TAHIR AMIN
ISLAMABAD: Asian Development Bank (ADB) has projected GDP growth for Pakistan at 5.6 percent in the current fiscal year which will decline to 5.1 percent next year as balance of payment constraints would outweigh improvements to supply-side factors such as improved security and energy supply.
In its latest Asian Development Outlook (ADO) 2018, the ADB maintains that Pakistan must address fiscal challenges, and revive exports to sustain growth. Securing adequate financing to contain the drawdown in foreign exchange reserves is a concern. Addressing fiscal and external imbalances and revitalizing exports are also major challenges for the government now and following national elections in 2018, states the report.
GDP growth is expected to accelerate to 5.6 percent on strong prospects for large-scale manufacturing and crop harvests for a second year in a row, continued buoyant domestic demand, including from China Pakistan Economic Corridor (CPEC) and other infrastructure investments, strengthened economic growth globally that will revive exports, much improved power supply, and commodity prices that are still broadly favorable despite a further double-digit increase in the oil price.
While the budget deficit may moderate slightly in fiscal year 2018 from a year earlier, spillover from higher investment expenditure is expected to widen the current account deficit.
Growth in fiscal year 2018 is being led by large-scale manufacturing, which expanded by 6.3 percent in the first 7 months of fiscal year 2018 from 3.6 percent in the same period last year. This improvement was largely from solid expansion in cement, iron, and steel products that reflect higher demand from construction on public infrastructure projects.
Higher domestic demand was indicated by sharp expansion in consumer goods such as automobiles and electronics. Recovery in engineering, petroleum products, and rubber also contributed to growth, which is expected to continue in light of a favorable demand outlook.
Provisional estimates for major winter crops suggest strong agriculture in fiscal year 2018 for a second year in a row, supported by increased cultivated area, fertilizer use, and credit. However, the wheat crop is expected to be slightly below target with reduced sown area. Food inflation was 2.2 percent in the first 8 months of fiscal year 2018, well below that in the year-earlier period, as abundant agricultural supplies held headline inflation to 3.8 percent even as nonfood inflation rose to 5 percent.
Currency depreciation and the transmission of rising international oil prices to the domestic market are expected to boost inflation in the second half of the year, generating average inflation at 4.5 percent for all of fiscal year 2018.
Inflation is projected to accelerate marginally to 4.8 percent in fiscal year 2019 reflecting increase in global oil prices and Rupee depreciation against major currencies.
The consolidated government budget for fiscal year 2018 envisages a fiscal deficit equal to 4.1 percent of GDP, much narrower than the 5.8 percent deficit in fiscal year 2017.
Higher tax collection and further rationalization of current expenditure are expected to allow capital expenditure of 6.3 percent of GDP while meeting the fiscal deficit target.
Budget expenditure grew by 14 percent in the first half of fiscal year 2018 on increases in both current and development expenditures. Tax collection rose by 16.4 percent, and total revenue including non-tax revenue by nearly 20 percent. Higher tax revenue and $2.5 billion in proceeds from a $1 billion Sukuk and a $1.5 billion euro bond issued in November 2017 contained government domestic borrowing for budgetary support. If this momentum continues in the second half of the year, the budget deficit may be held below 5.8 percent of GDP.
The current account remained under pressure in the first 8 months of fiscal year 2018 as the deficit rose to $10.8 billion, or 4.8 percent of estimated GDP for the period, from $7.2 billion in the year-earlier period. The deficit expanded on larger imports that widened the trade deficit despite a strong revival in exports.
During the fiscal year 2004-2011, exports grew by 10.7 percent per year; since then exports have declined by an average of 2.6 percent annually. Over the past decade, exports as a share of GDP have contracted from 11.2 percent in 2007 to 7.2 percent in 2017, far below the 28 percent average in developing Asia. The circumstances that caused exports to deteriorate have undermined economic growth, beyond directly worsening the country’s external position.
Various structural weaknesses undermine Pakistan’s trade performances. In particular, weak logistics and trade facilitation, including customs procedures, add to transaction costs.
