The overall slowdown in the US economy is showing a
turnaround but the recent decision by the Fed to continue to keep
interest rates low likely to hit Pakistan economy: Among the major
sufferers will be indicators like GDP growth, foreign investment,
exports and balance of payments. This downturn in the US was triggered
by the cycle of rate cuts by the US Fed over the past two years and tax
cuts introduced soon after that.
Recent reports suggest that while the economy is
recovering the labour market is suffering badly and economists wonder if
this coupled with fast economic growth could fuel inflation.
Pakistan is just one of the several economies that
will be affected by this and growth in emerging Asia has already
weakened as a result of the economic slowdown in the US and higher oil
prices. We can expect the effect to be most prominent in the newly
industrialized economies (NIEs) and Asian countries, particularly those
where the process of corporate and financial restructuring has lagged.
It is clear that the pattern will have important
ramifications for the global economy, including Pakistan. Because of the
composition of Pakistan's GDP where agriculture accounts for a
significant for 25 percent of the total, aggregate growth is not as
synchronised with the global economic cycle as one may expect.
As can be expected, however, there is a greater
degree of correlation between Pakistan's exports and global and US
economic cycles. On a single-country basis, the US is Pakistan's largest
export market, accounting for roughly 25 percent of its export receipts.
Further exacerbating the vulnerability of our exports is the fact that
the European Union (EU) accounts for 30 percent of total exports (the
largest destination as a region), which itself has been significantly
correlated to the US economy in the past. Thus, a possible slowdown in
the US is likely to have a knock-on impact on the EU and Japan as well,
ranging from moderate to mildly severe. The magnitude of the effect on
the global economy will depend on the extent and duration of the
slowdown in the US. It should be noted that the cycle of aggressive
easing of US interest rates by the Fed, is likely to keep the economy
from decelerating a bit longer.
However, in the short/medium-term, this effect on
Pakistan may be countered to a significant extent, by the fact that the
recent appreciation of the Euro against the US currency, if sustained,
is likely to translate into an improvement in the competitiveness of
Pakistan's exports to the Euro-zone (which is a larger destination as an
export market). On the positive side, a slowing down of the global
economy will almost certainly precipitate a softening of international
commodity prices such as oil and cotton. In the case of the former, this
will be good news for countries such as Pakistan, which are heavily
dependent on oil imports. However, in the case of a softening of cotton
prices, Pakistan's export receipts from textile exports may be hurt.
The individual export sectors most vulnerable to a
recession in the US are the ones with a high degree of direct sales to
US-based companies. Using this benchmark, the following items/sectors
fall into this category (with relative approximate share in total USD
export earnings within parentheses): 1)
Knitwear/hosiery (50 percent); 2)
Cotton made-ups (50 percent); 3)
Readymade garments (40-45 percent); 4)
Towels (50 percent); 5)
Medical products (45 percent); and 6)
Bedwear (25 percent).
The next level of vulnerability is for those
categories whose export markets are themselves positively correlated
with the US, or for which there is a derived-demand originating from
US-based companies. On the basis of available data, the latter cannot be
reasonably estimated. For the former, we are using a stylised assumption
that the EU, Japan and Hong Kong economies have a fairly high positive
correlation with the US economy.
On this basis, using a benchmark of 25 percent of
total exports being routed to any one of these markets, the following
items/sectors fall into this category (with relative approximate share
in total USD export earnings within parentheses): 1)
Cotton yarn (50 percent); 2)
Cotton fabrics (25-30 percent); 3)
Leather apparel & clothing (40-45 percent); 4)
Sports goods (40 percent).
On balance, the effect of the former is likely to
outweigh the impact of the latter development, translating into a slight
easing of pressure on Pakistan's external account in aggregate terms.
This is predicated on the experience of previous episodes of recession
in the US economy, where the international price of oil fell drastically
as compared to cotton. From the perspective of the exchange rate, it has
already triggered a weakening of the US dollar in international markets,
which should provide a reprieve to the Pakistan rupee. For
import-dependent corporate importing in USD terms, this may lead to a
slight easing of cost pressures as well as a reduction in liquidity
strain. Finally, the cycle of interest rate cuts in the US will
eventually be followed by cuts in key interest rates in the Euro-zone,
as well as in benchmark rates such as Libor. This will alleviate the
debt servicing costs on those contracts which are benchmarked to any of
Growth is expected to be relatively well maintained
in China and India. In China, a gradual shift to a more neutral fiscal
policy stance is appropriate given the considerations of medium-term
sustainability. In India, the easing of the monetary policy should be
supported by continued improvements in the environment for private
investment and substantial reduction, over the medium-term, in the
overall public deficit.
The world outlook remains subject to considerable
uncertainty and a prolonged and deeper downturn is clearly possible.
Against this background, macro-economic policies, particularly on the
monetary side, will need to be pro-active to guard against the
possibility of a steeper than expected downturn.