As hopes are building for easing of lockdown, which should not continue for indefinite period, it is necessary to evaluate the prevailing situation and come up with our own homegrown plan. One of the positive points is, this time International Monetary Fund (IMF) and other multilateral financial institutions are more than willing to extend help to every country, Pakistan is certainly not an exception. The latest assessment of IMF of Pakistan’s economy lays out immediate economic fallout from COVID-19, as well as provides initial guidance on program modalities once conditions become normal.
It is necessary to examine the key takeaways. The lender of last resort expects the economy to contract by 1.5%YoY in FY20 as against an estimate of 2.4%YoY growth previously. It is for the first time ever since the 1950s – primarily due to voluntary and government mandated social distancing measures to contain the spread of the virus, with accompanying impact on the fiscal (negative) and current account (positive) of 2% of GDP and 0.6% of GDP, respectively.
Going forward, fiscal and energy chain will remain key focus areas under the EFF, with the fund looking for a massive additional revenue effort of 3.3% of GDP in FY21 while projecting fiscal deficit to decline to 6.5% of GDP as against 9.2% of GDP projected for FY20. While the fund’s inflation estimate (year-end) of 9.8%YoY and overall tone imply limited room for further cuts, particularly after the latest 200bps reduction in interest rate, analysts do not rule out further monetary easing, given the high level of uncertainty, benign inflationary backdrop and improved external account position following G20 debt relief and funding commitments by multilateral financial institutions.
The Fund estimates an incremental fiscal cost of 2% of GDP from COVID-19 in FY20, with a hit from tax revenue loss and elevated social spending, partially offset by a cut in development spending and savings from debt servicing. The IMF now expects fiscal deficit of 9.2% (2.7% of GDP) as against 7.2% (0.7% of GDP) previously. While FY21 estimates may later be subject to revision considering the high level of uncertainty at this stage, the same provides initial guidance on type and scale of potential fiscal adjustment under the EFF. The IMF looks for generation of additional revenue of Rs1.5 trillion (3.3% of GDP) in FY21 — a whopping 34% increase as compared to FY20. On the expenditure side, FY21 estimates imply the need for adoption of strict fiscal discipline, with a mere 8%YoY increase assumed in current expenditures (excluding defense and debt servicing and adjusted for one-offs in FY20). Development spending is projected to increase but still remain on the lower side (2.8% of GDP as against an average 4% of GDP during FY17-19).
On the external side, the IMF’s assessment is a bit optimistic. The Fund estimates net savings of US$1.57 billion in the current account in FY20, with savings from a decline in imports and less profit repatriation more than compensating for a decline in exports and remittances. The Fund assumes a relatively moderate decline in exports, roughly equivalent to one month of exports. Nonetheless, even assuming a more drastic decline in exports, near term impact remains manageable. Over the medium term, the impact would be negative as being highlighted by analysts. The Fund also estimates net negative impact of mere US$0.58 billion compared to the baseline estimate of FY21. From a Balance of Payment vantage, while the shock has increased immediate financing needs by US$2/1.2 billion in FY20/FY21, the external conditions remain manageable considering the mobilization of funds from multilaterals (IMF/WB approved US$1.4/US$0.2 billion, while additional US$0.8 billion each is in pipeline from World Bank and Asian Development Bank) and debt relief from G20 countries (though Pakistan has yet to make a formal request, the relief would be US$4.5 billion, 32% of total repayments in FY21) assuming an 8-month period and going by IMF’s estimates, though actual repayment and relief may differ based on a varying understanding with bilateral institutions.
The IMF’s inflation estimate for year-end at 9.8% and the tone in detailed document imply that the space for further monetary action is limited. While the latest 200bps rate cut has clearly narrowed the room for further easing, analysts do not rule further monetary action yet for three reasons. First, there is a high level of uncertainty at this stage, the longevity and extent of the crisis and subsequent economic fallout is not known yet. Therefore, both longer and higher than expected fallout may necessitate further monetary policy easing. Secondly, the inflation albeit temporarily is falling sharply due to a steep decline in consumption, plunge in commodity prices, and scrapping of utility adjustment, creating space for further reduction in interest rates. Analysts see headline inflation to average around 7.02%YoY over the next six months. For April 2020, they expect inflation to be around 8.55%YoY as against 10.2%YoY in the preceding month and 8.30%YoY for April 2019. Finally, improving external account position, following mobilization of funding from multilateral institutions and debt relief from G20 countries also provides room to take further action, if needed.