Emerging negative factors

There is an air of general optimism about the economy today. The Extended Fund Facility of $7 billion was approved by the IMF Executive Board almost two weeks ago.

The first installment of the loan of over $1 billion has been received. This has facilitated the increase in foreign exchange reserves, now equivalent to import cover of two months. The current account deficit has been small in the first two months of 2024-25. The rupee has also remained nominally stable.

Other positive indicators include the extremely large reduction in the rate of inflation. The Consumer Price Index, on a year-to-year basis, rose by only 6.9% in September 2024. It was 31.4% a year ago in September 2023.

The large-scale manufacturing sector has demonstrated some recovery with a year-to-year growth rate of 2.5% in July 2024. To top it all, the high level of optimism is reflected in the peak attained by the stock market, with the KSE index surpassing 84,000 points for first time in history.

However, there is need to recognize that Pakistan remains vulnerable to emerging negative factors. Perhaps surprisingly, this relates first to the IMF Programme. Despite the Board approval and payment of first installment of the loan, there is a delay in the release of the IMF Staff Report on the Extended Fund Facility with Pakistan.

The last time an Extended Fund Facility was approved by the IMF Executive Board for Pakistan was the 3rd of July 2019.

Only five days later the Staff Report was released. This contained all the macroeconomic targets for the duration of the Programme, projected external financing requirements and their financing, schedule of reviews and purchases, quantitative performance criteria and indicative targets.

The delay in the release of the Staff Report on the approved EFF is worrisome. Does this mean that discussions are still on-going on the targets, structural reforms and external financing arrangements with the Authorities in Pakistan?

This report should be released immediately. This will enable determination of the extent of toughness of the targets and the reforms required to achieve these targets.

Turning first to some recent negative developments on the international trade front, the first is the escalation in the price of crude oil due to the escalation in the Middle East conflict.

The Brent price has approached $80 per barrel, with an increase in one week of almost 14%. If this increase persists then we could see again the price of above $90 after the commencement of the war in Ukraine. There is a risk that the oil import bill of Pakistan could see an upsurge of $2.5 to $3 billion in 2024-25.

Exports of goods have shown moderate growth of 7% in the first two months of 2024-25, according to the SBP estimates. The major part of the increase is in rice exports, which have fetched significantly higher prices in the presence of rice export restrictions by India.

However, the ban has been removed recently. This is likely to lead to lower prices of 15% to 20%, leading thereby a decrease in rice exports of up to $1 billion.

Combined; these two developments will increase the trade deficit by almost $3.5 to $4 billion. Fortunately, there has been truly exceptional growth in home remittances of almost 44%, in the first two months of 2024-25.

This is probably a reflection of the stability in the value of the rupee and the closure of gap between the official and hundi markets. This growth in remittances will need to be sustained to keep the current account deficit at a manageable level.

There is the risk otherwise that within the framework of the IMF Programme, Pakistan may be compelled to adopt a market-based exchange rate policy.

There is also some worrying news on the front of agricultural production. Apparently, as of August 31, 2024, there has been a big decline of 66% in the quantity of cotton reaching the ginning factories in Punjab and Sindh.

The shortfall is due to factors like delayed sowing, heavy rains, pest infestations and reduced crop acreage. Inevitably, there could be an increase in cotton imports of up to 3 million bales, costing over $1 billion.

There is also an indication by IRSA of an emerging water shortage during the Rabi season of almost 15%. Coupled with the big fall in wheat price of almost 40% after the bumper crop and larger imports last year, there is the likelihood of less planting of wheat this year.

Overall, these factors, combined with the high-base effect, it is likely that the major crop sector may see a big negative growth rate in 2024-25. This will jeopardize the attainment of the GDP growth rate target of 3.5% and put further pressure on the size of the total import bill.

There are also some emerging developments on the monetary front. Between the end of June and the 8th of September, 2024, there has been an actual decline in bank deposits of Rs 830 billion, equivalent to a fall of 3%. During the same period last year there had been an increase of Rs 390 billion.

The question is whether the big reduction of 450 basis points in the interest rates by the SBP has contributed to this decline. There has been consequently a decline in lending by banks both to the government and the private sector. The volume of credit to the private sector has clearly contracted by Rs 375 billion.

First indications are that there is unlikely to be a recovery of private investment from the historically lowest level in 2023-24. This will be a major factor limiting the prospects for a sustained higher GDP growth rate in years to come.

Finally, there is need to highlight the emerging shortfall in FBR revenues. The first quarter of 2024-25 has witnessed good revenue growth of over 25%. However, there is still a shortfall with respect to the quarterly target of Rs 90 billion. If the target growth rate of 40% for 2024-25 was also to be achieved in the first quarter, then the shortfall is significantly larger at Rs 306 billion.

In particular, the rupee value of imports has increased by only 5% in the first quarter of 2024-25. This is severely restricting revenue growth from import-based taxes.

Overall, there has been a spate of good news in recently weeks. The government is close to declaring victory, especially with regard to containing the rate of inflation. However, there continues to be uncertainty about the nature and extent of reforms in the IMF Programme.

Further, some emerging negative factors identified above could reduce the GDP growth rate, increase the size of the trade deficit, raise the rate of inflation and put pressure on the size of the fiscal deficit in 2024-25. As such, economic management will need to minimize the impact of the emerging negative factors.

Copyright Business Recorder, 2024