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Economy not in control-SBP is required to reduce its discount rate by 100BP in November 22nd 2019 MPS.

Muhammad Arif
Muhammad Arif: Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

While CY 2020 has remained just one month away, the challenges to the macro economy have continued to persist. Specifically, fiscal deficit seems to further deteriorate and while the current account gap has relatively improved, its sustainability is still doubtful.  Meanwhile, CPI inflation averaging at 6.8 percent in the first 9 months of FY19 has already exceeded its 6.0 percent target to reach about 11.5%.for the current fiscal year.

Furthermore, as per provisional national income accounts, GDP growth moderated to 3.3 percent in FY19 from 2.5%. However these figures are doubtful and international agencies still consider it below 3%.

With these backlogs State Bank of Pakistan is going to decide about its monetary policy for the next two months by 22nd Nov 2019. Current SBP rate is 13.25% that is adding up to demand push inflation (cost of production is too high). Further yield curve of the country has gone inverted i.e. 6 month T Bill profit rates are 13.21% whereas PIB of 15 years stands with profit rate of 10.0%. This indicates looming recession. Sensing this SBP should cut its prime rate at least by 100bp making it 12.25%. Whether they do it or not is yet to be seen on 22nd Nov 2019.

These trends expose Pakistan’s structural deficiencies and its vulnerabilities to the buildup of external and internal deficits. Government has only shifted its burden on poor population. Now Assad Umar has been again brought back as Minister for Planning. What he can do is yet to be seen. But Profit on NSS scheme meant for old age people and pensioners have already been cut down by 2%. Even State Bank management has not allowed any increase in pension of its retired employees. Both sides are treating old age people as a burden on this country and are making all out efforts to send them to graveyards as soon as possible.

Demand management measures by the government and SBP has already led to contraction in LSM. At the same time, adverse developments such as water shortages and high input costs undermined the agriculture sector performance.

These developments also contributed to a slowdown in private sector credit during the third quarter of FY19. The overall economic slowdown, along with specific import compression measures, led to a sizeable contraction in country’s import bill ($ 3.64 bil in 1Q FY 2020). Exports managed to post a marginal growth in quantum terms ($ 277 m in 1 Q FY 2020); however, this recovery was not sufficient to offset the adverse price effect stemming from lower unit values. Further improvement in this trade deficit has coupled with decline of workers’ remittances by $ 14 million in 1st Q FY 2020. Moreover slowdown in FDI inflows has kept the external financing requirements at elevated levels.

Thus, while the realized bilateral inflows from friendly countries did provide some support to foreign exchange reserves, its adequacy is still below the three-month of import coverage and the overall BoP position remained weak. In the same vein, fiscal indicators have continued to deteriorate in the first nine months of FY19 despite a steep cut in development expenditures by 34.0 percent. At the same time, interest rate hikes and exchange rate depreciations accentuated the rigidities in the current expenditures. Making things worse, revenue mobilization remained weak due to stagnant tax revenues and steep fall in non-tax revenues. These trends are largely attributed to slowdown in economic activity and lack of tax effort both at provincial and federal level. As a result, the fiscal deficit increased to 8.0 percent of GDP; which suggests that the debt servicing ability has deteriorated sharply and the country would be requiring more debt to service its current debt.

In spite of being in stabilization phase led by demand management policies for the last sixteen months, three challenges still stand out in Pakistan’s economy. First, external sector remains vulnerable. Second, fiscal consolidation remains elusive. Third, inflation continues to attain higher plateaus. This basically suggests that current stabilization agenda needs to be reinforced with deep rooted structural reforms.

First of all the revenue measures announced in FY20 Federal Budget are not allowing the industrial growth to rebound next year. These need to be improved in consultation with traders. Having said that, some support to the GDP growth can possibly come from strong prospects in the agriculture sector, where there is a potential for higher output if the impact of constraints affecting area under cultivation and yields is managed effectively. Early investments in agriculture and SEZs under the CPEC and higher outlay of next year’s PSDP can also have a positive impact on GDP growth in FY20.

As for the current account, the government is projecting the deficit to reduce further in FY20, on the back of an expected better export performance, containment of import payments and rehabilitation of momentum in workers’ remittances. However, downside risks persist in the wake of a slowdown in global economy, attributed to escalated trade war between US-China and uncertainty in Europe. Under these circumstances, increasing exports to the traditional markets may prove challenging. On the financing side, the initiation of the IMF Extended Fund Facility program would help assuage the overall external sector concerns.

Finally, despite monetary tightening, the government is projecting CPI inflation to be higher in FY20. This outlook is largely explained by supply-side factors, such as the upward adjustments in domestic energy prices and recent episodes of PKR depreciation along with their second-round impact, which are likely to increase the cost of production and doing business.

So going forward SBP is required to reduce its Prime rate and government is required to go with above stated reforms.


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