The motivation for this article lies in the macroeconomic projections for 2021-22 contained in the Annual Report for 2020-21 of the SBP (State Bank of Pakistan). These relate to the GDP growth rate, rate of inflation, current account deficit and the fiscal deficit anticipated in the on-going financial year. The SBP projections border on optimism and are perhaps somewhat out of touch with recent trends in the national economy.
The GDP growth rate is expected to range between 4 percent and 5 percent in 2021-22 by the SBP. This is even more at the upper end of the range than the projection in the Annual Plan of 4.8 percent. The rate of inflation is expected to remain between 7 percent and 9 percent during the year. Already, during the month of October the rise in the Consumer Price Index was 9.2 percent.
The current account deficit, a critical metric this year, is anticipated by the SBP to range from 2 to 3 percent of the GDP. However, in the balance of payments estimates for July to October, the SBP has indicated that the current account deficit is effectively at a level which if it continues will reach 4.7 percent of the GDP by the end of 2021-22.
Turning to the projection of the fiscal deficit, the SBP is showing a degree of realism. The budget estimate for the year is 6.3 percent of the GDP. The SBP expects that it will be in the range of 6.3 percent to 7.3 percent of the GDP.
A comparison can be made at this stage with the projections made of Pakistan by the IMF (International Monetary Fund) in its October publication of the World Economic Outlook. The GDP growth in 2021-22 is projected at the lower end of the range given by the SBP of 4 percent. The inflation rate is expected to be 8.5 percent, which is closer to the upper end of the range given by the SBP.
The fiscal deficit estimate by the IMF is close to the budget estimate of 6.3 percent of the GDP. The current account balance is projected at the level of 3 percent of the GDP, equivalent to the upper end of the SBP estimate. However, it remains to be seen what the Macroeconomic Framework will be for 2021-22 and 2022-23 in the Staff Report following the completion of the Sixth Review.
The World Bank also makes projections for Pakistan in its publication, South Asia Economic Focus of Fall 2021. These projections are significantly different from those of either the IMF or the SBP. The GDP growth rate is expected to remain relatively low at 3.4 percent. Inflation is seen as higher at 9 percent. The fiscal balance is projected at 7.2 percent of the GDP and the current account deficit at 1.9 percent of the GDP.
Based on the trends observed in the initial months of 2021-22 and emerging developments an attempt is made to assess independently the prospects for 2021-22.
The range of GDP growth rate expectation by the three institutions is from 3.4 percent to 5 percent. The year started well. The level of cotton arrivals showed a quantum jump and the large-scale manufacturing sector demonstrated buoyancy with a growth rate of over 7 percent. The budget of 2021-22 was expansionary in nature with development spending expected to rise by as much as 73 percent.
More recently, there are growing concerns about the likely performance of the economy. The planting for the Rabi crops, especially wheat, has been constrained by less rainfall and the big jump in fertilizer prices of 23 percent in the case of urea and 107 percent in DAP. The likely reduction in fertilizer input could lead to a drop in yields.
The growth rate of the large-scale manufacturing sector has plummeted to only 1 percent in September. Major industries like textiles, food, beverages and tobacco, pharmaceuticals, chemicals, and cement have experienced a decline of output during the month. The loss of buoyancy in the cement industry is of special significance as it reflected the process of dynamism earlier in the construction sector.
The industrial sector is also likely to be the negatively impacted by the gas loadshedding in winter months. Further, the big jump anticipated in development spending in 2021-22 has not materialized in the first quarter. Only 12 percent of the annual target expenditure has been incurred from July to September.
The implementation of prior actions and other reforms agreed with the IMF in the sixth review are also likely to impact negatively on GDP growth. Already, the policy rate has been raised by 1.5 percentage points and it may be increased further in coming months by the SBP. This is bound to impact negatively on private investment. Increase in electricity and gas tariffs will also exert a negative impact on the production process in the economy. Moreover, the withdrawal or enhancement in the reduced rate of the sales tax on a number of items will also adversely impact many industries.
Based on the above, a more realistic projection of the GDP growth rate is 3.5 percent. There is now the new risk factor of the new Omicron mutant of COVID-19. If it enters Pakistan in coming weeks and is tackled by widespread shutdowns, then this could bring the GDP growth rate down to possibly even below 3 percent.
The rate of inflation could approach double-digit rate in the initial months of 2022. This will be the consequence of a rising trend in petroleum prices with the rise in petroleum levy. However, the price of crude oil has fallen in the last few days by over 10 percent, and this will ensure initially some price stability. The additional revenue from the sales tax is also likely to have a cost-push impact on prices.
A big area of concern relates to the extent of increase in electricity tariffs. Not only will the base tariff have to be raised in line with the agreement with the IMF but also the Fuel Adjustment Charge is rising to unprecedented levels. In September, it was fixed at Rs 2.52 per kwh by Nepra (National Electric Power Regulatory Authority). Now, a demand has been placed for an increase of Rs 4.50 per kwh in October. Cumulatively, the industrial tariff could jump by 30 to 40 percent, with inevitable consequences on the price level.
The rate of inflation will also depend on the extent of the depreciation of the rupee in 2021-22. This will be a key instrument in containing the current account deficit to a manageable level. The combination of the multitude of factors could imply that the average inflation rate could be in the range of 9.5 percent to 10.5 percent in 2021-22.
The lower end of the projection of the size of the current account deficit by the SBP is optimistic at 2 percent of the GDP. At 2 percent of the GDP, it means that while in the first four months of 2021-22 it was cumulatively above $5 billion it will need to be restricted to less than $2 billion in the remaining eight months. Extremely draconian moves would be required to achieve this quantum decline in the average monthly deficit. A more realistic level is 3.5 percent of the GDP. If international prices start falling as has already happened in the case of oil, then it could be restricted to 3 percent of the GDP.
Turning to the expectation about the budget deficit, the SBP has shown unusual faith in the Ministry of Finance, which will have to contend with some negative factors. First, the on-going increase in the policy rate could add Rs 200 billion to Rs 250 billion to the budgeted level of debt servicing in 2021-22. Second, the exceptional dynamism shown by import-based tax revenues will taper off if as the year proceeds international prices fall, as has happened already in the case of crude oil.
Third, the adjustments agreed with the IMF, including a cut in development spending and rise in the rate of petroleum levy, may not fully compensate for lower sales tax revenues from petroleum products, shortfall in revenue from the petroleum levy target of Rs 610 billion and likely lower non-tax revenues due to smaller transfer of SBP profits to the Government. Further, the Provincial Governments are unlikely to generate a joint cash surplus of Rs 570 billion. It is unlikely to exceed Rs 350 billion. Therefore, the more likely outcome is a budget deficit between 7 percent and 7.5 percent of the GDP.
In summary, the alternate set of macroeconomic projections for 2021-22 are as follows:
GDP Growth Rate: 3% to 3.5%
Rate of Inflation: 9.5% to 10.5%
Current Account Deficit: 3% to 3.5% of the GDP
Fiscal Deficit: 7% to 7.5% of the GDP.
(The writer is Professor Emeritus at BNU and former Federal Minister)
Copyright Business Recorder, 2021