Economic impacts of the floods

The rate of inflation may rise between 17 and 19% - virtually double the rate projected prior to the floods.

The floods in Pakistan have caused unprecedented devastation. Almost one-fifth of the land area of Pakistan is under water and 20 million people have been displaced. There has been extensive damage to infrastructure, housing and standing crops. While estimates of the damage by the World Bank and the Asian Development Bank are awaited, some attempts have already been made to quantify the impact of the floods on Pakistan’s economy. According to one extreme estimate by the ministry of finance, there could be zero GDP growth in 2010-11 and inflation could rise sharply to 25 per cent.

At the start of the current fiscal years, the Annual Plan envisaged a continued process of recovery of the economy with the GDP growth rate rising to 4.5 per cent and the inflation rate to 9.5 per cent. According to the model, post-floods, the growth rate could now fall to below one per cent. The damage to major crops like cotton, rice and sugarcane could lead to a big fall in the value added by the agriculture sector of almost eight per cent. Industrial growth will be limited to below four per cent by the negative impact especially on agro-based industries like textiles and sugar. The services sector may grow by less than three per cent because of the lower volume of domestic trade and bottlenecks in the transport sector due to the damage to infrastructure. Both private investment and per capita consumption are expected to register declines. The potential loss to GDP is almost $7 billion or over Rs600 billion.

The rate of inflation is expected to rise to between 17 per cent and 19 per cent, virtually double the rate projected prior to the floods. Contributory factors are supply shortages of basic food items including food grains, vegetables and livestock products, faster expansion in money supply (including borrowings from the SBP) to finance the expected higher fiscal deficit and the likelihood now of a somewhat faster depreciation of the rupee. Of particular concern is the prospect of food prices rising by up to 25 per cent with severe impact on poverty levels.

There is a danger that macroeconomic imbalances could rise once again to the near-crisis levels of 2007-08. Given the need for higher outlays initially for relief and rehabilitation, the total expenditure by the federal and provincial governments in 2010-11 could be over Rs150 billion higher in relation to the original budgeted levels, even if there is some cutback in the regular PSDP and funds are diverted for reconstruction. Tax revenues will also be lower due to slower expansion in the tax bases, especially of manufacturing. The fiscal deficit could approach seven per cent of GDP and, even in the presence of larger aid inflows, necessitate substantially larger SBP borrowings.

The current account deficit in the balance of payments was originally projected at about 3.5 per cent of GDP in the Annual Plan. It could now approach five per cent of GDP due to contraction in exports of rice and textiles and significantly higher imports of food items. However, the capital account could improve in the event of higher aid inflows and emergency IMF assistance.

With the growth process interrupted by floods, the employment situation is likely to worsen considerably. The unemployment rate may exceed 10 per cent in 2010-11. Coupled with the precipitous increase in food prices, 68 million people or over 40 per cent of the population may fall below the poverty line, including a large proportion of those displaced by the floods.

The economic prospects are indeed very depressing. The economic managers of the country will have to develop an effective strategy of not only mobilising and disbursing resources for the relief and rehabilitation and for the subsequent large-scale reconstruction effort but also for providing some protection to the general population affected by rising unemployment and exploding food prices.

Published in The Express Tribune, August 31^st, 2010.