Global economies have become highly integrated. We had experienced this during the 2008 financial recession. The epicentre of the crisis then was the US housing market. As the housing market crashed, all financial institutions that had heavily invested in it, either through direct loans or buying mortgage-backed securities, felt an extreme liquidity crunch. The crisis went shockwaves around the world.
This time it’s China. The novel coronavirus has disrupted supply chains across the world. Itsunrelenting spread has spooked global investors. The root of the oil price crisis on March 9, 2020 can be traced to coronavirus-induced reduction in oil demand. The economic impact of COVID-19 is becoming prominent each day.
Trading was halted twice during the preceding week as S&P 500 plummeted headlong within few minutes after the opening bell. Modern stock markets have incorporated a built-in mechanism to automatically halt trading of equities during times of extreme volatility. The Pakistan Stock Exchange (PSX) also halted trading twice as bears run rout at the local bourse. Bears decimated the key support area of 38,000 points where many technical support levels were aligned. Despite sharp intra-day recovery on Friday, break of such a potent support does not bode well for the PSX. We can expect that the PSX may remain stressed in the coming weeks. But the major concern for Pakistan does not lay with the PSX only. The hard fought but vulnerable stability that our economy has achieved during the last six months has come under a serious stress test. Apart from the bearish hold at the PSX, dollar-rupee (USD/PKR) exchange rate has depreciated toa six-month low of Rs 159.8 per US dollar on March 13, 2020. Our treasury bond market has seen $1 billion worth of outflow according to a recent update. The outgoing investment is part of the $3 billion hot money that Pakistan had received from international investors. There are two major explanations for this outflow. First, investors may have pulled out due to the expected easing cycle inthe Pakistani monetary policy. The reduction in the inflation rate for the month of February and coordinated monetary easing by different economies may prompt the SBP to slash the policy rate.
Second, the global assets sell-off can be responsible for this outflow as well. During times of financial crises, dollar becomes a wanted commodity as assets are liquidated in order to get hold of dollars. Its safe-haven status also complements the dollar demand. Spread on swaps of different currencies have widened in the international market, hinting rush for dollar.Either ways, these outflows are the sole determinant of the depreciation of our exchange rate vis-à-vis US dollar. The situation can worsen more in the coming days. If Pakistani rupee comes under pressure, the sceptre of inflation will haunt Pakistan once again. One of the reasons for the historic levelsofthe inflation rate in Pakistan is the record depreciation of rupee in 2019.
The economic environment produced by the outbreak of COVID-19 is adversely affecting our bond market and foreign exchange market. Both of these markets lay on the fault lines of our economy.Pakistan’s ability to raise funds by issuing Eurobonds can be hampered. If the SBP is more concerned with these perverse developments in bond and foreign exchange market, it may surprise the market participants by holding policy rates unchanged.The SBP, though, has ample room to cut the policy rate and maintain the attractiveness of Pakistan Investment Bonds (PIBs) relative to the regional economies.
A higher policy rate, disruptive tax regime, coercive tax compliance measures and higher electricity tariff rates have all contributed to dent the private sector growth
Potential slowdown in remittances asglobal economic growth stalls is another point of concern for the Pakistani economy. Reduction in oil demand and subsequent price war between Russia and Saudi Arabia haveextremely depressed the price of the black gold. A large chunk of Pakistani labour works in oil producing economies. Reduction in oil prices can cause an economic recession in these countries.
Prior to COVID-19 inspired financial crisis, Pakistani economy had already slowed down considerably. A higher policy rate, disruptive tax regime, coercive tax compliance measures and higher electricity tariff rates have allcontributed to dent the private sector growth. A record level of inflation rate during the last six months may have caused food insecurity and poverty in so many households. Unfortunately, global headwinds produced by COVID-19 are highly unfavourableto our economy. But every crisis begets an opportunity. Rather than looking outwards for obtaining dollars through Eurobonds, PIBs, or any other loan deal, Pakistani government should give much-needed policy support to its own private sector.
Since early 2019, local Pakistani investors have been stashing their funds in either high-yielding PIBs/T-bills or bank accounts. Some of them are scared of investing in businesses because of the tough stance by tax authorities. First, the SBP must cut its policy rate and bring it at or under 10 percent within its next two monetary policy meetings; second, the FBR must scale down its predatory approach to ensure tax compliance; third, distortionary withholding tax regime should be rationalised; fourth, government must transfer the benefits of low international oil price to consumers and producers; and lastly, construction projects by the government must be streamlined.
Economies of the world are in full-on expansionary mode with both fiscal stimulus and monetary easing. It is high time we cushioned our own private sector through pro-growth measures and stabilise our economy from within and not just from without.
The writer is associated with the financial market of Pakistan