No signs of economic relief

Govt could avoid trade curbs, allow adjustment in rupee value to reduce deficit

KARACHI:

Alarm bells continue to ring on the economic front as there are signs of little relief in the poor economic conditions engulfing the country.

The State Bank of Pakistan (SBP) increased the policy rate from 15% to 16% in its latest monetary policy decision on November 25, 2022. This decision was primarily due to the inability of policymakers to reduce the inflationary pressures that have proven to be not only stronger but more persistent than their previous expectations.

The SBP believes that the rising inflation will rather become entrenched in the long run if measures are not taken to stem its increase in the short run. It prefers to pay the short-run costs of increasing the policy rate rather than suffering the long-run consequences of a high interest rate.

Furthermore, the SBP states the pressure on the external front will ease in the upcoming months. Although it expects imports of agriculture inputs to increase and exports to decline due to the massive floods in the last monsoon season, the decline in global oil prices and the intensity at which policy rates are increased is likely to reduce the pressure from the current account deficit on Pakistan’s economy.

It is clear that the SBP is expecting favourable outcomes in the global economy to soften the pressure on Pakistan’s economy.

The foreign exchange reserves held by the SBP continue their downward trend. They were at $7.8 billion on November 18, 2022, down from $8.9 billion on October 28, 2022.

The reserves increased by approximately $1.5 billion in the last week of October, but dropped by $1 billion in November.

The official interbank PKR to USD exchange rate is fluctuating around the 223 mark, while the real effective exchange rate was reported at 90 in September 2022.

Although the real effective exchange rate may suggest appreciation of the rupee in respect to the US dollar, the lack of reserves coupled with the role of currency market speculators are likely to trigger a downward trend for the rupee.

Unless the government is able to build its foreign exchange reserves, it is unlikely to manage the influence of currency market speculators and in turn appreciate the rupee value to what it believes is a more desirable level.

The trade deficit, as reported by the Pakistan Bureau of Statistics (PBS), was 40% lower in October 2022 compared to the value in October 2021 as it declined from $3.9 billion to $2.3 billion. Exports dipped by 3.3% while imports fell by 26%.

The trade deficit in the first four months of FY23 was 26% lower than that reported in the same time period of previous year as it declined from $25 billion to $21 billion, again driven primarily by the decrease in imports.

The drop in imports was forced by the imposition of import restrictions and the curtailing of domestic demand. The import curbs, which included import bans and delay in opening letters of credit, created trade friction that has not only impacted imports but also the ability of exporters to sell their products abroad.

For instance, imports of textile machinery decreased by 37% year-on-year in the first four months of FY23, while imports of synthetic fibre decreased by 39%.

PBS also reported a sharp decline in imports of fertilisers that are often critical for the production of agro-based products. Imports of petroleum products and petroleum crude declined by 34% and 23% respectively in terms of quantity.

Exports from Pakistan have only increased slightly year-on-year in the first four months of FY23. Textile group has reported a slight decline, with exports of raw materials and intermediate goods decreasing.

This is likely exacerbated by the recent floods, which have significantly damaged the cotton crop. Exports of bedwear and towels have also declined.

Furthermore, exports of the food group have risen, primarily driven by the increase in exports of fish and fish preparations, meat and meat preparations and vegetables.

Exports of rice, which is the most important agricultural commodity exported by Pakistan, declined by 8% and exports of fruit dropped by 33%.

In essence, the economic conditions may have reduced imports but are also likely to create challenges in relation to exports, particularly if imports of critical raw materials and intermediate goods to produce export products are restricted.

The year-on-year growth in remittances, as reported by the SBP, is also showing a downward trend as remittances decreased by 15.7% in October 2022. The monthly average for FY23 is -5% compared to 6.2% in FY22.

Remittances from Saudi Arabia and the UAE decreased by more than 10% year-on-year in the first four months of FY23.

More than $31 billion was generated in terms of remittances in FY22. This may fall below $30 billion in FY23 if the current trend continues. With economic conditions worsening, the fall in remittances can adversely affect household incomes across Pakistan.

The Business Confidence Index, a joint initiative of the SBP and the Institute of Business Administration (IBA), Karachi, remained in the negative zone in October 2022.

Both the industry and services sector remained negative. Although inflation expectations have slightly decreased, the current capacity utilisation has contracted from 72% in October 2021 to 64% in October 2022.

Rising inflation coupled with the reduction in capacity utilisation is an ominous sign. The large-scale manufacturing index has also shrunk by 0.4% in the current fiscal year, mainly due to the decline in production in the food and automobile industries.

Import restrictions are likely to further exacerbate the economic problems. Hence, policies that promote efficiency in production are much needed. For instance, the government could avoid imposing trade restrictions and allow the value of the rupee to adjust to reduce the trade deficit.

In essence, the economic indicators are showing ominous signs and the government policies are likely contributing to the contraction of production with no signs of economic relief.

The writer is the Assistant Professor of Economics and Research Fellow at CBER, Institute of Business Administration, Karachi

 

Published in The Express Tribune, December 5^th, 2022.

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