Pakistan is expected to continue facing foreign exchange liquidity issues due to persistent trade deficit and limited access to external financing.

ISLAMABAD  -  The World Bank has projected that Pakistan’s economy is ex­pected to grow by only 1.8 per­cent in the current fiscal year ending June 2024.

“After a contraction in FY23, economic activity has strength­ened over the first half of FY24 on the back of strong agricul­tural output. This, together with improved confidence, also sup­ported some recovery in other sectors. But growth remains in­sufficient to reduce poverty, with 40 percent of Pakistanis now liv­ing below the poverty line. Mac­roeconomic risks remain very high amid a large debt burden and limited foreign exchange re­serves,” the World Bank has noted in its recent report, Pakistan De­velopment Update: Fiscal Impact of Federal State-Owned Enter­prises released yesterday.

The World Bank has predicted that Pakistan’s gross domestic product (GDP) to remain be­low 3 percent in the next three years. Pakistan’s GDP growth is estimated at 1.8 percent for cur­rent fiscal year and 2.3 percent for next and 2.7 percent for the year 2025-26. “The broad-based but still nascent recovery has been inadequate to reduce pov­erty, with growth expected to reach only 1.8 percent in FY24; the poverty rate is expected to stagnate at current high levels of around 40 percent” it noted.

The World Bank predicted a de­cline in inflation next year which was likely to be 26pc this fiscal year. Inflation may reach 15 per­cent in fiscal year 2025. However, inflation was expected to drop down to 11.5 percent in fiscal year 2026. World Bank report further said industrial growth may remain around 1.8 percent during current fiscal year. Ac­cording to the report, agricultural growth is likely to reach 2.2 per­cent in 2025 and 2.7 percent in 2026. While industrial growth is expected to remain 2.2 percent in FY 2025 and 2.4 percent in 2026. Fiscal deficit is expected to reach 8 percent of GDP this fiscal year. While fiscal deficit is projected to be 7.4% of GDP in fiscal year 2025 and 6.6 percent of GDP in fiscal 2026. However, after a con­traction in FY23, Pakistan’s eco­nomic activity has strengthened over first half of FY24 on the back of strong agricultural output.

After contracting for two con­secutive quarters, real gross domestic product (GDP) at fac­tor cost rose by 2.1 percent year-on-year (y-o-y) over July to September 2023 (Q1 FY24) on the back of strong agricultural output and some improvement in confidence. Agricultural out­put expanded by 5.1 percent in Q1 FY24, the highest quarterly growth on record, as conducive weather conditions contributed to strong yields. With continued import management measures, high input and borrowing costs, and weak domestic demand, the industrial sector’s activity remained weak. Meanwhile, the wholesale and retail trade sub-sector benefited from the agri­culture sector rebound and sup­ported 0.8 percent growth in the overall services sector output.

The poverty headcount is ex­pected to remain stagnant at FY23 levels. The poor and vul­nerable are likely to have ben­efited from the windfall gain in agricultural output in Q1 FY24. However, these gains would have been partially offset by contin­ued high inflation and limited wage growth in other sectors that employ many of the poor.

The current account deficit (CAD) narrowed to US$0.8 bil­lion in July–December 2023 (H1 FY24) from US$3.6 billion in H1 FY23 largely due to a substantially smaller trade def­icit on account of reduced do­mestic demand, import manage­ment measures, and lower global commodity prices. Meanwhile, official remittances decreased by 6.8 percent y-o-y in H1 FY24 due to exchange rate rigidi­ties earlier in the year. Reflecting fresh multilateral and bilateral inflows, the financial account ran a substantial surplus leading to a balance of payments (BOP) surplus of US$3.0 billion in H1 FY24, compared with a deficit of US$4.2 billion in H1 FY23. Con­sequently, international reserves increased to US$9.4 billion at end-December 2023, equivalent to 1.7 months of imports. With the BOP surplus and regulatory reforms in the foreign exchange market, the rupee appreciated modestly (1.2 percent) against the US dollar over H1 FY24.

