Covid-19 shock to cause big impact on BoP

Pakistan's primary deficit is now expected to deteriorate to 2.9 percent of GDP in fiscal year 2020 (from 0.8 percent expected earlier) due to a 1.8 percentage point decline in tax revenue relative to the pre-virus baseline and the needed higher spending to support the health response, social safety nets for the very poor, and employment.

This was revealed in the Staff Report prepared by a staff team of the IMF for the Executive Board's consideration on April 16, 2020, following discussions that ended April 3, 2020, with the officials of Pakistan on economic developments and policies underpinning the IMF arrangement under the Rapid Financing Instrument (RFI).

While the fall in oil prices and weaker import demand provide some support to the current account, the Covid-19 shock will have a severe impact on the Balance of Payments (BoP). In particular, (i) export growth is likely to come to a halt due to the fall in external demand; (ii) remittances are expected to drop by over US$5 billion during FY 2020 and fiscal year 2021 as activity in GCC countries declines; and (iii) outflows from non-resident holdings of domestic treasuries could continue, despite having experienced $2.0 billion in outflows so far.

This scenario will result in new external financing needs of about US$2 billion (0.8 percent of GDP; SDR 1,400 million) in Q4 of fiscal year 2020. It is envisaged that these urgent external financing needs will rise as Pakistan's fiscal year ends June 30. National accounts are only available on an annual frequency.

These increased external financing needs will be met through the use of Fund credit under the RFI and fresh resources of around US$250 million committed by multilateral partners.

These disbursements would maintain central bank reserves at US$12 billion (2.7 months of imports) by end fiscal year 2020, a level similar to that prior to the shock. Moreover, a potential financing gap of around $1.6 billion could emerge in fiscal year 2021, which would be filled through the use of reserve assets, additional support from multilateral partners, and, if needed, additional policy adjustments.

The near-term economic impact of Covid-19 is expected to be significant. While uncertainty is high, Pakistan's economy will be impacted through external and domestic channels:

Externally, the global downturn, including in Pakistan's major export markets (China, the EU, and the U.S.), would reduce demand for Pakistan's exports, especially textiles, and lead to more limited financial flows. In addition, remittances are expected to decline sharply. Domestically, the impact of containment measures together with heightened uncertainty and a generalized loss of confidence by business and consumers are likely to result in concurrent demand and supply shocks feeding off each other, with severe effects on investment and output.

While forecasts are subject to higher than usual uncertainty, economic activity is expected to contract for the first time since the 1950s. Real GDP is projected to decline by -1.5 percent in fiscal year 2020 as a result of a severe contraction in output during the last quarter of the fiscal year.

Growth is expected to remain tepid in first half of fiscal year (H1-FY) 2021, depending on the success of efforts to contain the spread of the pandemic in Pakistan and worldwide, and to return gradually to faster growth in the second half of the fiscal year in line with the expected global recovery.

Cumulatively, real GDP growth has been revised downward by 5 percentage points over fiscal year 2020-21. Manufacturing, especially textiles, transportation, and services are expected to be the sectors more severely impacted. Private sector credit is likely to weaken further due to the heightened uncertainty.