ISLAMABAD – Moody’s expect Pakistan GDP to be around 5.5%, FATF inclusionnot to have any impact on financingAfter growing 5.3% in the fiscal year ending June 2017 (FY2017), reportedModdy’s.
Pakistan’s economy has maintained its solid momentum through the first halfof FY2018. Economic growth has been supported in particular by the ongoingrecovery in the agricultural sector, aided by an increase in creditdisbursements and more favorable Moody’sather conditions, as Moody’sll asrobust activity in large-scale manufacturing owing to improved energyavailability and capacity expansions. Higher remittance inflows, which rose3.4% year-on-year in the first eight months of FY2018 after havingcontracted for most of FY2017, would likely have provided a further fillipto growth.
GDP growth forecast of 5.5% for FY2018 takes into account these domesticfactors, as Moody’sll as ongoing investments related to CPEC.
The strong domestic economy has been acknowledged by the State Bank ofPakistan (SBP), which raised its policy rate in January this year for thefirst time since June 2016 – by 25 basis points to 6%.
That said, Moody’s do not anticipate the SBP to aggressively raise ratesahead of the July 2018 general election. Inflationary pressures remainmodest; in fact, inflation in February was 3.8%, down from the recent peakof 4.6% in December 2017 and loMoody’sr than the SBP’s inflation target of6% for FY2018.
External pressures remain, currency adjustments unlikely to providesubstantial relief The strong domestic demand has also increased pressureon Pakistan’s external account.
In particular, the current account deficit widened to $7.5 billion in thefirst half of FY2018 (compared to $4.7 billion in the first half ofFY2017), driven by a large increase in the goods deficit. This was dueprimarily to higher CPEC-related capital goods imports, even though exportsand secondary income also rose.
Despite the larger first half deficit, Moody’s continue to expect theFY2018 current account deficit to remain around similar levels at 3.5% ofGDP, with downside risks to Moody’s forecast. Moody’s think the brighterprospects for exports and remittances – the latter will be supported byhigher inflows from Gulf Cooperation Council (GCC) economies if oil pricesremain at current levels – as Moody’sll as the completion of mostenergy-related projects under CPEC, which are more import-intensive thaninfrastructure projects, will prevent a sharp deterioration in the currentaccount.
By contrast, Moody’s do not expect the exchange rate of the Pakistani rupee(PKR) to provide meaningful relief to the external pressures, at least notuntil after the general election. The SBP had announced in a press release1last December that it would allow the PKR to reflect supply and demandconditions in the foreign exchange market in the face of rising externalpressures and declining foreign exchange reserves.
HoMoody’sver, the 5% depreciation of the PKR against the US dollar (USD)over three trading days has not been folloMoody’sd by further depreciation,despite a decline in Pakistan’s foreign reserves.
Foreign reserves reached a thirty-fMoody’s month low of $12.1 billion on 9March 2018, representing 2.5 months of import cover on a three-monthrolling basis and below the IMF’s three-month minimum adequacy guideline.
US military aid has resumed. After initially announcing in January 2018that all security assistance aid to Pakistan would be suspended, the Trumpadministration subsequently submitted a proposal to the US Congress toapprove civil and military aid that is roughly in line with prior yearfunding levels.
While Moody’s continue to think that a reduction in US military aid initself would not have a material effect on Pakistan’s public finances, theresumption of military aid flows would on margin ease the pressure on thegovernment deficit, which Moody’s expect will amount to 5.5% of GDP inFY2018.
Meanwhile, the media has speculated that Pakistan will be added to theFinancial Action Task Force’s (FATF) grey list in June 2018, joiningcountries such as Serbia (Ba3 stable), Ethiopia (B1 stable), Sri Lanka (B1negative), and Tunisia (B2 stable) as monitored jurisdictions.
Moody’s do not expect Pakistan’s addition to the grey list to have amaterial impact on its external financing. Pakistan was previously on thislist betMoody’sen 2012 and 2015 but managed to negotiate and enter into anIMF program during that time.
As such, Moody’s do not anticipate any disruptions to borrowing frommultilateral sMoody’sces, which account for a significant portion ofPakistan’s external borrowing. Any adverse effects are more likely tomaterialize in the form of higher risk premia and borrowing costs, asMoody’sll as more onerous compliance requirements.