In Doing Business 2018, the World Bank ranked Pakistan 171 out of 189 economies in ease of trading across borders. Further, business in general suffers under a tax structure with multiple taxes and high rates. The time required to prepare and pay taxes disadvantages business in Pakistan more than in peer developing economies.
A simple average of most favored nation applied tariff rates stood at a high level of 12.1 percent in 2016.
In addition, the overvalued domestic currency is also thought to hold down exports. The Pakistan rupee has appreciated by 20 percent in real effective terms since fiscal year 2011, as exports fell by 17 percent.
Evidence suggests that supply-side factors—including workforce skills, the business environment, and infrastructure factors, especially power supply and logistics—significantly limit export performance.
To address these issues, the government is preparing a medium-term framework on trade policy that will be implemented over the next 5 years. It aims to revitalize exports by promoting investment and resolving trade facilitation, e-commerce, and tariff issues.
These reforms are steps in the right direction and align with large CPEC investments now improving infrastructure and connectivity.
The ADO maintained both efforts are essential to facilitate Pakistan’s integration into global value chains and production networks. In addition, the government should consider other reforms: greater exchange rate flexibility, enforcing industrial compliance with quality control and other standards, operationalizing a national single window for trade, skills development that aligns with industry demand, and instituting legal and institutional frameworks to support new industries such as information and communication technology services.
Exports revived to grow by 12.2% in the first 8 months of fiscal year 2018. Large increases in food exports (mainly sugar and rice), readymade garments and knitwear, leather manufactures, and chemical and pharmaceutical products accounted for the bulk of the rebound.
Despite new regulatory duties, imports grew by 17.3 percent in the first 8 months of fiscal year 2018, slightly faster than in the comparable period of fiscal year 2017 to meet sustained domestic demand and the continued large import needs of infrastructure projects reflected in double-digit growth in machinery, metals, and vehicles. Imports of petroleum products were especially large because of higher prices, accounting for a third of the rise in imports.
In the remainder of fiscal year 2018, the current account deficit should be reined in by the lagged effects of adjustments to regulatory duties, currency depreciation and credit tightening in January, and the favorable external environment for exports. However, with increased seasonal spending on infrastructure projects, the current account deficit will likely edge up a bit, to equal 4.9 percent of GDP.
The central bank raised its policy rate by 25 basis points to 6 percent in its January 2018 monetary policy statement and maintained it at that level. While credit growth slowed in the first 8 months of fiscal year 2018 from the year-earlier period, demand pressures have kept imports high, and the resulting steady drawdown of foreign exchange reserves indicates a need for policy tightening.
Other concerns were the rise in global oil prices and a firming outlook for higher interest rates in the US and global capital markets. In a departure from past policy, the central bank has permitted greater flexibility in determining the Pakistan rupee–dollar exchange rate since December 2017 and by the end of March 2018 the rupee had depreciated by 9.2 percent.
Flexibility in determining the rate will help mitigate eroded competitiveness indicated in recent years by appreciation in the index of the real effective exchange rate.
Remittances, the traditional off set to the trade deficit, grew by 3.4 percent in the period, reversing a decline a year earlier, but had only a limited impact on the current account.
Net financial inflows increased by about 14 percent from the year-earlier period. Filling the financing gap required a drawdown of $3.9 billion in foreign exchange reserves to $12.2 billion.
The amount of foreign financing available in the final months of fiscal year 2018 will determine any further pressure on foreign exchange reserves. The preliminary projection for the current account deficit in fiscal year 2019 is 4.5 percent of GDP, with somewhat slower growth but continued implementation of CPEC projects. Successfully financing these large investments will require the government to pursue real structural reform.
“Pakistan’s economic prospects in the coming years remain positive if budget and current account deficits are reduced and exports are rejuvenated by improving the country’s competitiveness,” said Xiaohong Yang, ADB Country Director for Pakistan. Pakistan can maintain a stronger growth trajectory through domestic and regional stability, improving overall competitiveness, revitalizing public sector enterprises, as well as timely completion and effective use of infrastructure projects.