Headline consumer price infla­tion rose to a multi-decade high of an average of 28.8 percent y-o-y in H1 FY24, up from 25.0 per­cent in H1 FY23, reflecting higher domestic energy prices, contin­ued liquidity injections into the banking sector through open market operations (OMOs), and domestic supply chain disrup­tions. Food inflation remained high, particularly impacting poor and vulnerable households that spend half of their budgets on food. Transportation costs rose faster in rural areas, increasing the cost of accessing markets, schools, and health centers for the rural poor. To mitigate the high inflation rates, the policy rate was held at 22.0 percent, implying negative real interest rates throughout H1 FY24.

With fiscal consolidation ef­forts, the primary fiscal surplus doubled to PKR 1.8 trillion in H1 FY24. Supported by higher direct taxes and the petroleum development levy hikes, total rev­enue rose by 17.1 percent after adjusting for consumer price index (CPI) inflation. Mean­while, although non-interest expen­diture rose by 24.6 percent nominally, mainly due to higher subsidy spending, it declined by 4.2 percent in CPI inflation-adjusted real terms. The overall fiscal deficit registered at PKR 2.4 trillion for H1 FY24.

Pakistan is expected to con­tinue facing foreign exchange liquidity issues due to the per­sistent trade deficit and limited access to external financing. Even with the recent successful completion of the IMF-SBA and continued rollovers, reserves are projected to remain low. Im­port management measures are expected to continue disrupting domestic supply chains, while tight macroeconomic policies will mute aggregate consump­tion and investment. In the ab­sence of a credible and ambi­tious economic reform agenda, uncertainty is expected to linger, affecting confidence and growth. Economic activity is therefore expected to remain subdued with real GDP projected to grow at 1.8 percent in FY24. As confi­dence improves, output growth is expected to recover to an aver­age of 2.5 percent over FY25 and FY26, remaining below potential in the medium term. Inflation is projected to remain elevated at 26.0 percent in FY24 due to higher domestic energy prices. With high base effects and low­er projected global commod­ity prices, inflation is expected to moderate over the medium term. With lower domestic de­mand and continued import management measures, the CAD is expected to remain low at 0.7 percent of GDP in FY24 and to further narrow to 0.6 percent of GDP in FY25 and FY26.

The fiscal deficit is projected to increase to 8.0 percent of GDP in FY24 due to higher interest payments. It will then gradually decline over the medium term as interest payments decrease and fiscal consolidation measures take hold. The primary deficit is expected to decline to 0.1 percent of GDP in FY24, reflecting the recent fiscal consolidation mea­sures. It is expected to grow to 0.3 percent of GDP in FY25–26. A deeper fiscal consolidation over the medium term will be neces­sary to restore fiscal and debt sustainability With a tax-to-GDP ratio of only about 10.0 percent of GDP, Pakistan has been heav­ily reliant on domestic borrow­ing for fiscal financing. Grow­ing exposure to the sovereign is exposing the banking sector to risks. Additional downside risks include growing policy uncer­tainties that could lead to weaker than expected business confi­dence, even more limited exter­nal financing, and therefore more pronounced macroeconomic vul­nerabilities. Potential increases in world energy and food prices in the context of intensification of regional geopolitical conflicts, slower global growth, and tighter than expected global financing conditions pose additional risks to the macroeconomic outlook.

Pakistan’s economic structure includes a significant number of state-owned enterprises (SOEs) operating across most sectors of the economy. These SOEs have been consistently making losses since 2016, and the Government has been providing them with significant financial support through subsidies, grants, loans, and guarantees, leading to large and growing fiscal exposure. The Special Focus section of this Development Update discusses the fiscal drain and risks of the federal SOEs and the critical re­forms needed to improve their performance, efficiency, and gov­ernance. The Government has initiated reforms to improve the financial discipline of SOEs and strengthen oversight under the new State-Owned Enterprises (Governance and Operations) Act 2023 and the SOE Ownership and Management Policy 2023. Full and effective implementation of these reforms is now critical, along with accelerating privati­zations and implementing the SOE Triage exercise completed in 2021. The Government should move to eliminate the practice of covering SOE operating losses with transfers from the federal budget and implement measures to manage fiscal risks associated with explicit and implicit obliga­tions, such as holding SOEs ac­countable for performance and responsible for fiscal risks arising from their operations.