The global forecast of declining growth rates for various economic indicators may lead the world economy into recession. Pakistan must identify the possible impacts and embrace the structural and selective sectoral growth to minimize the negative impact of recession.
Nowadays, rising inflation and contracting Gross Domestic Product (GDP) growth is the point of discussion globally. In major economies, their central banks have concurrently raised the policy rates to curb inflation. This may reflect that the economies throughout the world might be inching towards global recession in 2023. Along with that, developing economies might get trapped into a string of financial crises and it can cause them lasting harm. Numerous blows have been dealt to the global economy, inter-alia, the Russian invasion of Ukraine driving up energy and food prices following the pandemic outbreak, while the rising rate of interest and burgeoning costs have threatened to rebound across the globe.
The purpose of this article is to explain the risk(s) associated with global recession in the coming year 2023, and how Pakistan can deal with these situations given the current fragile state of Pakistan’s economy. In the post pandemic era, a huge supply side disruption has been observed which has intensified the inflation rate globally. After the pandemic, the war between Russia and Ukraine was the last nail in the coffin as it exacerbated multiple negative shocks over the world commodity market. Due to such economic shocks, the major economies had to raise their policy rates. The United States of America has raised its policy rate to 4 percent. This is the first major interest rate hike for the USA since the financial crunch of 2008. It is likely that the interest rate of the USA will rise more than 4 percent in 2023. Similarly, the United Kingdom also hinted a positive trend towards the rate of interest. The adoption of these contractionary monetary tools, taken by various central banks of both developing and developed nations, are slowing the worldwide trade and economic growth.
In the Global Economic Outlook published by the International Monetary Fund (IMF), the IMF has estimated the worldwide GDP growth to be at 3.2 percent in 2022, compared to a growth of 6.0 percent in 2021. This reflects a downfall in growth by 2.8 percent in just a year. The fact that the IMF has projected GDP growth in 2023 to be only 2.7 percent is worrying, as with a further decline in the growth, it is likely that multiple countries will fall into recession. What is even more worrying is that these devastating trends may persist in the long run, which will be disastrous for developing nations.
Several of the largest economies in the world, such as the USA, China, and multiple European countries may witness a decline in 2022 and a slow-to-moderate growth in 2023. Under such crisis, even a moderate hit to the GDP growth across global economies in the next year will eventually lead the world to a recession. In parallel with an expected slowdown, the latest Global Economic Outlook also predicted a decline in the world trade volume of goods and services. It is expected to lose momentum from 10.1 percent in 2021 to 4.3 percent in 2022, and it will remain subdued to 2.1 percent in 2023. The trade volume will be weighed down amidst various related shocks, such as energy prices hike, decline in import demand, and monetary tightening.
The import demand is supposed to soften as decline in growth has been observed in several economies for various reasons. Soaring energy prices as a result of the outbreak of the war between Russia and Ukraine, and squeezed spending power of households has raised the cost of manufactured goods in Europe. While on the other hand, the USA has opted for a tight monetary policy to squeeze the demand and people tend to invest more on fixed investments. This sort of an international supply disruption has also hit developing economies through an increase in the amount of import bills for oil, food and other essential products.
Seemingly, these high import bills will lead developing countries to a debt trap.
As far as inflation is concerned, the rising pressure on prices is the most immediate threat to the prosperity of humankind. Inflation has increased to such levels that has not been witnessed in several decades. Many countries, including advance economies, identify rising prices as their top concern. Moreover, the average global inflation rate is predicted to peak at 8.8 percent in 2022 from 4.7 percent in 2021, and will have an expected decline to 6.5 percent in 2023 and further dropping to 4.1 percent by 2024. Presuming the ongoing forecast is realized, the inflation rate will be low in 2023 but would remain above 5 percent. We all know that to ensure price stability, monetary policy is a key instrument to reduce or control inflation. Yet, economies that have been pursuing structural reforms can fight inflation without necessarily raising their interest rates to an exorbitant level. It enhances productivity and removes supply-side constraints. It is worth noting that due to unpredictability of monetary tools in major economies along with the unstable nature of the ongoing Russia-Ukraine conflict, high uncertainty is associated with these forecasts.
Consequences of Global Recession on Pakistan’s Economy and Possible Way Out
Since, Pakistan is also linked with the global supply chain, it is possible that we might also face production volatility. Despite having a high growth rate of 5.97 percent in fiscal year 2021-22 (FY22), Pakistan is struggling with its external imbalances. The current account deficit is one of the main pillars which highlighted that the FY22’s GDP growth is mostly fueled by imports and is consumption oriented. As per the annual planning report of the Planning Ministry, the GDP growth forecasted for ongoing FY23 will be 5.0 percent. However, growth progression will slow down as a result of policy tightening, harrowing floods, external imbalances, fragile economic situation and political chaos.
