Global events can’t wait, pose threat to external account outlook

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Major global commodities’ dilating prices, ticking up global monetary tightening, reviving Saudi facility, IMF-Pakistan Extended Fund Facility (EFF) pending reviews, fragile global economic growth and Russia-Ukraine conflict are posing threat to Pakistan vulnerable external account outlook and cannot wait for the new managers to take their decisions.
Pakistan’s widening current account (CAD) has been putting sustainability at risk, needs immediate steps of reducing nonproductive government expenses, discouraging luxury imports besides encouraging non-traditional exports. CAD conclusively has been widening amid surge in the international commodities prices along with strong domestic demand in addition of delays in taking vigorous steps. It is expected to stretch to $ 17.6bn around 4.8 percent of GDP by the end of current fiscal year, registering increase of $13.2bn for first three quarters of fiscal 2022 against $275mn of the same period last year that roughly that is above previously State Bank projected range of 4 percent of GDP.
Lofty imports bill, primarily owing international commodity prices and domestic demand steered pressure on CAD and the rupee accordingly. It is being assumed that Pakistan may get success in completing seventh review of IMF and subsequently tranche may get release followed by potential inflows from bilateral agreements, expectedly ease-Rupee to recover in near term, may settle around 182/dollar by June this year and then with annual 4 percent depreciation assumption, clocking-in at 186/dollar by December 2022 end.
However, primary global commodities including oil, coal, copper, iron ore, steel, aluminum food items and natural gas have been extending abnormally charged prices during ongoing year. Price trends have kicked off another “Super cycle” shocking everyone as how long prices would take time to sustained spells of surge tied to a period of rapid development. The international oil prices have peaked to a level last seen in 2014 after witnessing an all-time low level in 2020 during outbreak of COVID-19.
Various other macro aspects such as inflation and current account stayed vulnerable to the evolving situation. The upshots of the Russia-Ukraine conflict on the Pakistan’s economy are being borne via higher global commodity prices including oil, LNG, coal and essential food items (such as wheat) as Pakistan is a net commodity importer. The impact of the energy price shock on the main macroeconomic variables can be inferred through a two-step empirical analysis. The first step consists in estimating the effect on the level of domestic prices and subsequently, on the inflation profile.
Among number of factors contributing towards ongoing surge, flouting all expectations such as: i) reemerging oil demand during economic recovery and reopening of travel, ii) few and far restrictions as of new COVID-19 variant, iii) Russia-Ukraine stalemate, iv) OPEC+ adhering to the plan of unrolling production cut only by 400k barrels each month rather than adding more production; and v) oil producers’ knockback to increase output to meet rising demand.
LNG prices pose another risk to domestic economy following depleting natural gas reserves have intensified pipeline gas imports in recent years (393,342btu / 1,078mmcfd in FY21). Significantly, according to estimates, every USD 1/mmbtu increase in RLNG price enhances Rupees 1.08/Kwh of RLNG based power generation that increases overall power generation cost of the country by 0.08/KWh, which is analyzed around 0.6 percent. As per our calculations, every USD 1/mmbtu change in international LNG prices, results in an alteration in import bill by $ 393mn.
Pakistan needs further incentivizing foreign remittances to amplify it as it became the largest source of capital flows into country and expected to remain case in 2022. Geopolitical contexts, lifting of containment measures across the regions and economic imbalances aggravated by uneven global recovery, will stay to be main drivers of related flows. Remittances figured up $ 23bn during first nine months of fiscal22, indicating 7 percent year on increase. Related flows proved to be resilient with monthly average still above the $ 2bn mark since Jun 2020.
Likewise, high demand for technology-related services will endure to be a benefit for Pakistan. However, the growing trade deficit highlights the export-reliant economy’s exposure to soaring commodity and raw material costs, on which manufacturers rely for producing goods at home. Meanwhile, goods import growth is being expected to recover $ 70bn in fiscal 2023 from $ 73bn estimated for fiscal22 amid domestic growth recovery. Accordingly, trade balance is estimated to turn in at $39bn in fiscal 2023 from $45bn of this fiscal.
The successful completion of IMF reviews expectedly would restore confidence of all stakeholders including other multilateral institutions like ADB, World Bank and direct investors that are likely to bring cost of borrowing down via Sukuk and Eurobonds that have spiked in the recent past.
SBP is under pressure with reserves standing at $10.9bn as of 16-Apr, which require buildup of forex reserves to provide the much-needed cushion to ensure import cover stays above three month at least. Moreover, USD is being boosted by safe-haven demand, high inflation and a hawkish Federal Reserve (Fed).
US dollar index may continue marching north following the present circumstance to lift the greenback in fiscal22-23, pushing rupee further down against the greenback. In addition, remittances are expected to play a significant role in reducing the country’s current account deficit due to the fact that the trade balance is expected to remain under pressure this year and domestic demand is viewed to rebound more swiftly. These are being expected to continue witnessing resilience on that front; however, outlook is not without risks.
Moreover, USD is being boosted by safe-haven demand, high inflation and a hawkish Federal Reserve (Fed). If these tailwinds continue to lift the greenback in FY22-23, the US dollar index will continue marching north making PKR weaken further against the greenback.