Public debt-to-GDP ratios have continued to rise in Pakistan: IMF

ISLAMABAD: The public debt-to-GDP ratios have continued to rise in Pakistan, reflecting the combination of still-large overall fiscal deficits and the impact of exchange rate depreciation, and offsetting the eroding effect of high inflation, says the International Monetary Fund (IMF).

The IMF, in its latest report, ‘Regional Economic Outlook Middle East and Central Asia, Safeguarding Macroeconomic Stability amid Continued Uncertainty’ stated that Pakistan’s growth rate is expected to slow materially from 6.0 percent in 2022 to 0.5 percent this year, reflecting challenging macroeconomic conditions, including damage from widespread flooding, broad-based inflationary pressures, and tighter monetary and financial conditions.

Inflation in Pakistan is projected to more than double to about 27 percent this year, reflecting broadening price pressures, the report noted.

Inflation has continued to rise in Egypt, Pakistan, and Tunisia, with the comparison of current policy interest rates relative to natural policy rate estimates suggesting that further interest rate increases are needed to stabilise inflation.

The high level of policy interest rates relative to terminal rates at the end of 2022 can be expected to continue putting downward pressure on inflation throughout 2023.

Where the policy stance is loose and inflationary pressures persist, tighter monetary policy should be considered to stabilise inflation and its expectations (for example, in Egypt, Pakistan, and Tunisia), the report recommended.

The Fund further stated MENA economies and Pakistan are expected to go through a soft patch this year, reflecting tight policies in many countries to restore macroeconomic stability, OPEC+-related curbs in oil production, and the fallout from the recent deterioration in financial conditions.

Headline inflation continued trending upward in most EM&MIs (Egypt, Morocco, Pakistan, and Tunisia, but not Jordan because of its peg to the US dollar and temporary fuel subsidies), partly reflecting the impact of past exchange rate depreciations and persistently elevated food prices, but also broadening price pressures (including on services) as underscored by the rise in core inflation amid loose monetary policy (Egypt, Pakistan, Tunisia).

Central banks across the region continued to tighten policy through the end of 2022 in response to persistently high inflation and exchange rate pressures and to prevent inflation expectations from de-anchoring (Egypt, Mauritania, Morocco, Pakistan, Tunisia).

For some MENA EM&MIs (including Egypt and Tunisia) and Pakistan, policy interest rates stood at levels below model-based estimates of natural rates, suggesting that monetary policy stances were still loose at the end of 2022.

For oil importers, primary fiscal deficits (excluding grants) improved on average in most MENA EM&MIs (except for Egypt) in 2022 relative to 2021, reflecting higher tax revenues partly offset by the policy response to mitigate the impact of rising commodity prices, while interest expenses remained broadly stable (about four percent of GDP on average). By contrast, Pakistan undertook a sizable fiscal expansion.

Higher inflation was the main factor in containing public debt in most MENA EM&MIs and Pakistan in 2022.

By contrast, public debt-to-GDP ratios continued to rise in Pakistan and Tunisia, reflecting the combination of still-large overall fiscal deficits and the impact of exchange rate depreciations, offsetting the eroding effect of high inflation.

Current account deficits for MENA EM&MIs deteriorated from 4.7 per cent of GDP to about fiveper cent of GDP on average in 2022. However, the widening in Pakistan was more marked (rising from 0.8 per cent of GDP to 4.6 per cent of GDP), reflecting rising import bills because of higher commodity prices.

The slight easing of financial pressures across the MENA region and Pakistan since October 2022 was reversed by the tightening of global financial conditions in March amid global banking turmoil. However, strong differentiation remains across the risk spectrum. Sovereign bond spreads have widened, and borrowing costs have increased sharply on net in many EM&MIs (Lebanon, Pakistan, Tunisia) relative to October 2022.

Overall, government bond yields across the region are higher than at the end of 2021 (by about 130 to 3,000 basis points). Capital flows had reversed even before the recent financial turmoil, with portfolio fund inflows to the MENA region and Pakistan reaching $1.2 billion in the first two months of 2023 (after a record $4.5 billion in outflows in 2022).

Pressures on exchange rates and international reserves remain significant, with sharp depreciations in some EM&MIs (Egypt, Pakistan) since October 2022.

Growth prospects are set to weaken across the MENA region and Pakistan as tighter monetary and fiscal policies to safeguard macroeconomic stability dampen domestic demand in EM&MIs; heightened fragility, fiscal pressures, and persistently high inflation weigh on growth prospects and worsen living standards in LICs and FCS; and economic growth moderates in oil exporters because of lower oil production in line with the October OPEC+ agreement.

Growth in the region’s EM&MIs is projected to gradually accelerate in 2024 (to 4.4 per cent in MENA EM&MIs and 3.5 per cent in Pakistan) and over the medium term as some of the headwinds dissipate, provided countries sustain implementation of policy and structural reforms, particularly under IMF-supported programs (Egypt, Pakistan).

MENA EM&MIs (especially Egypt, Jordan, and Tunisia) and Pakistan are expected to undertake meaningful fiscal consolidation, including subsidy reforms (Egypt, Morocco, Pakistan, Tunisia), with primary fiscal deficits projected to decline by about 3 per centage points of GDP on average between 2022 and 2025, in the context of IMF-supported programs for some countries (Egypt, Pakistan) or announced programs (Tunisia).

Overall, public debt-to-GDP ratios should decline in the medium term in most EM&MIs, further reflecting the erosion of the real value of public debt from persistent inflation (Egypt, Pakistan, Tunisia) and growth recovery, the report noted.

External financing needs for MENA EM&MIs and Pakistan are projected to stay large, though declining from about $132 billion in 2022 to $123 billion in 2023 (about 212 per cent and 171 per cent of gross international reserves, respectively).

The Fund further stated that GCC countries are progressively investing in the MENA region and Pakistan in energy infrastructure, renewable energy, health care, and agriculture. Although only a few countries have received investments to date, reforms to make the private sector more investment-friendly—for example, reducing state-owned enterprises’ outsize role in the economy, leveling the playing field across all economic agents, lifting red tape, and liberalizing the labor market—would improve investment prospects in these areas and foster employment.

During 2018–22, GCC countries provided about $54 billion1 in balance of payments and budget financing to MENA emerging market and middle-income economies (EM&MIs) and Pakistan, with additional support planned. GCC debt relief to MENA countries (Djibouti, Mauritania, Somalia) and Pakistan totaled about $1.3 billion at the end of 2022.

Equity markets have declined across most of the region, with Egypt, Jordan, Oman, Pakistan, and Qatar experiencing the largest declines. Bank equities were most affected in Egypt, Gulf Cooperation Council financial hubs, and Pakistan.

Bond spreads widened significantly for Pakistan, Tunisia, and to a lesser extent in Egypt, and currencies have broadly gained on US dollar weakness, while some Central Asian currencies (Kazakhstan, the Kyrgyz Republic) have weakened with the Russian ruble. Point estimates of natural policy rates suggest that the monetary policy stance was appropriately tight or neutral in many countries in early 2023, the Fund added.