The English saying, “It never rains but it pours” is proving true. It is not only COVID-19, a pandemic that is haunting humanity, but accompanying it is the global economic recession, the worst since the great depression, and a looming food crisis.
In the words of Nobel Laurette Jeffrey Sachs, “We are facing not only a new virus but also a new kind of economic crisis. For the first time in modern economic history, we have deliberately shut down much of the economy to break the transmission of COVID-19”.
COVID-19 has exposed the preparedness of governments across the globe against a pandemic. The U.S., with a score of 83.5, was the readiest nation on the “Global Health Security Index”, yet it utterly collapsed when tested by this pandemic.
Not only the U.S., but in most countries, the pandemic has filled hospitals, broke healthcare systems, shattered economies and emptied public spaces. None of the current head of governments/states in the world would have witnessed the disruption of modern society before on the scale where COVID-19 has led to. Hence, for most of them dealing with this pandemic is “learning by doing”.
The United Nations has warned that Afghanistan, Pakistan, and India may be the next hotspots for COVID-19. One hopes that the UN’s warning does not come true. However, it is too early to predict anything as the disease is still unfolding in South Asia. Having said this, its economic implications are already being felt in South Asia.
Pakistan: Early Signs of Recession with a Negative Growth for the First Time in 68 Years
In the case of Pakistan, the National Accounts Committee (NAC) after its meeting on May 18, announced provisional estimated GDP growth rate of negative -0.4 percent (precisely -0.38 percent) for the outgoing fiscal year against a pre-COVID projection of 2.4% GDP growth. Here it is pertinent to mention that Pakistan’s economy contracts for the first time in 68 years. The only savior of Pakistan’s economy is “agriculture” which is estimated to grow by 2.7% (still missed the target) during this fiscal year, whereas both the industry and service sectors witnessed negative growth rate.
One can argue that fiscal consolidation policies under the IMF program, especially a very high interest rate and efforts for import compression which in turn had affected the supply of raw material for many industries, had already negatively affected the performance of industries and services this fiscal year. However, negative growth of economy can be contributed to COVID-19 as the pandemic affected both the supply as well as the demand side of the economy. Let us see how?
How Has the Supply of Goods and Services Been Affected by COVID-19?
The decision to lockdown the country was rightly taken to gain time for preparation against COVID-19. However, like everywhere else in the world, it had its economic cost. On supply side, the most affected are our small and medium enterprises (SMEs). SMEs have a vital role in Pakistan’s economy; they contribute around 40% to GDP, 40% to exports, 80% to non-agricultural employment, and 35% in total value additions. According to a study by Sustainable Development Policy Institute (SDPI), SMEs faced decline in their income. One in every four SMEs had not got the cashflow to sustain more than a month’s lockdown. They had no collateral, and this restricted their likelihood to get benefit of State Bank’s refinancing offer, forcing them to lay off their employs which would add to unemployment.
Even if we had not locked down, which would have resulted in unabated spread of disease, our large businesses and export sector would have been hit badly as our major export destinations, the U.S., United Kingdom, Italy, Spain, France, Germany and China are the worst affected by COVID-19. These countries cater for half of our exports.
The Gulf states are Pakistan’s another export destination, though not that badly affected by COVID-19 but they have been hit by crashing oil prices (yet another sign of global recession). Falling oil prices, extended lockdowns, and closure of business in the Gulf region would translate to our declined exports and declined remittances from these countries. Figures published by the Pakistan Bureau of Statistics (PBS) reveal a sharp contraction in exports since March 2020. Exports in April 2020 decreased to $960 million, a 54% reduction compared to April 2019. Due to demand side constraints in our export destination, our export industry is facing cancelation of export orders. Many are being victim of bankruptcies filed by their buyers in Europe and the U.S. This would yet again translate into layoffs by many industries.
While supply of manufactured goods and services saw a decline, the supply of agricultural commodities remained unaffected despite COVID-19. Fortunately, Pakistan fulfils 90% of its food requirements through domestic resources. As the pandemic is unfolding in Pakistan, wheat, Pakistan’s staple grain, is already being procured by public sector procurement agencies. The production and supply of fresh vegetables, fruits, meat, milk, and eggs remains uninterrupted. We also have sufficient stocks of rice, sugar, pulses, and edible oil. This is helping to meet inelastic demand of food.
How Has COVID-19 Affected Demand of Goods and Services?
On the demand side, COVID-19 has negatively affected both the demand for manufacturing and services goods as well as the purchasing capacity of consumers. There was no car sale in Pakistan in April 2020. Cement domestic sales were down by 60%. Export fell by 47% in April on a monthly basis and 54% against April 2019. Lockdown, social distancing and economic uncertainty have squeezed livelihood opportunities and would push millions below the poverty line. This has contracted the demand of all types of goods and services except health services and food items.
How COVID-19 Would Affect Government Revenue?
