ISLAMABAD: The Asian Development Bank (ADB) maintained GDP growth projection for Pakistan at 2.8 percent and inflation at 15 percent for fiscal year 2025, amid warning that the new government faces challenges owing to elevated political and institutional tensions and the prospects of social unrest from a steep drop in real incomes.
The bank in its latest report, “Asian Development Outlook (ADO)”, stated that Pakistan’s economy expanded by 2.4 percent in fiscal year 2024, driven by higher consumption following the government’s economic stabilisation and reform programme. Growth is projected to further improve to 2.8 percent in fiscal year 2025, supported by a revival in private investment.
Pakistan’s economic growth rebounded in fiscal year 2024 (ended 30 June 2024), supported by higher domestic consumption from increased agriculture income and workers’ remittances.
Pakistan’s outlook hinges on continued and effective economic reform. In July 2024, the IMF and Pakistan reached a staff-level agreement on a 37-month Extended Fund Facility (EFF) arrangement worth about $7 billion that should catalyse significant international financial support for the underlying economic stabilisation and reform programme.
Once approved by the IMF Executive Board, the arrangement should enhance macroeconomic stability. The programme aims to consolidate the public finances, expand social spending and protection, rebuild foreign exchange reserves, reduce fiscal risks from state-owned enterprises, and improve the business environment to encourage growth led by the private sector.
The new government has committed to the necessary stabilisation and structural reforms but faces challenges owing to elevated political and institutional tensions and the prospects of social unrest from a steep drop in real incomes.
The bank stated that economic activity was boosted by fiscal discipline, a market-determined exchange rate, energy sector efficiency, climate resilience, and an improved business environment. Growth is likely to accelerate in fiscal year 2025 on the implementation of a comprehensive economic reform programme agreed with IMF.
Pakistan’s inflation slowed to 23.4 percent in fiscal year 2024 mainly on lower food inflation resulting from higher agriculture production. Inflation in 2025 is expected to moderate to 15 percent, supported by a tighter monetary policy and more stable global commodity prices. In Pakistan, inflation slowed substantially from 28percent at the start of the year to 11percent July, bringing it slightly below target.
The report noted that high downside risks cloud the economic outlook. With Pakistan’s sizeable external financing requirements, its economic outlook is vulnerable to any shortfall in external inflows, making timely disbursements from multilateral and bilateral partners crucial.
Lapses in policy implementation could jeopardise these inflows, increasing pressure on the exchange rate and worsening sovereign debt vulnerabilities. Devastating floods in 2022 demonstrated Pakistan’s vulnerability to climate-induced natural disasters, further complicating the economic outlook.
Externally, the main risks to macroeconomic stability stem from the economic impacts of adverse geopolitical developments, including higher food and oil prices and tighter global financial conditions. On the upside, improved global financing conditions and lower international food and fuel prices would reduce fiscal and external vulnerability, lower inflation, and allow for a faster build-up of external buffers.
The central bank has committed to maintaining an adequately tight monetary policy to meet its medium-term inflation target. The central bank has adopted a data-driven, forward-looking monetary policy framework and aims to keep real interest rates positive to bring inflation down to its target of 5percent –7percent over the medium term. Inflation is expected to rise from its recent lows due to the impact of fiscal measures in the fiscal year 2025 budget, including higher sales taxes on some items, and energy tariff adjustment required to ensure cost recovery in the energy sector. However, with an appropriately tight monetary policy, reduced exchange rate volatility, and a stable outlook for international food prices, inflation expectations are anticipated to moderate later in the year.
The current account deficit is expected to remain moderate but rise to 1.0percent of GDP in fiscal year 2025. The trade deficit is expected to widen as imports grow more rapidly than exports, driven by ongoing recovery in domestic economic activity and the improved availability of imported inputs.
The rise in the trade deficit will be partly offset by higher worker remittance inflows. In addition, the new IMF programme has improved prospects for multilateral and bilateral financing. Investment is also expected to revive as investor confidence is restored with the implementation of the programme.
