Pakistan's economic growth will be negatively impacted in the short run due to tighter monetary and fiscal policies as a result of the International Monetary Fund's bailout package, says Fitch Solutions. Fitch Solutions in its latest report, "Economic analysis - IMF deal to weigh on Pakistan's growth in the short run" states that the bailout package from the IMF will see tighter monetary and fiscal policies in Pakistan, which will be negative for growth in the near term. Investment in the China-Pakistan Economic Corridor (CPEC) will continue to provide some support to the economy.
After close to eight months of negotiations, Pakistan reached an agreement with the IMF in May for $6 billion bailout package to address its balance of payment crisis.
Following the agreement, the State Bank of Pakistan (SBP) increased the policy rate by 150bps. Shortly after, the Ministry of Finance of Pakistan presented a budget in June with the aim of trimming Pakistan's primary deficit to 0.6 percent of GDP in fiscal year 2019-20, from 1.9 percent of GDP in fiscal year 2018-19. Given the tighter monetary and fiscal policies amid an already subdued economic growth outlook, Fitch Solutions have revised its forecast for Pakistan's real GDP growth to come in at 3.2 percent in fiscal year 2018-19 (slightly lower than the government's expectation of 3.3 percent) and 2.7 percent in fiscal year 2019-20 (from previous estimate of 4.4 percent in fiscal year 2018-19 and 4 percent in fiscal year 2019-20); and 5.4 percent in fiscal year 2017-18.
Fitch Solutions further states that higher taxes will erode purchasing power. Growth of consumption (around 82 percent of GDP) to slow down to 5.3 percent in fiscal year 2019-20, down from 6.3 percent in fiscal year 2017-18 as purchasing power will likely decline.
Inflation has been on the rise in Pakistan, increasing by 9.1 percent year on year in May, compared with 4.2 percent y-o-y in the previous year. Moreover, as part of the deal with the IMF, Pakistan promised to reduce its primary deficit to 0.6 percent of GDP in fiscal year 2019-20, primarily through tax-based measures including raising the tax rate on sugar from 8 percent to 17 percent and moving cigarette taxes into higher brackets.
"Given our expectations for continued upside pressure on consumer prices over the coming months, we believe that the consumers' purchasing power will continue to fall over the coming months, thereby weighing on consumption. However we note that some of the effect of price hikes will be partially offset by the government's populist measures, such as providing electricity subsidies to consumers who use less than 300 units of electricity per month", maintained the report.
Fitch Solutions projected that growth of government spending (around 12 percent of GDP) would slow down to 6.4 percent in fiscal year 2019-20, down from 14.2 percent in fiscal year 2017-18, as the country embarks on an austerity drive.
The IMF bailout packages typically require countries to undergo fiscal consolidation, which usually include austerity measures. While Pakistan and the IMF have agreed on focusing on tax-based measures to manage the fiscal deficit, Fitch Solutions maintains that projects that the Pakistani government will fall short of its ambitious revenue targets and will likely have to cut spending to meet the primary deficit target of 0.6 percent of GDP.
Fitch Solutions projected little improvement in Pakistan's net exports, which recorded a deficit of around 11 percent of GDP in fiscal year 2017-18. Despite the government's efforts to increase export competitiveness, such as subsidizing electricity and gas to the industrial and export sectors, a global slowdown will likely weigh on exports over the coming months.
Global growth to slow from 3.2 percent in 2018 to 2.9 percent by 2020, with growth in two of the largest main export destinations, the US and China, slowing to 2 percent and 6.1 percent respectively by 2020, from 2.9 percent and 6.6 percent in 2018.
The imports could increase over the coming months acting as a slight drag on growth. Given that Pakistan's main imports are petroleum and its products (around 28 percent of total imports), rising oil prices will likely weigh on net exports.
Fitch forecasts Brent crude oil prices to average $70/barrel (bbl) in 2019 and $76/bbl in 2020, from a year-to-date average of $66.15/bbl. The impact of rising oil prices on imports will be exacerbated by a weakening currency.
Following the agreement with the IMF, the Pakistani rupee has been devalued by more than 10 percent to around Rs157/USD, from around Rs142/USD before the agreement took place in May.
Growth of investment, which accounts for approximately 17 percent of GDP, will slow down to 5.1 percent in fiscal year 2019-20, from 5.7 percent in fiscal year 2017-18, as tighter monetary policy being implemented by the SBP will likely weigh on investment.
Since the start of the fiscal year (July 2018), the SBP has increased its policy rate by 575bps, to 12.3 percent in May from 6.5 percent in the beginning of July 2018. Moreover, the government has committed to borrow less from the SBP as part of the IMF deal, which will improve the monetary policy transmission in the country.
In addition, business sentiment will likely remain subdued in Pakistan, leading to slower investment growth. Pakistan's Karachi Stock Exchange-100 Index has already fallen by more than 14 percent since July 2018, reaching the lowest levels since March 2016, suggesting that investor confidence in the economy has fallen.
The large-scale manufacturing (LSM) industries have also been contracting over the past few months, with the quantum index recording a 6.7 percent y-o-y decline in March. With a slowdown of manufacturing activity, Fitch projects a fall in investment appetite related to LSM industries, such as investment in capital.
Investment related to the CPEC, a centerpiece of China's Belt and Road Initiative will likely provide some support to the economy over the coming quarters. Construction of many key CPEC projects has already started and will stretch over the coming years. In addition, there are more projects in the pipeline that are still at the planning stage but will likely commence soon.
Fitch projects that the CPEC will continue to make progress given China's continued push on project implementation and the improving bilateral relationship between the two countries.
Debt concerns, which were one of the major challenges for the CPEC projects, also seem to have receded for now. In December 2018, Pakistan's Ministry of Planning, Development and Reform and the Chinese embassy in Pakistan released statements to improve transparency of the financials relating to the CPEC projects.
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