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Deficits threaten Pakistan’s financial outlook in 2018

According to World Bank’s forecasts, owing to improved security and energy supply situation, economic growth in Pakistan is expected to increase from 5.2 percent in FY2017 to 5.5 percent in FY2018. This is contingent on the fact that growth among the world’s seven largest emerging market economies is forecasted to increase and exceed its long-term average by 2018. Recovering activity in these economies should have significant positive effects for growth in other emerging and developing economies.

After a prolonged slowdown, recent acceleration in activity in some of the largest emerging markets is a welcome development for growth in their regions in particular and for the global economy in general. Now is the time for emerging market and developing economies to assess their vulnerabilities and strengthen policy buffers against adverse shocks. Pakistan should seize this moment to undertake institutional and market reforms that can attract private investment to help sustain growth in the long-term by investing in people and building resilience against overlapping challenges.

Although growth in Pakistan has improved in FY2017 mainly on recovery in agriculture and manufacturing sectors, the government needs to address fiscal and external sector vulnerabilities that have reappeared with the wider current account deficit, falling foreign exchange reserves, rising debt obligations, and consequently greater external financing needs. This is further validated by Asian Development Outlook report that warns Pakistan’s external sector situation could become unsustainable due to a lack of policy actions. At present, however, official foreign currency reserves can still cover the current account deficit and external debt payments.

In 2017-18, the reserves are expected to be slightly below the sum of the current account deficit and scheduled debt repayments, creating an external financing need. Since the IMF program came to an end a year ago, external economic indicators have started to deteriorate. The current account deficit has doubled to 4 percent of GDP or $12.1 billion, which should ring alarm bells in the concerned quarters of the government. Mounting debt and deficits in Pakistan is raising the prospect that an abrupt rise in interest rates or tougher borrowing conditions might be damaging.

The current account deficit is expected to remain high in fiscal year 2018, projected at 4.2 percent of GDP, with rising imports, declining remittances, and stagnant exports. Imports are expected to continue to increase as growth spurs domestic demand that domestic production cannot meet. Financing Pakistan’s burgeoning trade deficit remains a key challenge as remittance inflows, however substantial, continue to fall. Worker remittances have shown some unexpected improvement, however, in the first 2 months of fiscal year 2018, increasing by 13.2 percent from the same period in fiscal year 2017. If this rebound can be sustained for the rest of fiscal year 2018, it may ameliorate the projected deficit. The share of exports in GDP nearly halved from 13 percent in fiscal year 2006 to a dismal 7.1 percent in fiscal year 2017. Exports fell annually by 2.5 percent on average from fiscal year 2013 to fiscal year 2017 due to lack of competitiveness and bad conditions for modernizing investment, leaving persistently low value addition to fetch low unit prices.

Stability of global commodity and food prices and pick up in global manufacturing and trade has risen market confidence. However, persistent policy uncertainty could dampen confidence and investment. Further, new trade restrictions could derail the welcome rebound in global trade. Over the longer term, persistently weak productivity and investment growth could erode long-term growth prospects in Pakistan that are key to poverty reduction.

Pakistan has important strategic endowments and development potential. The increasing proportion of Pakistan’s youth provides the country with a potential demographic dividend and a challenge to provide adequate services and employment. In the near future, the government must carefully manage external debt, the balance of payments and their financing requirements, while instituting macroeconomic and structural reforms to support economic stability and expansion as well as to make Pakistan more competitive and fiscally sustainable. This has become increasingly important given the increasing government and CPEC-related repayment obligations.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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