Pakistan most vulnerable in South Asia to balance of payment crisis: Moody’s Report

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Amid a glooming economy, Pakistan is the most vulnerable to the balance of payment (BOP) crises among the South Asian countries with the lowest level of exports of 10.5 per cent of GDP, Business Recorder reported citing a report by Moody’s Investors Services.

The rating agency in its latest report, ‘Sovereigns — South Asia, Low trade openness fuels vulnerability to shocks and curbs growth in the longer run’, stated that Pakistan and Sri Lanka are the most vulnerable among the four sovereigns.

Both countries have experienced significant BOP pressures because of very low exports and FDI, combined with much weaker policy management and higher political risk.

It also mentioned that India is the least vulnerable because of its larger and more diversified export sector, as well as better macroeconomic policy management which has allowed it to accumulate and maintain adequate foreign exchange reserves, Business Recorder reported.

For Sri Lanka and Pakistan, low trade openness and weakly diversified export baskets, combined with weak macroeconomic policy management and higher political risks, have contributed in low foreign exchange reserves to buffer against shocks. On the other hand, India is least vulnerable, reflecting its larger and more diversified export sector, as well as better macroeconomic policy management which supports it having adequate foreign exchange reserves, the report stated.

Within South Asia, Pakistan and Bangladesh have the lowest level of exports at 10.5 per cent and 12.9 per cent of GDP, respectively.

Sri Lanka and India, which have more developed services export sectors, have exports of 21.5 per cent and 22.4 per cent of GDP, respectively.

By country, Pakistan’s export potential is about six times its current exports, while Bangladesh, India and Sri Lanka have export potential of about two to three times current export, Business Recorder reported.

These factors, combined with very weak fiscal policy effectiveness in both Pakistan and Sri Lanka, drive their bigger macroeconomic imbalances that exacerbate their inability to adjust to external shocks.

Also, both countries run persistent current account deficits, driven by low saving rates amid persistently large government fiscal deficits.

The report further highlighted that domestic political risks are also very high, which disrupt policymaking and weigh on their ability to attract foreign direct investments (FDI) to build and maintain adequate reserves.

Low FDI, in turn, contributes to their limited participation in global value chains. Pakistan and Sri Lanka have net inflows of FDI amounting to an average of 0.6 per cent and 1.0 per cent of GDP from 2013-22.

In 2022-23, Pakistan’s and Sri Lanka’s credit profiles deteriorated significantly. A global commodity price shock coincided with expansionary fiscal policies which led to strong import demand. At the same time, global financial conditions tightened. The combination of these factors drove a rapid widening of their current account deficits and large drawdowns of their foreign exchange reserves, Business Recorder reported.

As per the report, Pakistan’s foreign exchange reserves fell to a cycle low of USD 2.6 billion at the end of May 2023, sufficient to cover less than one month of imports, although reserves have since picked up to USD 7.5 billion as of October 2023.

Sri Lanka reserves dropped to USD 1.9 billion in December 2022 from USD 2.7 billion a year earlier.

Bangladesh’s credit profile also weakened, although by a smaller extent, as it had more reserves compared with Pakistan and Sri Lanka to absorb the global energy price shock that hit in early 2022.

Earlier, World Bank research found that Pakistan’s cascading tariffs are among the steepest in the world, which incentivizes export substitution. South Asian sovereigns also have high prevalence of non-tariff trade barriers, such as labelling requirements and administrative fees, which further encourages export substitution, Business Recorder reported.

In comparison, Bangladesh, Pakistan and Sri Lanka are further back in many areas, including political stability, governance, trade infrastructure and policies, and labor quality. Their much weaker attributes will impede their ability to credibly develop and diversify the export sectors.

The report added that all three countries face macroeconomic imbalances to varying degrees, which would further constrain capacity to invest in infrastructure and education needed to support the development of the external sector.

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