direct investment decreased, while portfolio inflows increased with the issuance of USD2.5 billion Eurobonds. Overall, the balance of payments surplus was 1.9 percent of GDP in FY21. Gross official foreign exchange reserves rose to USD20.6 billion as of October 1, 2021, equivalent to 3.7 months of total imports. After gaining ground against the U.S dollar in FY21, the Pakistani Rupee depreciated by 7.7 percent against the U.S. dollar in Q1 FY22 - partly due to pressures from the rising import bill.

In FY21, the fiscal deficit (excluding grants) narrowed to 7.3 percent of GDP from 8.1 percent in FY20, as revenue growth, underpinned by stronger domestic activity, outpaced higher expenditures. Public debt, including guaranteed debt, ticked down to 90.7 percent of GDP at end-June FY21 from 92.7 percent of GDP at end-June FY20.

Bolstered by the recovery in the industry and services sectors and resultant off-farm employment opportunities, poverty incidence, measured at the international poverty line of USD1.90 PPP 2011 per day, is expected to have declined to 4.8 percent in FY21 from 5.3 percent in FY20. However, this change is not statistically significant, and downside risks arising from lockdown-induced disruptions to employment and high food inflation remain.

World Bank maintained that in line with the 25-basis point policy rate hike in September 2021, fiscal and monetary tightening are expected to resume in FY22, as the Government refocuses on mitigating emerging external pressures and managing long-standing fiscal challenges. Output growth is therefore projected to ease to 3.4 percent in FY22 but strengthen thereafter to 4.0 percent in FY23 with the implementation of key structural reforms, particularly those aimed at sustaining macroeconomic stability, increasing competitiveness and improving financial viability of the energy sector. Poverty is expected to continue declining, reaching 4.0 percent by FY23.

The Bank further stated that inflation is projected to edge up in FY22 with the domestic electricity tariff hikes announced in October 2021, and higher oil and commodity prices before moderating in FY23.

The CAD is projected to widen to 2.5 percent of GDP in FY23 as imports expand with higher economic growth and oil prices. Exports are also expected to grow strongly after initially tapering in FY22, as tariff reform measures gain traction, supporting export competitiveness. In addition, the growth of official remittance inflows is expected to moderate after benefiting from a COVID-19-induced transition to formal channels in FY21.

Despite fiscal consolidation efforts, the deficit (excluding grants) is projected to remain high at 7.1 percent of GDP in FY22 and widen to 7.2 percent in FY23 due to pre-election spending. Implementation of critical revenue-enhancing reforms, particularly the harmonization of the General Sales Tax, will support a narrowing of the fiscal deficit over time. Public debt will remain elevated in the medium-term, as will Pakistan's exposure to debt-related shocks. This outlook assumes that the IMF-EFF program will remain on-track.

Major downside risks include delays in and the stalling of the IMF-EFF program and the consequent external financing difficulties; exceedingly high domestic demand leading to unsustainable external pressures; more contagious COVID-19 strains requiring widespread lockdowns; and worsening regional and domestic security conditions, including those stemming from the situation in Afghanistan. All of these could delay critical structural reforms.

WB brings rising food inflation in Pakistan under the spotlight

Debates on appropriate policies to reduce the trade deficit have resurfaced with the recent increases in the trade gap. A key factor driving the trade imbalance is the declining export competitiveness. Indeed, the share of exports in GDP has been declining since the turn of the century, from 16 percent in 1999 to 10 percent in 2020. This falling export share has implications for foreign exchange, jobs, and productivity growth. At the firm-level, the decline is consistent with low entry rates into exporting, and exporters that struggle to expand over their life cycle. At the economy level, the lack of a sustained robust growth in exports has resulted in little diversification or sophistication gains for the export bundle.

While the causes of the falling export share are manifold, there are three key ones. First- the high effective import tariff rates including Customs Duty (CD), Additional Customs Duty (ACD) and Regulatory Duty (RD) and limited export market access tend to discourage exports. Second, the supporting services for exporters are inadequate, especially those for long-term financing of capacity expansions and market intelligence services to secure new export contracts. Third, the low productivity of Pakistani firms hinders them from successfully competing in global markets. These issues will be examined in detail and a policy agenda for export revival based on Pakistan's context and on international best practices will be proposed, they said.

