The Asian Development Bank (ADB) has revised GDP growth projection for Pakistan down to 4.8 percent (from 5.1 percent), and raised the projection for inflation to 6.5 percent (from 4.8 percent) and the current account deficit to 5 percent (from 4.5 percent) for the ongoing fiscal year 2019.
In an update of its annual economic publication, Asian Development Outlook (ADO) 2018, the ADB maintained that with the new government considering policy options to implement its economic and social agenda, twin deficits widened by a rising import bill and higher spending continued to pose a challenge.
Challenges to maintaining growth momentum is tighter monetary and fiscal policies to contain domestic demand, currency depreciation, and tension in the global trade environment, ADO advises.
The newly elected government urgently needs to address the large budget and current account deficits, rising debt obligations, and falling foreign exchange reserves. This requires mobilizing substantial external financing to buy time for orderly reform to reduce the large external and domestic imbalances. Such resources may be acquired from bilateral and multilateral sources, the diaspora, and international capital markets, the report states.
The key challenges are to adopt the right reforms and achieve good outcomes to sustain public support. Assuming government success in obtaining financing, Pakistan has reasonable growth prospects for fiscal year 2019 on the strength of improved security and energy supply, continued investment in the CPEC and other initiatives, and recognition of the need to rein in deficits.
On balance, the Update projects GDP growth in fiscal year 2019 at 4.8%, down by 1.0 percentage point from last year. The growth forecast for Pakistan in 2019 is downgraded in light of a pressing need to deal with large budget and external imbalances.
On the supply side, water shortages in some areas are likely to restrain agricultural production. Growth in manufacturing and services will likely be affected by fiscal and monetary tightening.
ADO further states that growth sustainability will depend on how effectively the government manages the fiscal and current account deficits, and on its consistent implementation of policy to arrest the widening of imbalances and preserve macroeconomic stability.
On top of dealing with macroeconomic imbalances, the new government has to undertake tariff reforms to contain rapidly rising and potentially disruptive inter-company arrears in the energy sector-so called "circular debt" that exceeds Rs1.4 trillion, or 5% of GDP.
Gas prices were already raised by as much as 143% in September. Average annual inflation is projected to reach 6.5% in fiscal year 2019 because of currency depreciation and elevated international oil prices. Inflation accelerated sharply for both food and other purchases in the first 2 months of fiscal year 2019, to 5.8% from 3.2% a year earlier.
The report further states that the central bank increased the policy rate by 100 basis points to reach 7.50% in July 2018 in an effort to contain inflation. It is likely to raise the rate further as part of its monetary tightening.
The federal government budget for fiscal year 2019, written by the previous government and administered by it until the new government took office in August 2018, set a deficit target equal to 4.9% of GDP, much lower than the fiscal year 2018''''s deficit of 6.6% of GDP.
Revenue was targeted at 16.3% of GDP, including a 17.7% increase in tax collection to be achieved mainly by improving tax administration. However, the budget reduced tax rates without any rationalization on the expenditure side.
Expenditure was set at 21.2% of GDP. The budget called for 82% deficit financing to come from domestic sources. A revenue target equal to 16.3% of GDP in a slowing economy would be a tall order, considering that the revenue ratio has averaged 14.9% in the past 5 years.
For fiscal year 2019, the new government presented supplementary budget proposals for parliamentary approval with the objectives of reducing development expenditure, introducing regulatory duties on selected luxury items to generate additional revenue, and reversing earlier tax cuts, while also withdrawing the petroleum development levy to ease the burden on the general public. The focus over the medium term must be to further enhance the revenue base to enable durable expansion in funding for social welfare and infrastructure that is necessary to lift growth.
The current account deficit is now expected to moderate from the equivalent of 5.8% GDP in fiscal year 2018 to 5.0% in fiscal year 2019 but exceed the ADO 2018 projection of 4.5%.
Exports are likely to continue to expand with the benefit of currency depreciation, fiscal incentives, and improved electricity supply and connectivity. However, slower growth in some advanced economies poses a risk to the forecast, as do rising trade tension and protectionism.
Growth in import demand will be contained by some scaling back of budgeted expenditure, additional import duties and taxes under discussion in the government, tighter monetary policy, and a freer exchange rate.