The three major sources of government’s income are export earning, remittances, and taxes. We have already discussed a downfall in Pakistani export earnings. A global recession would also hit our remittances, which are expected to decrease by USD 5 billion during calendar year 2020. The third source of income i.e., taxes are also witnessing a huge shortfall. The FBR was already facing mammoth tax collection shortfall of Rs. 470 billion in first nine months (July to March) of the ongoing fiscal year. Pandemic, reduction of oil prices, and exemption of medical supplies from withholding tax/additional custom duty gave another jolt to FBR tax collection efforts and it saw a shortfall of another Rs. 300 billion in its tax collection during the last two months.
How COVID-19 Would Affect Government Expenditures?
While the government’s income is decreasing, its expenditures on containing the pandemic, testing, screening, and treating it have increased manifolds. Budget deficit (difference between expenditure and income) which was perceived to be 7.2% of GDP pre-COVID is now expected to increase to 9.2% provided the pandemic remains in control in Pakistan. The Government of Pakistan has announced a package of Rs. 1.2 trillion to boost the economy, to strengthen COVID-19 response and to enhance social protection under Ehsaas program. Some of the measures such as payback of duty drawback to textile exporters were long overdue. However, certain COVID-19 specific measures include, Rs. 50 billion for Utility Stores Corporation for food distribution; Rs. 200 billion of cash assistance for the daily wagers working in the formal industrial sector and who had been laid off as a result of COVID-19 outbreak; Rs. 381 billion for power tariff freezing; and USD 50 million (from Asian Development Bank) for National Disaster Risk Management Fund for COVID response.
Responding to COVID-19 through Monetary Policy
To respond to growing concerns of economic recession and vulnerable external accounts, the State Bank of Pakistan reduced policy rate by 525 points during the last eight weeks. The objective is to provide stimulus to the economy along with maintaining financial stability. It is expected that due to contraction in demand, inflation would further decrease providing cushion to the State Bank to further decrease the interest rate. One of the beneficiaries of the reduced interest rate is the Federal Government, as it saves on debt servicing. Not all the debt tenures are same. However, it is estimated that for each 1% reduction in interest rate, the government gets a cushion of Rs. 100 billion in debt saving. The flip side of too low of an interest rate would be dollarization of economy. People would start buying and investing in dollars, which in turn would depreciate the value of rupee against dollar.
Resources to Respond to COVID-19
The magnitude of this pandemic is too high to be managed by any single country irrespective of her development status. Public borrowing in the global north is set to soar to levels last seen amid the rubble and smoke of the Second World War. Developing countries like Pakistan cannot go the route of public borrowing. They are relying on multi and bilateral lenders. The multilateral and bilateral partners will provide USD 4.4 billion over the next 15 months to finance disaster risk reduction plan. The IMF has already provided USD 1.38 billion Rapid Finance Instrument Facility. While the World Bank Group (WBG) is preparing its comprehensive lending arrangement for Pakistan, an initial support of USD 240 million has already been provided. Over the next 15 months, WBG will also provide USD 2 billion in new financing. The Asian Development Bank will also provide USD 500 million worth Counter Cyclical Support Facility and USD 305 million as Emergency Assistance Lending within FY20.
Budget 2020-21 and the IMF
Amidst health and economic emergencies, the federal and provincial budgets for the fiscal year 2020-21 would be presented in the month of June. It would be a challenge to prepare the federal budget as there will be difficulties in balancing the soaring fiscal deficit and missed FBR revenue collection targets with the government’s high spending. Macro fundamentals are not strong enough to support large and prolonged quantitative easing. Pakistan is banking on spending external assistance (loans) but there are limits to future external assistance, and in 2021 Pakistan may face a larger debt trap or problem of current account deficit.
The budget would be prepared in consultation with the IMF as Pakistan is still under extended fund facility program (EFF, the existing loan program). My gut feeling is that the IMF would be flexible with Pakistan on non-policy fiscal slippage, i.e., the fiscal deficit accrued due to COVID-19 response. It would be flexible to changing some performance criterion and indicative targets, including ease in floor on net tax revenues by FBR. However, it may not be flexible to allow accumulation of energy circular debt or financing loss-making public-sector enterprises.
I think that after preparing an indicative budget, the government would have to negotiate two scenarios with the IMF: Business as usual, the current rate of new cases and deaths by COVID 19; and a worst case scenario, where (Allah forbid) the spread of pandemic and fatality turns out of control, very similar to what one observed in the U.S. or Europe. Depending on how the disease unfolds, the government would have to maintain a balance between lives and livelihoods through budgetary measures. However, one thing is certain, the pandemic will increase calls for lavish spending, not belt-tightening. We need to get ready for big budget deficits as long as the expenditures are accrued on healthcare, economic recovery, social protection, and reducing digital inequality. Reduction in digital inequality and providing quality internet services across Pakistan is extremely important if we have to live with COVID-19 for a few more years. In that case e-governance, e-banking, telehealth, tele-education, remote working, e-surveillance, and e-commerce etc., would be the name of the game and all of that would depend on reducing digital inequalities.
The writer heads independent policy think-tank Sustainable Development Policy Institute (SDPI).
He tweets at @abidsuleri.
E-mail: [email protected]
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