By: Dr Hafiz A. Pasha
What the new year holds for the country?
he year 2018 ended with a hangover of uncertainty on the economic, political and social fronts. Consequently, the outlook for 2019 is seen with some trepidation. Will the incipient domestic financial crisis finally be overcome or will there be a veritable collapse on the economic front? Will the political temperature cool down and joint efforts made to introduce legislation for implementation of many of the needed structural reforms? Will the process of accountability proceed in a just and proper way and lead to visibly less corruption? These are some key elements characterizing uncertainty about the prospects for 2019.
However, before the domestic economy is focused on, there is a need to look at the likely global and regional developments. Pakistan’s economy will be directly impacted by the prospects for global trade, the trend in oil prices, FDI and other capital flows. The IMF’s World Economic Outlook and other international institutions present a mixed perspective on the global economy in 2019. They expect the growth rate to moderate somewhat; global trade to be impacted negatively by US-Sino trade tensions; exit of funds from emerging capital markets and higher interest rates. The expectation regarding oil is that it will rise from the present level to $65 to $70 per barrel due to some supply cuts by OPEC and Russia, but will remain below the level attained in the middle of 2018. The regional situation may, however, improve with peace overtures by the USA in Afghanistan.
Turning to the domestic economy, it has experienced a substantial slowdown in the latter half of 2018. Industrial production has shown negative growth and many of the dynamic industries in 2017 have lost their buoyancy. The output and planting of major crops have been constrained by the big increase in fertilizer prices and water shortage. Exports have been stagnant despite the large depreciation in the value of the rupee. Construction activity has ebbed because of the big cut in development spending and building restrictions and so on.
Combined with the slowing down of economic activity, there has been an upsurge in the rate of inflation. The Wholesale Price Index is already showing a double-digit rate of inflation and the Consumer Price Index is slowly catching up with a time lag. The fundamental question is whether the economy is now in the grips of ‘stagflation’ or as the months elapse in 2019, the economy will regain some momentum and the price level will stabilize?
The process of economic recovery in 2019 will hinge crucially on an improvement in the rate of private investment and in exports. Also, a positive stimulus could be provided if the Budget for 2019-20 in June this year will restore the level of public development spending, especially in key areas like water, power and CPEC projects.
There is, in fact, one positive indicator since June 2018. Credit to the private sector has expanded at a substantially faster pace and more than trebled in magnitude as of 21st December 2018, in relation to the level last year. This is one of the redeeming features of an otherwise depressing situation. However, here again, there are some mixed signals with import of machinery, excluding that for power generation, down by 13 percent in the first five months of 2018-19.
Perhaps, the most crucial factor that will influence the prospects for 2019 is whether the economy achieves a degree of stabilization or not. Here, the trends continue to be worrying in nature. The fiscal position remains precarious. Tax revenues are showing only low single-digit growth while current expenditure, especially on debt servicing and defence, is demonstrating an exponentially rising trend. The cut in development spending has hitherto been unable to restrict the size of the fiscal deficit. Already by the end of the first six months, the budget deficit is likely to have approached 2.4 to 2.7 percent of the GDP. Domestic bank borrowing, in particular, has shown a big increase of 22 percent. The provincial governments are unlikely to be able to generate large cash surpluses by the end of the year in the presence of very slow growth in transfers. At the current rate, the deficit could approach last year’s deficit of 6.6 percent of the GDP.
Turning to the balance of payments, the situation is somewhat better. The current account deficit in the first five months has declined by 11 percent. However, this has been made possible by some buoyancy in home remittances. The underlying structural problem of a large trade deficit persists. In fact, it has worsened by 5 percent up to November 2018. The perplexing question is why a devaluation of 32 percent has not been accompanied by an increase in exports. Meanwhile, imports continue to grow, albeit at a visibly lower rate.
Therefore, the area of concern remains the lack of major improvement in the imbalances in the economy in the form of two big deficits. This raises the consequential question of whether Pakistan will be able to finance its imports and external debt repayment obligations on a sustained basis in 2019.
Gross foreign exchange reserves of the SBP are currently at $7.2 billion; barely enough to provide import cover for six weeks. They have fallen by 26 percent since the start of the financial year. This has happened despite the receipt of special assistance from China in July of $2 billion and deposits with SBP from Saudi Arabia of $1 billion in November and December, respectively. Therefore, the underlying position of the balance of payments continues to be adverse. In the absence of this support from friendly countries, reserves would have fallen to only $ 3.2 billion, barely sufficient to provide import cover for only three weeks.
Hopefully, further support from Saudi Arabia, the UAE and China will be forthcoming as promised. This will provide a buffer over the next few months. However, there is still some uncertainty about the sustainability of the balance of payments position up to the end of June 2019.
This brings us to the ultimate question: What will be the relationship of Pakistan with the IMF in coming months? The PTI leadership has indicated that there is no urgency in finalizing the negotiations with the Fund and an agreement will only be reached on terms that are acceptable to Pakistan. This should help in reducing uncertainty but unfortunately it does not. What will happen, say, after June 2019? Will our friends, especially Saudi Arabia, the UAE and China, be willing to provide a second round of substantial assistance? By the end of 2019, repayments against the Saudi oil facility will also start. Therefore, in the event that Pakistan avoids going to the IMF then a draconian process of adjustment will have to be undertaken in the second half of 2019 to preserve the already low level of reserves. There is a finite risk that external payment obligations will become increasingly difficult to honour as the year proceeds. This could lead to a plummeting of the rupee and the beginning of a process of hyperinflation.
However, we have a government that is sensitive to the impact of measures beyond a point on the lives especially of the poor people of Pakistan. As such, there is need to retain some optimism that as 2019 proceeds, there will be the beginnings of an economic turnaround and the quality of life will start improving gradually once again. This will be facilitated if there is a degree of improvement in the political environment, good governance, reforms which impact more on the relatively better off and, hopefully, a more supportive international and regional environment. We hope and pray that the worst will be over by the end of 2019.