KARACHI: Identifying some structural vulnerabilities, the State Bank of Pakistan (SBP) expects inflation and current account deficit to increase in the future.
According to the SBP’s third quarterly report on the state of the Pakistani economy for fiscal year 2020-21, in the future, in fiscal year 22, the economic momentum that has manifested itself during the exercise 21 should strengthen further. The ongoing vaccine rollout, coupled with continued economic activity during the second wave of the virus and most of the third wave, offers some optimism.
However, the report states that a major downside risk to the overall growth outlook for FY22 is the ongoing and potentially additional third wave of Covid-19, which may require the imposition of mobility restrictions and therefore disrupt the current economic dynamic.
In addition, in the external sector, while remaining limited, the current account deficit is expected to increase, mainly due to a further widening of the trade deficit due to a likely increase in import payments. The increase in imports reflects rising oil prices, which are now expected to add to pressures from steadily increasing import volumes of energy products.
The State Bank said that while the economy experienced an encouraging recovery in FY21, some structural vulnerabilities continue to deserve attention.
First, in the agricultural sector, the secular decline in cotton production needs to be addressed. The timely availability of pest-resistant seed varieties and additional support from agricultural extension services, especially to promote the adoption of climate-smart farming practices, could lead to better outcomes.
Second, in the external sector, the widening goods deficit must be contained to a sustainable level. Greater agricultural self-sufficiency, through the adoption of better agricultural and crop management practices, and the maintenance of adequate stocks can reduce the need to import basic commodities (such as wheat, sugarcane and cotton. ) to fill domestic shortages or counter temporary price pressures. Discouraging the import of luxury consumer goods and promoting greater export diversification, in terms of value-added items and destinations, could also help.
Third, efforts are needed to mitigate food inflation, triggered in large part by supply issues in the management of agricultural products. This can be achieved through better coordination between federal and provincial food departments, the provision of reliable data, vigilant monitoring of food stocks and prices, and the timely importation of products.
Fourth, the double debt service burden and a narrow tax base leave less fiscal space for public investment. This calls for accelerated efforts to broaden the tax base, increase documentation in the economy, improve public financial management, restructure loss-making public sector enterprises and reduce circular debt in the electricity sector.
The report says recent CPI results indicated a steady increase in year-on-year inflation in February, March and April 2021 coming mainly from the supply side, with the output gap still estimated to be negative.
The current increase is concentrated on the prices of food products and utilities (electricity), while wage pressures are considered stable at this stage. In addition, better stewardship of commodities, including building up strategic staple food reserves, is likely to ease pressure on the food supply side. As a result, the second-round effects of supply-induced inflationary shocks are currently being mitigated and inflation expectations remain firmly anchored.
However, the report indicates that there are multiple upside risks to inflation expectations. First, the current upward trend in international commodity prices is widespread, with oil, food and metal prices all increasing significantly. Second, an upward adjustment in administered tariffs for utilities (electricity, gas and fuel) could further fuel inflation as well as inflation expectations. Third, wage pressures will need to be carefully monitored, especially in the context of any increases in minimum wages and public sector pay. Fourth, the removal of sales tax exemptions and other potential income-generating measures in the fiscal year 22 budget may also cause inflation to increase during the fiscal year.
In addition, in the tax sector, decent revenue growth has been seen so far in FY21, with collections through April 2021 above target. In addition, spending growth is lower than last year (FY20), mainly due to lower development spending and restraint in non-interest current spending. On this basis, SBP expects the fiscal deficit for fiscal year 21 to be 6.5-7.5% of GDP.
However, an upside risk for this projection is higher payments due to circular debt settlements. For FY22, pending the budget, an improvement in the budget deficit is expected against a background of continuing current trends of revenue collection growth in FY22, as well as acceptance of the proposal to abolish corporate tax exemptions. Finally, the higher growth result in FY22 would further stimulate revenue collection, while PSDP spending is expected to increase.
On the agricultural side, the impetus is likely to come from further improvement in production, with the government emphasizing the use of better seed varieties and modern technologies. In particular, cotton production is expected to recover from the multi-year low recorded in FY21.
The government’s Kharif and Rabi programs, which typically include subsidies on fertilizers and other inputs, are also expected to support the growth of the agricultural sector.
Further impetus to economic growth will likely come from the expected investments under the TERP and the political impetus for construction activities.
In addition, the government has indicated its intention to increase spending on the PSDP, which would also be a major factor contributing to higher growth. These favorable trends in agriculture and industry would also affect the service sector.
On the other hand, the growth in export earnings is expected to come mainly from the continued strong momentum of high-value textile items (i.e. clothing and home textiles), as well as a rebound in prices. rice exports in a context of better crop forecasting (which allows exporters to offer more competitive prices).
However, potential downside risks to export growth include the continued rise in international prices for textile inputs (including cotton yarn), which could impact the competitiveness of exporters; as well as the resumption of economic activity among the main competitors (notably India and Bangladesh) against the backdrop of vaccinations and a slowdown in Covid cases.
Finally, workers’ remittances are expected to remain strong, as the main drivers (shifting to formal channels, incentives for banks and OTAs, etc.) will still be in place. In addition, progress on the IMF program would contribute to continued inflows of foreign currency from external sources, while promoting greater balance of payments stability.
Copyright Business Recorder, 2021