Protected Papers

Two pieces of economic data captured media headlines: the 220 bps fall in YoY inflation in March, and the unexpected weakness of the rupee on the 25th of March.  The cause for the sudden weakness of the rupee can be traced to the retiring of dollar loans by importers, when the latter realized that the pandemic could add further pressure on the rupee. 

While the economic impact of the pandemic is yet to be quantified, it is clear that the GCC will be severely impacted.  Oil prices have collapsed and so has travel/tourism, which means the abrupt slowdown in economic activity in the GCC, could reduce remittances into Pakistan and keep the rupee under pressure.  With a bleak global outlook for the next several months, we see the currency weakening to 173-174/$ by June 2020. 

SBP’s FX reserves will fall and the outflow of portfolio investment will continue, but social concerns now dominate policymaking.  Since the bulk of non-farm labor works in the undocumented sector, the lockdown is taking a serious toll on daily wagers.  The Prime Minister has stated that Pakistan cannot extend the lockdown indefinitely, and there is no choice but to move towards reopening the economy.  The government has announced special incentives for the construction sector, which specifically targets daily wagers and creates demand for a host of ancillary industries.  In the paper, we suggest a number of steps to ensure that the end of the lockdown is not chaotic nor does it unleash a larger health crisis. 

This pandemic is only about hard choices: more people will be infected and die; businesses will suffer; people will lose jobs/livelihoods; markets will remain volatile; investment will stop; savings will be depleted and wealth will be eroded.  This may remain in play till a vaccine is created, tested, mass produced and administered, which could take up to a year.  Nevertheless, this crisis gives the government an opportunity to prove its worth.  In this period of uncertainty and fear, the government should do things it would otherwise shy away from.  In this period of Covid-19, it should consider implementing disruptive economic reforms. 

This paper tries to do two things: one, discuss how the pandemic will impact Pakistan’s marco economy; and two, how G-7 governments are scrambling to understand the impact of this pandemic, and the difficult choices they face.

As of now, the spread of the virus in Pakistan has been contained.  We agree that this is because of the lack of testing and/or that a large number of people have been infected but not diagnosed as such.  It is safe to say that infections and deaths will increase, and the country’s health infrastructure will be tested to the breaking point.  In terms of the economy, the out-of-schedule 150 bps cut in rates on March 24th, reflects two things: the need to be ahead of the curve (after the disappointing 75 bps cut on March 17th); and the likelihood that YoY inflation will fall sharply in the next two months.  The Rs 1.1 trn relief package announced by the PM on March 24th, will include a Rs 15/liter cut in retail fuel prices.  This will reduce our annual inflation projection to 10.8% in FY20, with YoY inflation in June at only 8%.  Growth will also take a hit, but since Pakistan was already in a recession before the pandemic, the most obvious impact of the virus is to delay the economic recovery.  This will also shift the focus away from austerity, which is one positive for Pakistan; another is the collapse in oil prices.

The global challenge is unprecedented.  24-hour media outlets are reporting with a sense of urgency, which has caught many G-7 governments off-guard and on the defensive.  While most OECD countries have locked down their cities to stop the spread, the economic cost of this lockdown is increasingly obvious, specially since there is no end in sight.  We argue that lockdown is only a holding pattern, which gives the country some time to gear up its medical response (i.e. to flatten the curve).  If a vaccination is 12-18 months away, some people have argued that the cure may be worse than the disease.  This means the cost to the economy (unemployment, recession) cannot be ignored, even though the priority is to sharply reduce the infection rate.  In our view, a lockdown is necessary to build medical capacity, but eventually less vulnerable people should be allowed to return to work.  In effect, till a global vaccination has been administered, herd immunity may be the only viable option.  This is not easy to advocate (i.e. people take their chances and develop immunity after a mild infection), but this pandemic cannot be ignored and there are no good options.

This paper seeks to explain how inflation exceeded 14% in January 2020, despite subdued demand in the economy.  The explanation is simple: YoY food inflation almost touched 24% last month, and this category is the heaviest in Pakistan’s consumer price index (CPI).  With the government scrambling to control food inflation, we expect inflation to begin falling in the months ahead, and just as the January number surprised the market, the fall in inflation could be just as sudden. 

While this development contradicts the neoclassical view that inflation is driven by demand pressures, it again questions the need for SBP’s stated objective to target 200-300 bps real interest rates.  In our view, it will be hard for SBP to resist pressure to cut rates in March, and a token cut will not suffice – we suggest that SBP could cut rates by 75-100 bps.  As we have hinted at before, if the FBR revenue target become challenging in FY20 (as is likely), GoP may encourage imports as the bulk of FBR’s revenue collection is done at Karachi ports.  We summarize by noting that GoP may use the external sector gains to increase revenue collection, but the price it will pay is the growing burden of carry trades.  Word count: 1,184.