Pakistan’s economy will face further headwinds

When Jerome Powell, chairman of the most important central bank in the world, Federal Reserve Bank of America (otherwise known as Fed), gave a speech at a key symposium held annually at Jackson Hole in Wyoming, the world listened closely. The speech was widely covered in financial press and even its wording and tone was analysed.

If the message is that of further hikes, we say the Fed’s tone is hawkish and otherwise, it is dovish (zoological imagery is commonly used in economics).

This Jackson Hole speech was probably one of the most hawkish and Powell minced no words.

The continued possibility of further rate hikes to bring down inflation is a cause of concern for developing countries like Pakistan. The rupee, as a consequence, will continue to face headwinds for the rest of the year.

The message by Jerome Powell's in his speech was unequivocal — the world should not expect the Fed to pivot any time soon. Recent economic data, especially CPI figures, took a slight correction however still at multi decades high. That led many to believe the Fed will now start to ease their aggressive interest rate hiking cycle.

However, Powell said that they will keep at it "until the job is done". He also mentioned another very important aspect that strictly shunned any likelihood of a 'neutral' stance as, according to the chairmank it “was not a place to stop or pause”.

Furthermore, he also made it clear that the world might not be expecting any decrease in policy rates:

"Restoring price stability will likely require maintaining a restrictive policy stance for some time," he noted. In just eight minutes Jerome Powell's speech wiped off about $78 billion from America's richest — that speaks about the reaction of market.

Dollar index is now at its 20-year high and at one point touched 109.44 points. A strong dollar has serious consequences for developing, low- and middle-income countries as most of their debt is dollar denominated.

But it has implications at home too: for instance, S&P 500 companies earn about 30 percent of their revenue outside the U.S. It can also hurt exports and widen the trade deficit. And finally incentivise other countries such as China, Russia, Saudi Arabia to move away from the greenback.

However, as Fed eyes another 75 basis point interest rate hike, dollar’s strength can pose significant challenges for Pakistan’s currency and as an extension affect our imports, widening trade deficit and increasing inflation.

Pakistan’s imports witnessed a much-needed decline recently. But this can be mainly attributed to a fall in petroleum imports that declined by 60 percent while reduction in the bill of other imported items was a paltry 16 percent. There was also a ban on luxury items that played its role.

If the Fed continues to raise interest rates, our imports will continue to become more expensive — Pakistan remains an import-driven economy and even if it falls the volume cannot go down to such a level that a stronger dollar doesn’t adversely impacts us.

Secondly, our debt servicing costs will continue to increase. The World Bank reported the cost of debt servicing in middle-income countries is at a 30-year high. This was in March and dollar has gained since then.

Pakistan’s reserves have fallen. Debt servicing increased to $10.88 billion in the first three quarters of 2021-22 as compared to $13.38 billion for the entire FY21. A rising dollar will make it worse.

With oil prices rising again, tensions brewing between U.S. and China over Taiwan, and a full blown energy crisis unfolding in Europe, commodities can enter another rally.

We do not seem to realise the gravity of the energy crisis in Europe. As winters approach, chances are Russia may completely ban gas to Europe. As such, their appetite for LNG will increase further (as it already has). This can have drastic effects on inflation in Pakistan as the rising cost of electricity has already become too much to bear.

All of the above developments can have structural implications for a country already battling with a widening fiscal deficit, weak currency, rising imports and low value-added exports.

The recent flooding is expected to cost at least $4 billion to the country’s economy and threatens food security given the destruction of land and crops. There have been improvements as well.

But headwinds remain.

The article does not necessarily reflect the opinion of Business Recorder or its owners