By any definition, Pakistan enters 2021 with a high-risk political and economic situation, most likely to persist. The life for a common Pakistani will remain full of challenges. Going beyond deficit management, the government must focus on improving the lives and livelihoods of the people.

Presently, Pakistan’s economy is a pick-what-you-like. It is bouncing back if you are a macro-man. Current account surplus, for the fifth month in a row, rose to $447 million in November. Remittances, at $2 billion , maintained a strong momentum for the sixth consecutive month in November. The stock market is picking up.

At the same time, there are enduring woes of being trapped in low growth, decline in GDP per capita and slow economic recovery; disrupted food supply chains and rising food inflation coupled with a declining purchasing power; massive unemployment and many more people falling into poverty.

What 2021 may hold for Pakistan depends on three key factors. One, the shift of focus in economic policy away from deficit management; two, efficiency and efficacy of the response to the second wave of Covid-19; and three, political situation of the country. For a better understanding of the first two, we need to separate the impact of pre-Covid economic policy from that of Covid-19.

Unlike Bangladesh and India, the economy of Pakistan had slowed down much before Covid-19 because of the stabilisation policies. Economic growth rate had already dropped from of 5.48 percent in FY2018 to less than 2 percent in FY2019. Owing to contractionary fiscal and monetary policies to manage the twin deficits, investment was declining and unemployment and poverty were on the rise.

It was in this situation that the Covid-19 hit Pakistan. The GDP growth rate fell to -0.4 percent against the pre-Covid estimates of 2.2 percent, an overall contraction of 2.6 percent. Based on estimates by the UNESCAP, the loss was substantially lower than Bangladesh (3.6 percent) and India (10.7 percent) which grew at 3.8 percent and -.4.0 respectively compared to pre-Covid estimates of 7.4 percent and 6.7 percent in 2020.

The primary reason for lower loss of GDP for Pakistan was mainly that it had already touched the base - as low as 1.9 percent. Fiscal deficit for Pakistan widened by two percentage points, increasing from 7.2 percent to 9.2 percent of the GDP. Post-Covid inflation was estimated to be 10.8 percent compared to estimates of 6.8 percent before the pandemic hit the economy.

Economic response to Covid-19 was encouraging, despite early stage confusion on lockdown. The government immediately announced a fiscal stimulus roughly about the size of 3.1 percent of the GDP which included spending on health sector (Rs 114 billion), transfers targeting lower-income households (Rs 350 billion), firm liquidity supports (Rs 250 billion) and other measures (Rs 568 billion.

The State Bank of Pakistan (SBP) cut the interest rate from 13.25 percent to 7 percent in less than two months along with other measures to ensure liquidity in the market. Special loans were put in place for industrial sector, particularly for SMEs to avoid mass layoffs. Pakistan must continue to implement the stimulus throughout 2021 to help people strive through the pandemic and support economic recovery, with substantially improved efficiency.

According to a survey of the SMEs by Karandaz Pakistan, more than half of the SMEs in the country (58 percent) had laid off employees by April 2020. Around 47 percent of the SMEs cut the salaries of employees. More than half of the SMEs in the textile sector reported laying of half of part-time (52.4 percent) and daily wage (61.9 percent) workers. These numbers show that the measures to avoid layoffs remained largely ineffective.

On one hand, the commercial banks did not effectively implement the measures to provide liquidity to SMEs due to higher risk of defaults. On the other, the SMEs working in the informal sector feared documentation and future taxation and avoided applying for the concessionary loans and other available support measures. This led to a low disbursement to SMEs. The credit mainly went to larger firms. This needs to be taken care of in 2021.

Pakistan will face three key challenges to make 2021 a better year for its economy and its people. First of these is a dirty combination of highest inflation and lowest economic growth in the region. Asian Development Bank (ADB) and the IMF estimates respectively suggest that Pakistan is expected to have an economic growth rate of 2 percent and 1 percent in 2021, against an average growth rate of 7.1 percent for South Asia. In the same year, Bangladesh and India will grow at 6.8 percent and 8 percent, respectively. This may seriously limit Pakistan’s ability to finance economic recovery and produce enough livelihood opportunities for its people.

Under the financing constraints, Pakistan may end the fiscal stimulus abruptly when it needs it most. A second wave of Covid-19 is already there. Most importantly, the stimulus in 2020 was almost half (3.1percent of the GDP) of the required 7 percent of the GDP, according to the UNESCAP estimates. An abrupt withdrawal of fiscal stimulus will not only delay the economic recovery but also compromise the much-needed support to social protection, health, education and SMEs.

Second, the financial account risks are likely to push the government to resume the IMF programme and revert to its stabilisation regime. Pakistan’s financial account has already turned negative. Capital outflows worth over $300 million, repayments of outstanding loans and lower bilateral project financing inflows can be cited as major reasons. The situation will be worsening in the second half of 2021 when most of the debt relief from G20 and Paris Club mature.

Third, political instability may peak during early 2021. This will likely discourage capital inflow and drive the existing capital out of the market. The opposition alliance under Pakistan Democratic Movement (PDM) is committed to organizing a long march and a sit-in in March. Increased political uncertainty can further lower productive capacities, reduce investment and trade flows.

Violence around PDM protests can disturb immediate and potential long-term investment inflows increasing further the risks to financial account. A call for paying back the friendly cash deposits from Saudi Arabia and the UAE and rising oil prices on the back of global economic recovery after the Covid-19 vaccine can further pressure the financial account.

Certain steps are required to steer safely through 2021. First and foremost, the political heat needs to be cooled down. Political instability will not allow any meaningful planning and implementation of policies.

Second, the government must undertake growth-enhancing structural reforms. Any reforms slowing down the economic growth in the name of stabilisation and adversely affecting the lives and livelihoods of people must be avoided. The poor and marginalised segments of society must be protected against the negative fallout of these reforms through a proactive and dynamic social protection system.

Third, Pakistan must convince the IMF that exclusive focus on current account deficit and fiscal deficit may hurt the economic recovery. In this regard, policies of higher interest rate and raising the energy prices must be reconsidered. The revenue targets needs to be readjusted downward.

Fourth, the SBP must continue to support fiscal expansion at the current interest rate. The “enough is enough” feeling because of highest cut in the region must not motivate monetary authorities to increase the rate or not cut it further down when due. Clearly, we had the highest cut because we had the highest policy rate in the region. We still have the highest. Any increase in the interest rate will compromise the gains from fiscal stimulus and delay economic recovery. A priority focus of SBP on financial inclusion of SMEs can help restore many who were laid off in the first wave of the pandemic.

The writer is a research fellow and Heads Policy Solutions Lab at Sustainable Development Policy Institute (SDPI), Islamabad. He tweets @sajidaminjaved