A gathering storm

The new World Bank biannual report, Global Economic Prospects (GEP), carries an ominous sub-title ‘Darkening skies’. It is sombre reading as it sketches the rising risks to the global economy, primarily emanating from slow recovery in the emerging market and developing economies (EMDEs), the serious financial stress they faced recently and the vulnerabilities they are facing from the trade war between the China and the US. Fears of rising global interest rates, which could have a devastating impact on highly indebted economies, as during last year, are persisting.

This rather depressing economic outlook is predicated on softening trade and investment flows, elevated tensions and the financial stress felt by some major EMDEs. The EMDE economies have lost growth momentum, which was billed as the bulwark for global recovery. Weakening EMDEs would be vulnerable to policy shocks coming from advanced economies, especially by the trade war. There is a fear that there may be disorderly financial market developments not just affecting the concerned economy but also triggering spill-over effects and contagion that would threaten the stability of the global economy.

In an effort to look for cushions on the face of vulnerabilities, the report has undertaken an in-depth analysis of the informal sector in EMDEs. It is estimated that as much as one-third of the output is produced, and 70 percent of employment, is generated in the informal sector. While there are short-term advantages of flexibility, the sector poses challenges of low productivity, reduced tax revenues and greater poverty and inequality. To mitigate adverse implications for the sector and to preserve its contribution to growth and employment, a policy mix combining simplified regulatory frameworks, reduced tax burden, education and skills development programmes and enhanced access to finance are necessary.

Since 1974, when inflation was as high as 17.5 percent, EMDEs have brought down inflation to around 3.5 percent in 2018. However, inflation in developed economies fell more sharply. This synchronization was strengthened by robust monetary policy frameworks and global trade and financial integration. But there is no guarantee that such low inflation would continue in the future, particularly in view of disruptions in trade flows, roll back of structural policies and adverse developments in commodity supplies and pricing.

Debt vulnerabilities in low-income countries (LICs) have risen significantly in recent years. As much as a 20-point increase has been noted in the median LICs debt-to-GDP ratio, which is increasingly coming from non-concessional and private sources. Interest payments as percentage of revenues are increasing. “[The] majority of these countries would be hard hit by a sudden weakening of trade or global financial conditions given their high levels of external debt, lack of fiscal space, low foreign currency reserves and undiversified exports”.

Adverse food price shocks induce governments to undertake support programmes to insulate vulnerable segments of the population. But collective action by many countries could create more volatility in prices. The oil price is also a major factor in impacting the economic stability of low and medium-income countries. After going through significant volatility during 2018, oil prices are expected to average around $67 per bbl in 2019 and 2020 but the uncertainty around the forecast is very high.

The report has many comments on Pakistan’s economy and the challenges it is facing. Even though the South Asian region is billed as a high growth region,Pakistan and Bangladesh have been singled out: “Elsewhere in the [South Asian ] region, the forecast is for a moderation in activity, notably in Bangladesh and Pakistan. Over the medium term, growth is expected to remain at 7.1 percent, underpinned by robust domestic demand in the region. External vulnerabilities are rising, reflected in mounting external debt, widening current account deficits, and eroding foreign reserves. Risks to the outlook are to the downside.

“On the domestic front, vulnerabilities are being exacerbated by fiscal slippages and rising inflation, and there is a risk of delays in structural reforms to address balance sheet issues in the banking and non-financial corporate sectors. Key external risks include a further deterioration in current accounts and a faster-than-expected global financial tightening.”

At another place, the report notes: “In the rest of the region, economic activity will average 5.6 percent over the forecast horizon. In Pakistan, macroeconomic imbalances weigh on growth outlook. Pakistan is expected to face financing needs due to large current account and fiscal deficits combined with low international reserves. GDP growth is projected to decelerate to 3.7 percent in FY2018/19, with financial conditions tightening to help counter rising inflation and external vulnerabilities. Activity is projected to rebound and average 4.6 percent over the medium term with support from stabilizing macroeconomic conditions”

The global outlook is not favourable for Pakistan. Any major disruption could pose serious challenges for the country’s economic stability, which is already precarious. Since the last IMF programme (September 2016), the economy is in a drift. The process of reforms in many sectors has been rolled back or reversed. The key macroeconomic indicators of fiscal deficit, current account, reserves, interest rate, government borrowings from the central bank and inflation have already deteriorated rapidly. There are no buffers to cushion the shocks which look imminent. The Fund programme has been delayed inordinately, despite a new administration taking charge in August 2018.

The informal sector has been a very powerful adjunct to the formal economy. However, in more recent days, general economic slow-down, reduced access to the financial sector and a somewhat harsh drive to collect taxes have weighed on the efficiency and growth of the informal sector. The new benami law, while a positive move towards documentation, would further curtail the space for the informal sector. Under the circumstances, it is imperative that measures be adopted to provide a soft-landing to this critical sector as without its continued support the overall growth would remain lacklustre.

The writer is a former finance secretary. Email: waqarmkn@gmail.com