Both Asian Development Bank (ADB) and IMF have predicted Pakistan’s GDP to grow at a rate of 3.5 percent in the ongoing fiscal year. Secondly, the IMF projected the rate of inflation at 19.9 percent. However, the Consumer Price Index has averaged at the rate of 25.5 percent in the first four months in FY23. Whereas, average food inflation has gone above 31.0 percent due to supply side disruption amidst floods in most of the rural areas. The fundamental concern is whether the rate of inflation gradually slows down or persists during the ongoing FY23, as both IMF and ADB have predicted, inflation will remain in double digits for Pakistan. In the span of the last two years, spiraling inflation has been a worrying sign for Pakistan. Down the road, inflation might be largely dependent on the future path of the international commodity prices, the currency (PKR) parity performance and how the government deals with the next review of the IMF programme. Scenarios of price hike in the international commodity markets always have the potential to impact the liquidity negatively in the developing countries as they are mostly dependent on imports. We saw a recent hike in policy rate in advanced economies which can lead to capital flight from Pakistan to a much safer and stable country’s treasury assets. Resultantly, due to capital flight outside Pakistan, more pressure gets created on the exchange rate, making it difficult for the State Bank of Pakistan (SBP) to raise capital from the international markets. Moreover, foreign exchange reserves have depleted rapidly in the last six months, and with that, pressure has mounted on the Pakistani currency, and business confidence has eroded.
As discussed earlier, the trade volume is predicted to go down in FY23. As per the trade statistics of FY23, Pakistan exports grew by only 0.94 percent in July-October period over the last fiscal year. However, what is more disturbing is that the world merchandise trade volume is expected to plunge to 1.0 percent in 2023 from 3.5 percent in 2022, as per the World Trade Organization (WTO). Furthermore, as per the economic data from State Bank of Pakistan, 55.0 percent of the total exports receipts came from USA and Europe, solely in FY22. Notably, this export progression was achieved at a point where global growth rate was 6.0 percent (GDP growth of Europe and USA was 5.9 percent and 5.7 percent, respectively). As of now, GDP projections of these trading partners are very concerning. At a time when Pakistan is facing supply side disruption for the import of raw material due to tightening policies, a looming lower demand in the country’s export market is an immense challenge. Moreover, the ongoing uncertainty due to the Russia-Ukraine conflict may also take a toll on national exports of Pakistan by delaying and disrupting export orders, and raising the cost of imports for export oriented industries. As per the empirical evidence, when global demand for textile goes down in a global recession, as a consequence, it has an adverse impact on the country’s textile sector. So, it can be said the global recession and Pakistan’s exports, especially our textile exports are tied up. Pakistan needs to diversify products, as a lack of diversified products has often prevented sustainable growth in total exports. Additionally, Pakistan needs to focus more on value added products which can be helpful in increasing exports to different countries, and these products can compete in the global market. The growth rate of national exports must come along with the development in the domestic manufactured products, as they capture a larger share in the global market, so that we will not rely on a few markets only.
In view of Pakistan’s economy, the global recession can be good or bad. However, only time will tell. More importantly, it means a few indicators might be worse off such as, inter-alia: (a) National exports are going to fall; (b) Economic growth slowdown; (c) Capital investment may decline; (d) Unused capacity of industries; (e) Rise in unemployment; (f) Low per capita income; and (g) High poverty. While on the other hand, it may have some good impacts, such as lower worldwide oil demand will lead to a lower price, that can ease up the trade deficit and it can lead the current account deficit to a sustainable level. Yet, similar to central banks all over the world, the SBP also raised its policy rate, albeit to slow down Pakistan’s economy activity too early. Will this policy to jack up the rate of interest by SBP succeed in reducing the double digit inflation?
Currently, the main concern for the Government of Pakistan is to ensure a “soft landing” for the economy of Pakistan, cutting down the rate of inflation and simultaneously stimulate a recovery. The fiscal policy will be crucial, as it will help the government in managing the impact of; hike in prices, rising food insecurity, slowing business activity, and decreasing income of the vulnerable groups, many of whom were still reeling from the devastating floods, whilst maintaining a tough stance aligned with a tough monetary policy. Whereas, multilateral cooperation is also necessary for promoting trade volume and energy transition. Along with these recommendations, the government should announce a strategic plan for sustainable economic growth and build foreign reserves instead of looking at friendly countries for bailout packages. Effective policy measures should include, inter-alia: (a) Limit the size of the primary deficit in the budget; (b) Effective tax reforms to broaden the tax base; (c) Structural reforms in the commodity producing sectors; (d) Need to work on comparative trade polices to enhance national exports; (e) Reduce interest rate to boost economic activity and limit debt servicing; and (f) Manage external sector properly to avoid rampant devaluation of the domestic currency. Ultimately, in the past, we have seen global recessions arrive and depart, but when global recessions end, output activity increases again and after that, recovery starts. The crucial thing is how long the phase of the forthcoming global recession will persist. All in all, globally, governments want to cut short the recession period. Will the recession be short, or will it continue for a long time? Only time will tell.
The writer is a Fellow Chartered Accountant and a senior tax consultant. He has previously written several articles about the economy and tax system of Pakistan.
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