The current account balance will benefit as well from more stable prices for oil and other imported commodities. Import growth has already slowed in the first 2 months of fiscal year 2019. Worker remittances will continue to cushion the current account, but any significant increase will depend on more effort to tap diaspora resources.
Recent actions to tighten monetary policy and allow exchange rate flexibility are costly but necessary. Further monetary tightening, stronger fiscal discipline, and decisive efforts to contain losses incurred by public sector enterprises would help address external imbalances and fiscal risks.
Macroeconomic resilience and higher growth that is more sustainable and inclusive critically depends on vigilance in assuring that new external liabilities are phased in responsibly, the resumption of fiscal consolidation over the medium term, and accelerated reform to enhance the tax base, address distortionary tax incentives, and resolve the structural issues that undermine export competitiveness.
Economic growth in fiscal year 2018 accelerated to 5.8%, the highest in 13 years, on robust agriculture, an uptick in industry, and sustained expansion in services.
The rupee depreciated by 15.3% against the US dollar in the 8 months to July 2018, and the average rate on new lending to the private sector increased by only 41 basis points to 7.83% by June. While the very large decline in net foreign assets held by the central bank in itself should have sharply reduced bank reserves and curtailed commercial bank lending the central bank needed to provide Rs1.1 trillion of budgetary support to the government, which expanded reserve money by 14%. This expansion enabled commercial banks to meet credit demand with increased lending to the private sector by 15% and to state-owned enterprises by 30%.
The deficit in the general government budget, which consolidates federal and provincial accounts, surged to Rs2.3 trillion, which was equal to 6.6% of GDP in fiscal year 2018, up from 5.8% a year earlier and significantly higher than the budget target of 4.1%.
Revenue grew by only 5.9% but fell as a percentage of GDP to 15.2% from 15.5% a year earlier. Tax revenue increased by 12.5% to equal 13.0% of GDP. However, non-tax revenue declined sharply by 0.8 percentage points to 2.2% of GDP with marked declines in profit transfers from most sources but a modest increase from the central bank.
Expenditure increased by 10.1% to equal 21.8% of GDP, up by 0.5 percentage points from fiscal year 2017. Current expenditure rose by 0.7 percentage points to 17.0% of GDP on higher interest payments, defense spending, and federal government subsidies, the ADO stated.
Development expenditure fell to 4.7% of GDP from 5.3% as current spending exceeded the budget and revenue fell short. About two-thirds of the deficit was financed by domestic sources, and the remainder came from net external sources.
Among the domestic sources, borrowing from the central bank amounted to the equivalent of 3.3% of GDP, while non-bank sources provided the equivalent of 1.0% of GDP.
Net external financing increased to 2.3% of GDP from 1.7% as gross foreign borrowing rose by 14%. Public external debt and liabilities increased by $9.3 billion to $75.4 billion in fiscal year 2018, equal to 22.4% of GDP.
The current account deficit swelled to $18 billion, or 5.8% of GDP, significantly up from 4.1% in fiscal year 2017.
The deficit in services and primary income also increased substantially, by 19.0% to $11.2 billion. Workers remittances grew only by 1.4% but remained large at $19.6 billion.
Net inflows to the financial account grew by only $2 billion in fiscal year 2018 to reach $12 billion. As they were insufficient to finance the growing current account deficit, $6.3 billion in official foreign exchange reserves needed to be drawn down.
By the end of fiscal year 2018, reserves had fallen to $9.9 billion, or only 2 months of import cover. Under greater market influence, the rupee depreciated by 16% to Rs121 per US dollar at the end of fiscal year 2018. After national elections in late July the rate stabilized at about Rs124 per dollar.
"Pakistan''''s economy has time and again shown resilience and the capacity to bounce back. Although formidable development challenges remain, we expect the stability fostered by the smooth political transition and the new government''''s strong commitment to focus on pockets of vulnerabilities and implement pro-job and socioeconomic development policies that will stimulate robust, sustainable growth in the years ahead," said ADB Country Director for Pakistan Xiaohong Yang.
"The new government needs to move swiftly to put in place its macroeconomic policies including fiscal, monetary, tax, and trade reform policies to promote financial stability and growth. Pakistan needs to institute mechanisms to increase competitiveness, attract private sector investments, and strengthen the ease of doing business as well as Pakistan''''s position in the global value chain," said Yang.
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