ISLAMABAD-The ministry of finance has noted that inflation outlook has deteriorated, and there is heightened risk to external stability.
“In Pakistan, the inflation rate has been volatile in recent years, influenced by various factors such as currency devaluation, energy, and food prices in global market. The Pakistani rupee has experienced significant depreciation in recent years, influenced by various risk factors such as trade imbalances, external debt, political instability, and global economic conditions,” the ministry of finance said in Fiscal Risk Statement FY2023-24.
The State Bank of Pakistan (SBP) is actively responding to increasing inflation by raising the policy rate. Moreover, the government is also focusing on taking effective policy, administrative and relief measures to control inflation and stabilize the economy. A slow but steady recovery of the economy is expected. According to provisional estimates of Pakistan Bureau of Statistics, Pakistan’s real GDP growth rate is 0.29 percent in FY2023. Over the medium-term, growth is expected to rise to the levels even higher than five years (FY2018-FY2022) average growth rate of 4.0 percent and eventually reach to 5.5 percent in FY2026. A gradual decrease in the inflation rate due to improvement in domestic and global factors and PKR stabilization are expected over the medium term.
The pace of economic activity during FY2023 has been significantly constrained due to several factors, such as demand compression measures, losses in agricultural production caused by floods, uncertainty regarding the resumption of the IMF program, a difficulty in meeting external financing needs and maintaining foreign exchange reserves. The inflation outlook has deteriorated, and there is heightened risk to external stability. The uncertainty surrounding the future adjustment path in energy prices is the main upside risk to the inflation outlook. However, a potential moderation in international commodity prices may contribute to a reduction in inflation. Further, exchange rate adjustments, passing on the impact of energy price increases, and interest rates on higher side would enable the prices to decline over the medium term. Subsequently, it would follow the expansionary monetary policy and improvement in fiscal space in view of decline in mark-up payments. As such, the stabilization measures taken during the last one year can bring macroeconomic and fiscal benefits in the medium-term.
During the first half of the current fiscal year, there was a noticeable decline in average international oil prices, which is expected to continue soon amidst concerns of a global recession. The government has forecasted a reduction in the current account deficit to USD3.7 billion in FY2023, which appears feasible. However, this projection is subject to certain risks. A more significant than expected slowdown in global demand could have a negative impact on Pakistan’s export outlook and workers’ remittances. Furthermore, global, and domestic uncertainty also pose a downside risk to this forecast. On the upside, a larger than anticipated slowdown in domestic demand or a relatively sharp fall in global commodity prices could improve the current account deficit and reduce fiscal risk.
The government aims to reduce the fiscal deficit by implementing measures such as expanding the tax net, rationalizing subsidies, and promoting economic growth. However, the challenge of rising debt servicing could hinder the reduction of the fiscal deficit. Three scenarios (depicting macroeconomic risks) are simulated to analyze fiscal risks. The scenario 1 projects/simulates the reactions of revenues, expenditures, and fiscal deficit in a situation where government can have access to low-cost availability of financing options (reduction of 2 percentage points of interest rate on external debt and 4 percentage points in domestic currency interest rate). It is expected that the net federal revenues will remain at 6.7 percent of GDP, federal expenditures will eventually reach 9.7 percent of GDP whereas federal fiscal deficit will touch 3.0 percent of GDP.
The scenario 2 elaborates the responses of revenues, expenditures, and fiscal deficit to reduction of 50 percent in non-tax revenues against baseline projections. The net federal revenues will decrease to 5.3 percent of GDP, federal expenditures will remain at 10.6 percent of GDP, and federal fiscal deficit will increase to 5.4 percent of GDP. The scenario 3 highlights the reactions of revenues, expenditures, and federal fiscal deficit, if growth rate remains below the projected rate by 0.5 percent every year in the medium term.
By FY2026, the net federal revenues, federal expenditures, and federal fiscal deficit will remain at 7.1 percent, 11.0 percent, and 3.9 percent respectively. Federal fiscal deficit is more sensitive to low non-tax revenue collections than decrease in interest payments or GDP.
The Government of Pakistan has initiated several policy reforms to restore fiscal discipline and debt sustainability, safeguard monetary and financial stability, and maintain a market determined exchange rate (to rebuild foreign currency reserves). Key initiatives to manage macroeconomic shocks include the following restrictive monetary policy through higher interest rates, both to reduce inflation and help address external imbalances – monetary tightening has resulted in 8.75 percent increase in the policy rate since April 2022. Tighter fiscal policy (restricting current spending and mobilizing tax revenues) to create fiscal space for social protection and enhancing public debt sustainability. Amendment to the FRDL (Amendment) Act (2022), that establishes the Debt Management Office (DMO) in the Ministry of Finance, to consolidate external and domestic borrowing. Targeted transfer programs aimed at reducing poverty and protecting the most vulnerable. The piloting of a Treasury Single Account (TSA), the first stage of the implementation of reforms to cash and debt management. Close oversight of the banking system and decisive action to address undercapitalized financial institutions. Continued commitment to a market-determined exchange rate, to absorb external shocks, maintain competitiveness, and rebuild international reserves. Improving the business environment, including by creating a fair-and-level playing field for businesses, investment, and trade.
Challenge of rising debt servicing could hinder reduction of fiscal deficit