Overall remittances grew by 27.0 percent to reach a record high of $ 29.4 billion in FY21. Remittances from the Gulf Cooperation Countries (GCC) constituted 58.2 percent of total remittances (down from 65.4 percent in FY20) whereas those from the United States, United Kingdom, and European Union accounted for 32.4 percent of inflows (up from 26.3 percent in FY20). The unexpected sustained growth in remittances observed over the FY is in part due to: (i) cross-border air travel restrictions due to COVID-19, which may have helped channelize inflows toward formal banking channels as opposed to the informal channels used previously (via family members travelling, hawala/ hundi agents); (ii) air travel restrictions, including curbs on religious travel, which likely contributed to a build-up in savings with the overseas diaspora and as a result, expatriates were able to remit back higher funds; (iii) domestically, policy measures undertaken by the Government, including incentivizing banks to introduce digital products to facilitate migrants in sending remittances under the Pakistan Remittance Initiative; (iv) policy support in the host destinations (especially advanced economies) via unemployment benefits, rent and loan deferrals, and direct cash handouts, which likely increased the ability of migrants to remit higher amounts back home; and (v) favourable cross-currency movements against the U.S. dollar, which have also played an important role in driving up remittances in dollar terms.

The World Bank officials said that the government has to sort out circular debt and extend subsidy only to low income groups.

The financial account surplus narrowed in FY21 with net inflows declining to $ 8.2 billion from $9.3 billion received during FY20. Weak global trends, combined with a lack of lucrative opportunities to attract fresh investment, led to lower net foreign direct investment (FDI). Inflows to the telecommunications sector decreased, while those to the power sector (particularly thermal) increased. Overall, FDI inflows from most countries, including China, declined during the fiscal year. Net portfolio investment saw net inflows of $ 2.8 billion compared to net outflows of $ 0.4 billion FY20, as the Government raised $ 2.5 billion from a Eurobond issuance in March 2021.

Tarin describes food inflation as 'major' challenge

The net inflow of external loans into the country amounted to $ 4.0 billion in FY21, compared to $ 6.9 billion in FY20. During FY21, the financial account also benefited from inflows of $ 1.6 billion under the Roshan Digital Account, a scheme introduced by the Government to allow non-resident Pakistanis to participate in investment (including in Government securities), payment, and banking activities in Pakistan.

Aided by the sizable financial account surplus and a narrower current account deficit, the overall balance of payments recorded a surplus of 1.9 percent of GDP ($5.6 billion) in FY21, slightly narrower than the 2.0 percent surplus in FY20. The SBP's gross reserves, including the Cash Reserve Requirement and cash holdings, increased to $ 18.7 billion - the highest since January 2017. In July 2021, Pakistan raised an additional $ 1.0 billion in Eurobonds and in August 2021, received $ 2.8 billion from the IMF as per new SDR allocation - these inflows helped shore gross official foreign exchange reserves to $ 20.6 billion by October 1, 2021, equivalent to 3.7 months of imports, compared to $ 13.7 billion or 2.7 months of imports at end-June 2020.

The accommodative monetary policy stance of the United States also helped the Pakistani Rupee strengthen against the dollar, similar to the other emerging markets. However, after rallying strongly in Q3 FY21, the Rupee has lost ground against the US Dollar since June 2021, largely due to the surge in imports. Meanwhile, the Real Effective Exchange Rate (REER) appreciated by 10.4 percent in FY21, partly due to high domestic inflation relative to the inflation in Pakistan's trading partners.

After contracting in both FY19 and FY20, development expenditures and net lending grew by 9.3 percent in FY21 on the back of higher growth in the Provincial Public Sector Development Program's (PSDP) spending and net lending. Total PSDP expenditures grew by 11.2 percent, of which Provincial PSDP spending expanded by 23.8 percent y-o-y whereas the Federal PSDP declined by 5.7 percent. Net lending; however, increased by 58.5 percent, reflecting the payments made by the Federal Government to the Power Holding Private Limited (PHPL) for absorption of its loans into general government debt.

The World Bank said that they support reforms program being discussed between the government and IMF, adding that they are expecting increase of one percent of GDP.

"The issues of power sector are broad as it is not only a question of adjusting tariffs but also reduction in losses and technical losses, and cheap generation," said one of the officials.

World Bank also gave comparison of increase in exports of Pakistan and Vietnam as the latter has showed considerable growth in its exports.

Copyright Business Recorder, 2021