Headline inflation revised up to 18.0pc: ADB forecasts economy to slow down to 3.5pc

ISLAMABAD: Pakistan’s economy is forecast to slow to 3.5 percent in the fiscal year 2023 (ending 30 June 2023) from 4.5 percent (projected in April 2022) amid devastating floods, policy tightening, and critical efforts to tackle sizable fiscal and external imbalances. The forecast for headline inflation revised up to 18.0 percent from the earlier 8.5 percent projection due to a potentially strong second-round impact from the rupee’s depreciation and fuel and energy price adjustments, says the Asian Development Bank (ADB).

The Bank in its latest report “Asian Development Outlook (ADO) 2022 Update”, stated that the economic outlook will also depend on the continued availability of adequate external financing under challenging domestic and global economic and political conditions. The potential economic consequences of the recent severe floods heighten the already significant risks to the outlook, including the elevated inflation rate, possible fiscal slippage as general elections approach, and a higher-than-projected increase in global food and energy prices.

The recent floods have severely damaged farmland, property, and livelihoods, adding a serious risk to the outlook, including for the already elevated inflation rate.

GDP growth (expected to have reached 6 per cent) in Pakistan in the fiscal year 2022 was propelled by higher private consumption and an expansion in agriculture, services, and industry—particularly large-scale manufacturing. But in fiscal year 2023—as well as climate headwinds and Pakistan’s critical policy efforts—ADB’s lower growth projection also reflects double-digit inflation. The latest report is an update to ADB’s annual flagship economic publication.

“The recent devastating floods in Pakistan add profound risk to the country’s economic outlook,” said ADB Country Director for Pakistan Yong Ye. “We hope that flood-related reconstruction and economic reforms will catalyze significant international financial support, stimulate growth, and preserve social and development spending to protect the vulnerable. ADB is preparing a package of relief, rehabilitation, and reconstruction to support people, livelihoods, and infrastructure immediately and in the long-term.”

The economic outlook will be shaped largely by the restoration of political stability and the continued implementation of reforms under the revived International Monetary Fund program to stabilize the economy and restore fiscal and external buffers.

According to the update, private consumption expanded by 10 per cent in the fiscal year 2022 resulting in improved employment conditions and higher household incomes. Agriculture output increased by 4.4 per cent in the fiscal year 2022 supported by strong performances in crops and livestock. Agriculture growth is expected to moderate due to flood damage and high input costs next year, which may diminish services growth, particularly wholesale and retail trade.

In the fiscal year 2023, fiscal adjustments and monetary tightening are expected to suppress domestic demand. A contraction in demand, together with capacity and input constraints created by higher import prices from the rupee’s depreciation, will reduce industry output.

Inflation accelerated sharply in the fourth quarter (April–June) of 2022, spurred by the removal of fuel and electricity subsidies, a significant depreciation in the rupee, and the surge in international commodity prices. Inflation spiked to 21.3 per cent in June, its highest since 2008, lifting average headline inflation to 12.2 per cent in 2022.

In addition to the floods, the elevated inflation rate along with possible fiscal slippages as general elections approach, and a higher-than-projected increase in global food and energy prices, remain downside risks to the outlook.

The report noted a contraction in demand, together with capacity and input constraints created by higher import prices from the rupee’s large depreciation, will reduce industry output. Slower growth in agriculture and industry will in turn diminish services growth, particularly wholesale and retail trade. Inflation is expected to accelerate in fiscal year 2023 as new tax measures announced in the budget, together with an increase in the wheat support price and planned upward adjustments to electricity tariffs, are expected to keep inflationary pressures high.

The report further noted that the fiscal deficit is expected to decline to 4.9 per cent of GDP through a mix of ambitious revenue mobilization efforts and subsidy cuts. Revenue growth is expected to increase, underpinned by the new tax measures in the Finance Act of 2022, the resumed collection of the petroleum levy, a renewed focus on curtailing tax expenditure, and additional policy and administrative measures to broaden the tax base.

Expenditure is projected to decline in 2023 as a percentage of GDP, led by a 1.4 percentage point of GDP cut in budgeted subsidies. The government aims to preserve social and development spending to protect the vulnerable and limit the slowdown in growth amid efforts to stabilize the economy. The government has already raised domestic fuel prices to bring them in line with international oil prices and is undertaking a phased withdrawal of electricity and gas subsidies, which will contribute to higher inflation in 2023.

The current account deficit is forecast to narrow to 3 per cent of GDP in FY2023, unchanged from ADO 2022’s projection, on a sharp slowdown in economic growth, measures to curtail nonessential imports, and the pass-through effect of the rupee’s large depreciation against the US dollar. Exports and remittances are expected to remain resilient in 2023, supported by improved confidence, a flexible exchange rate, the continuation of the central bank’s export facilitation scheme, and government initiatives to reduce the cost of doing business.

While foreign capital inflows are expected to increase, financing challenges will remain given the large sums needed to cover the current account deficit and service debt repayments. Maturing external public debt will be at about $21 billion in fiscal year 2023.

Foreign direct investment should revive as investor confidence is restored by the implementation of the IMF stabilization and reform program. This should also help bring additional finance from multilateral institutions and other international partners, thus supporting the buildup of foreign exchange reserves. Pakistan’s medium-term prospects hinge critically on the restoration of political stability and the continued implementation and deepening of reforms under the revived IMF EFF program to stabilize the economy and rebuild fiscal and external buffers.

Copyright Business Recorder, 2022