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Pakistan’s economic on the resilience track

The Pakistan’s economy has been characterized as unstable and highly vulnerable to external and internal shocks. However, the economy proved to be unexpectedly resilient in the face of multiple adverse events.

The economy of Pakistan is the 22nd largest in the world in terms of purchasing power parity (PPP), and 45th largest in terms of nominal gross domestic product. Pakistan has a population of over 220 million giving it a nominal GDP per capita of $1,186 in 2020-21, which ranks 154th in the world and giving it a PPP GDP per capita of $5,839 in 2019, which ranks 132nd in the world for 2019. However, Pakistan’s undocumented economy is estimated to be 36% of its overall economy, which is not taken into consideration when calculating per capita income.

GDP growth

Last year, Pakistan economy contracted for the first time in 68 years by registering 0.4 percent negative growth due to outbreak of the Covid-19 pandemic. It posted 1.9 percent growth in fiscal year 2018-19 compared to a record-high 5.8 percent GDP growth in 2017-18. The real GDP growth is estimated to have declined from 1.9 percent in FY19 to -1.5 percent in FY20. The first contraction in decades, this reflects the effects of Covid-19 containment measures that followed monetary and fiscal tightening prior to the outbreak.

The services sector is estimated to have contracted, by over 1%, while industrial production is expected to have declined even more, due to the high policy rates prior to the pandemic and plunging domestic and global demand thereafter. The agriculture sector, partially insulated from the effects of the containment measures, is estimated to have expanded modestly over the year.

Household consumption

On the demand side, private consumption is estimated to have contracted in FY20, as households reduced consumption amid the lockdown and dimmer employment prospects. Similarly, with heightened uncertainty, disrupted supply chains and a global slowdown, investment is estimated to have fallen drastically. Exports and imports also shrank given weaknesses in global trade and domestic demand. In contrast, government consumption growth rose, reflecting the rollout of the fiscal stimulus package to cushion the effects of the pandemic.

Despite weak activity, consumer price inflation rose from an average of 6.8 percent in FY19 to an average of 10.7 percent in FY20, due to surging food inflation, hikes in administered energy prices, and a weaker rupee, which depreciated 13.8 percent against the US dollar in FY20. With elevated inflationary pressures, the policy rate was held at 13.25 percent from July to February but was subsequently lowered to 7.0 percent over the remainder of FY20 to support dwindling activity and as inflationary expectations fell amid the pandemic. The central bank also implemented multiple measures to provide liquidity support to firms. At end-FY20, the banking system remained well capitalized, though upticks in non-performing loans were beginning to erode capital buffers.

Current account deficit

The current account deficit shrunk from 4.8 percent of GDP in FY19 to 1.1 percent of GDP in FY20, the narrowest since FY15, driven mainly by import values falling 19.3 percent. Total export values also contracted 7.5 percent due to weak global demand. Despite the global downturn, workers’ remittances increased relative to FY19, underpinning a wider income account surplus. Meanwhile, higher net foreign direct investment, and multilateral and bilateral disbursements, more than offset a decline in portfolio flows, leading to a larger financial account surplus. The balance of payments consequently swung to a surplus of 2.0 percent of GDP in FY20, and official foreign reserves increased to US$13.7 billion at end-June 2020, sufficient to finance 3.2 months of imports.

Fiscal deficit

In FY20, the fiscal deficit narrowed to 8.1 percent of GDP from 9.0 percent in FY19. Total revenues rose to 15.3 percent of GDP due to higher non-tax revenue, as the central bank and the telecommunication authority repatriated large profits. Despite reforms, tax revenues slipped to 11.6 percent of GDP, with lower economic activity and larger tax expenditures. Expenditures rose mainly due to a fiscal stimulus package valued at around 2.9 percent of GDP, while the public debt, including guaranteed debt, increased to 93.0 percent of GDP by end-FY20.

Pakistan has achieved steady growth since 2013 in the aftermath of a credit facility agreement with the IMF. Economic growth slowed in 2019 due to measures taken by the authorities to address macroeconomic imbalances. In 2020, Pakistan’s economy collapsed due to the COVID-19 outbreak, reporting a negative growth balance of 0.4%. According to the IMF’s October 2020 forecast, growth is expected to resume in 2021, estimated at 1% of GDP, and stabilize in 2022 at 4%. In its most recent January 2021 update of the World Economic Outlook, the IMF revised its GDP growth projections for Pakistan to 1.5% in 2021 and 4% in 2022.

Impact of covid-19

The partial lockdown was imposed in March 2020; which includes restrictions on air travel, inner-city public transport, religious/social gatherings and the closure of all schools and non-essential businesses. It was gradually eased from May 2020 onwards. This disrupted domestic supply and demand, as businesses were unable to operate and consumers curbed expenditures, which specifically affected services and industries.