Thus, despite a larger current account deficit, international reserves are expected to increase from 1.8 months of import cover in fiscal year 2024 to about 2.1 months in fiscal year 2025.
The government plans to achieve primary surpluses over the medium term to reduce public debt to a sustainable level. The EFF program targets a primary surplus equal to 1.0percent of GDP in fiscal year 2025 and about 3.2percent over the next two years to put the debt-to-GDP ratio on a sustainable declining path.
The budget deficit in fiscal year 2025 is expected to equal 6.9percent of GDP. Interest payments in fiscal year 2025 are projected to remain elevated at 7.9percent of GDP, comprising about 57percent of federal current expenditure and absorbing about 75percent of federal taxes. Nevertheless, a disciplined fiscal stance is anticipated to significantly reduce these payments in the medium term.
A robust revenue mobilization effort and some reduction in interest outlays will create the necessary fiscal space for much-needed social and development spending. Provincial spending will be restrained to achieve a cumulative provincial surplus equal to 1.0percent of GDP in fiscal year 2025, and spending on defence and subsidies will be maintained at the fiscal year 2024 level in terms of GDP.
The government’s medium-term fiscal consolidation effort envisages a multiyear strategy for revenue mobilisation. The programme aspires to create a more equitable tax system with reform to broaden the tax base and remove exemptions. The medium-term revenue mobilisation programme aims to bring the retail and export sectors under the regular tax regime and to align provincial agriculture income taxes with the federal personal and corporate income tax regime through legislative changes.
Fiscal consolidation targets tax measures equal to 3.0percent of GDP over the EFF programme period. With tax revenue measures equal to 1.5percent of GDP already implemented through the fiscal year 2025 budget, tax revenue is projected to rise to 11.2percent of GDP in fiscal year 2025. With non-tax revenue forecast at 3.1percent of GDP, total revenue is expected to increase to 14.3percent of GDP by the end of this fiscal year.
Record interest payments on public debt kept spending high in fiscal year 2024. Interest payments increased to 7.7percent of GDP in fiscal year 2024 from 6.8percent in fiscal year 2023, absorbing 81percent of tax revenue. The rise in interest payments came from elevated debt levels, high interest rates, and 3.2percent rupee depreciation during fiscal year 2024.
To contain the deficit, the government cut development and current spending, reducing non-interest expenditure from 12.5percent of GDP in fiscal year 2023 to 11.6percent in fiscal year 2024. However, higher interest payments kept total expenditure at 19.3percent of GDP.
Private investment should rebound on more favourable macroeconomic conditions, including easier access to foreign exchange. This will also benefit manufacturing and services. However, higher personal income tax rates in the fiscal year 2025 budget and the government’s efforts to limit spending will constrain private and public consumption. In addition, growth in agriculture is projected to slow in fiscal year 2025 as higher administered prices for gas and lower subsidies raise the cost of fertiliser.
The report noted that some economies are facing a combination of elevated public debt and high shares of interest payments relative to fiscal revenues, including Pakistan and Sri Lanka. This will challenge their capacity for productive public spending and investment.
Travel and recreation dragged down services export growth in Pakistan, whereas telecoms and information technology drove services exports to positive growth. In Pakistan, public debt is forecast to decline as a percent of GDP in 2024, but risks remain as interest payments rose to close to 60percent of fiscal revenues.
“Pakistan’s economic prospects are closely tied to the steadfast and consistent implementation of policy reforms to stabilise the economy and rebuild fiscal and external buffers,” said ADB Country Director for Pakistan Yong Ye. “It is imperative that Pakistan continues to consolidate public finances, expand social spending and protection, reduce fiscal risks from state-owned enterprises, and improve the business environment to encourage growth led by the private sector.”
In fiscal year 2025, the implementation of the economic adjustment program is expected to support economic activity by providing a more stable macroeconomic environment. To rebound, private investment would need more favourable macroeconomic conditions, including easier access to foreign exchange, which would also benefit manufacturing and services. Agriculture; however, is projected to slow.
Copyright Business Recorder, 2024
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