Pakistan: Risk Assessment
Country Risk Rating
Business Climate Rating
- Large domestic market, supported by dynamic demographics
- Significant transfers from expatriate workers
- Large and inexpensive workforce
- Economic corridor prospects with China
- Major player in Islamic finance
- Tense geopolitical environment; domestic insecurity
- Informal sector (40% of GDP) and low tax revenues (12.7% of GDP)
- Deficiencies in education, health, infrastructure and agriculture
- Delays in the development of Balochistan and rural areas
- Energy dependence and low sector diversification
- 40% of the workforce in the agricultural sector; sensitive to weather and world prices
The economy is set to slow again…
Pakistani growth will continue to slow in 2020, driven by policies to reduce the twin deficits, with fiscal restraint accompanied by tight monetary policy. To control inflation in a context of sharp currency depreciation, the central bank raised its rates again to 13.25% in July 2019 (+675 bps over the year) and is expected to keep them at that level in 2020. As a result, a slight contraction in credit was observed. The 2019 slowdown was felt in all sectors, including agriculture, where production declined due to water scarcity. The electricity sector kept industrial growth in positive territory, thanks to the completion of new power plants. While private consumption (82% of GDP) remained brisk despite inflation and the rising cost of credit, public investment (12% of GDP) made a -1% contribution to GDP, reflecting lower development expenditure and the completion of many major energy and logistics projects, particularly in relation to the China-Pakistan economic corridor. Private investment also fell. Inflation accelerated sharply, mainly due to the price impact of depreciation, as well as food inflation linked to poor harvests. In 2020, the delayed effects of depreciation plus increases in taxes and utility prices will drive inflation.
... in order to address fiscal and external imbalances
Pakistan’s public finances deteriorated markedly in 2019. Total expenditure increased, following a 40% increase in interest coverage on debt for FY2019 that was not offset by reduced capital expenditure and flat revenues. Lowering the deficit in 2020 will require an increase in revenues (+1.7% of GDP expected), which are among the lowest in the world as a percentage of GDP (12.7%). Reform measures will include steps to rationalize tax rates and thresholds, reduce exemptions and preferential rates, and increase taxes on consumer goods. Budget utilization is problematic: one-third is allocated to the army and another third to interest payments. The 2019 deficit was financed mainly by domestic sources, with only 12% provided by external sources. External debt represents 37.9% of total public debt (up 10 points in one year), and 44.2% of it is held by multilateral creditors. The country has managed to secure considerable external support from China, Saudi Arabia, the United Arab Emirates and the IMF in particular (USD 38 billion in total). Pakistan received a USD 6 billion loan from the IMF in July 2019 in return for committing to a three-year stabilization and reform plan. This support offers grounds for optimism about short-term sovereign creditworthiness, despite the sickly public accounts.
Pakistan’s current account improved in 2019. Administrative measures and the price effect of the rupee devaluation (-25% in 2019) contributed to a sharp reduction in imports. Exports, of which textiles account for more than 50%, were unable to benefit from the depreciation this year, and remittances from expatriate workers remain the main means of financing the trade deficit: these transfers benefited from good performances by the Gulf economies and covered 77% of the trade deficit in 2019. FDI flows remain small (0.5% of GDP in 2019). The improvement will continue in 2020. Imports will be moderated by high costs and reduced growth, as well as low energy prices, while exports will start to benefit from previous currency depreciation. Workers’ transfers are expected to continue on their positive trend. In the future, exchange rate flexibility should prevent external accounts from becoming imbalanced. Foreign exchange reserves have shrunk and, despite a gradual accumulation, now represent only two months of imports.
Prevailing insecurity and mounting protests
Pakistan’s Prime Minister Imran Khan, who was elected in 2018, is facing calls to resign from opposition party Jamiat Ulema-e-Islam, which has mobilized about 50,000 demonstrators for the first time in his mandate. In a country where no Prime Minister has completed his term in 70 years, Mr. Khan is facing a real threat. Purchasing power is being undermined by soaring inflation and growth that is no longer sufficient to ensure an increase in per capita income, while population growth is very strong (+2.7% per year). Despite the improved security situation, the insurgency in Balochistan and the war in Waziristan continue, and tensions with India over Kashmir have been heightened after the region’s autonomous status was lifted. The stormy relationship with the United States will remain important and focused on military cooperation, while the Chinese partnership seems to be losing momentum: popular discontent is mounting over the advantages granted to Chinese companies, while FDI is drying up (-77% in 2019).
Pakistan jumped from 136th to 108th place in the Doing Business 2020 ranking thanks in particular to measures to simplify building permits and to digitize and reduce VAT and corporate tax.