As a result of this pandemic, private consumption is estimated to have contracted in FY2020 and investment to have fallen sharply. Exports and imports have also declined due to weak global trade and domestic demand. In contrast, growth in government consumption increased, reflecting the launch of the fiscal stimulus package to cushion the effects of the pandemic. Public debt has risen to 87.2% of GDP in 2022, but is expected to fall slightly to 86% in 2021 and 82.1% in 2022. In 2020, the fiscal deficit narrowed to 8.1% of GDP from 9.0% in 2019. Total revenues rose to 15.3% of GDP due to higher non-tax revenues, as the central bank and the telecom authority repatriated large profits (World Bank). The current account deficit narrowed from 4.9% of GDP in 2019 to 1.1% of GDP in 2020, the narrowest since 2015, driven mainly by a 19.3% decline in the value of imports. Total export values also contracted by 7.5% due to weak global demand. The IMF expects the current account deficit to widen slightly to 2.5% in 2021 and 2022. Despite weak activity, consumer price inflation rose from an average of 6.7% in FY 2019 to an average of 10.7% in FY 2020, due to surging food inflation, hikes in administered energy prices, and a weaker rupee, which depreciated 13.8% against the U.S. dollar in FY 2020. Inflation is expected to fall to 8.8% in 2021 and 7.3% in 2022, according to the IMF’s latest World Economic Outlook (October 2020). The central bank deployed multiple measures to provide liquidity support to enterprises. By the end of 2020, the banking system was still well capitalized, even though the increase in non-performing loans was beginning to erode capital buffers. While domestic economic activity is expected to recover, as lockdown measures are lifted and base effects materialize, Pakistan’s near-term economic prospects are subdued. Significant uncertainty over the evolution of the pandemic and availability of a vaccine, demand compression measures to curb imbalances, along with unfavorable external conditions, all weigh on the outlook. Economic growth is projected to remain below potential, averaging 1.3 percent for FY21-22. This baseline projection, which is highly uncertain, is predicated on the absence of significant infection flare ups or subsequent waves that would require further widespread lockdowns.

There are considerable downside risks to the outlook with the most significant being a resurgence of the COVID-19 infection, triggering a new wave of global and/or domestic lockdowns and further delaying the implementation of critical IMF-EFF structural reforms. Locust attacks and heavy monsoon rains could lead to widespread crop damage, food insecurity and inflationary pressures. Livelihoods for households dependent primarily on agriculture could also be negatively impacted. Finally, external financing risks could be compounded by difficulties in rolling-over bilateral debt from non-traditional donors and tighter international financing conditions.

Unemployment scenario

Pakistan’s unemployment rate increased slightly to 4.5% in 2020, from 4.1% in 2019, due to the negative economic impact of the COVID-19 pandemic. The IMF estimates that the rate will increase to 5.1% in 2021 and stabilize at 4.9 in 2022. The number of people no longer actively seeking work is increasing. The level of underemployment remains very high and much of the economy is informal. While the poverty rate has fallen by 40% over the last two decades to 24.3% in 2015 (latest data available), the IMF predicts a sharp reversal, with up to 40% of Pakistanis living below the poverty line as a result of the COVID-19 pandemic.

Nonperforming loans

The rating agency expects the slow economic recovery to affect loan quality, with nonperforming loans (NPLs) are expected to rise over the coming months from a sector-wide level of 9.9 per cent of gross loans in September 2020. Banks’ foreign operations, export-oriented industries and companies reliant on government payments and subsidies will be hit hardest, but loan repayment holidays and other government support measures should help contain some risks.

Future prospects

It is predicted that Pakistan economy will return to growth during the next fiscal year 2020-21, but economic activity will remain below pre-outbreak levels. However, the economy is expected to modest 1.5 per cent gross domestic product (GDP) growth in financial year 2021. It will return to growth in fiscal year 2020-21, gaining a modest 1.5 per cent and accelerate to 4.4 per cent in 2022. The government and State Bank of Pakistan responses and reforms will partially soften the pandemic’s impact and help revive the economy. Pakistan’s banking system reflects banks’ solid funding and liquidity is improving. The operating environment will weigh on asset quality and profitability. It projects rising asset risk as non-performing loans will rise from a sector-wide level of 9.9 per cent of gross loans as the economic slowdown takes its toll on borrowers’ repayment capabilities. The deposit-based funding and good liquidity buffers also remain strengths, while the probability of government support in a crisis is high, even if its ability to do so is limited by fiscal challenges.

The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. He could be reached at [email protected]

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