As the political government gears up to revert the economy back onto a growth path, the IMF mission is set to arrive in Pakistan next week to review progress against the structural benchmarks set under the latest Extended Funded Facility (EFF) program. Will the Fund be satisfied with Pakistan’s performance and issue the policymakers a clean chit, or is the macroeconomy about to receive a yellow—or even a red—card?
Six weeks since Pakistan entered its 25th Fund program—the highest number for any country since the Bretton Woods institutions were founded in 1944—the country has already missed several benchmarks set under the program. As per the staff report, the National Fiscal Pact—aimed at rearranging the expenditure sharing between the federation and provinces—was to be reached by September 2024. The political government’s legislative gymnastics over the last two months indicate that securing the pact is not a priority at all.
Similarly, enforcement of agricultural income tax beginning in the calendar year 2025 no longer looks likely, as all provinces are yet to amend legislation to align agricultural income tax slabs with the federal income tax brackets. The establishment of a Tax Policy Office, leaving the FBR with only the administrative functions of tax collection, has also stalled. The 4M-FY25 tax revenue collection target has also been missed. Similarly, “expected adjustments in gas tariffs and PDL rates” have also been delayed, according to the central bank. Disconnection of gas supply to captive power plants by the beginning of next year also seems impossible, as no efforts have been made to expedite the shift of industries to grid power. And let’s not forget the spectacular debacle that was PIA’s attempted privatization, which has laid bare the government’s commitment to reform for all to see.
In the midst of all of this, both the policymakers and market participants are behaving as if the economy has truly turned a corner. The central bank has delivered a colossal rate cut, arguably to keep the policy rate in line with market yields—but also signaling the beginning of the next credit bonanza. The stock market is up 14 percent since EFF’s approval and is showing no signs of slowing down. Low inflation, stable exchange rate, and higher remittances appear to be sufficient indicators for policymakers to unroll the “Mission Accomplished” banner. When, in fact, both the market and the policymakers should be preparing themselves for a very rude awakening.
While it may be true that the near-term outlook on the macroeconomy—at least until end of June 2025—does appear very stable, Pakistan once again stands at the cusp of either taking substantial actions to alter its destiny or risking reverting to its tried and tested ways of failure. Now that the incumbent politico-judicial-military complex’s medium-term future is secured, it appears ever more likely that the policymakers will go all out to secure FDI from bilateral partners while either ignoring or stalling key reforms needed to turn the country onto a truly sustainable path to growth.
Near-term indicators all point in this direction. The base effect alone will ensure that inflation remains on the targeted path until August 2025. Thereafter, the knock-on impact of higher price levels and sanguine global commodity market conditions may ensure that the medium-term inflation target remains stable, helping exchange rate stability. It appears likely that the central bank—egged on by Islamabad—will exploit these conditions to kickstart a credit bonanza for the private sector, as there exists sufficient room to bring down interest rates while also meeting the IMF’s two conditions: a positive real rate on a forward-looking basis and a headline CPI between 5 to 7 percent. It would be a mistake for the Fund not to advise caution on this front.
Historically, Pakistan’s policymakers have had very limited bandwidth and political space to deliver lasting structural reforms. In truth, the last such opportunity probably only appeared between 2015–2016, when inflation fell below 5 percent due to a collapse in global oil prices, leaving the political government in a very safe space, albeit for a period lasting no more than 12 to 16 months. That opportunity was squandered by stimulating economic growth on steroids via CPEC. Only stringent conditions by the Fund can ensure Pakistan does not go down the same path again.
The low inflation over the next 12 months, along with healthy remittances and a stable exchange rate, indicate policymakers may have another once-in-a-decade opportunity to undertake structural corrections without risking too much of their political capital. Stimulating growth by reducing interest rates drastically at this juncture could pull the country back on the path of a resurgent current account deficit; remember, growth momentum once stoked tends to take on a life of its own. Once that happens, the ever-precarious political conditions will ensure the will to undertake reform diminishes even further.
On the surface, Pakistan has room to reduce interest rates significantly over the coming 12 months, without violating EFF conditions. However, unless structural reforms precede the growth phase, the only path to growth known to the private sector is that of an import-led economy. The private sector will have little incentive to act differently, as low inflation will make an increase in domestic consumption once again possible.
Let’s not let it happen.
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