Pakistan’s economic outlook 2025: inflation, growth, & debt

Among macroeconomic indicators, primarily inflation has come down drastically over recent months, whereby consumer price index (CPI) has fallen from a high of 28.8 percent in January to 4.9 percent in November, with a big dip that happened in May when inflation fell to 11.8 percent from being 17.3 percent in April.

While a sign that kindles hope, nonetheless there is need for strong reality check by policymakers as premature euphoria is being built from the top by Finance Minister.

This is because an important determinant of inflation is imported inflation, and being a net-oil-importer the country has benefited from exogenous shocks such as dampened level of oil prices of a little more than USD 70 per barrel which, in turn, has resulted from a dull consumption demand due to geopolitical tensions, a tight monetary stance and slowdown in China.

That is all likely to change in the opposite, given US President-elect Donald Trump as he assumes office in January will likely come through on his strong election campaign indication of stopping wars anywhere and everywhere, which means in two main places, the Middle East, and in Ukraine.

Secondly, with inflation generally falling, policy rates have started to fall, and quite drastically; for instance, by 700 basis points in recent months in Pakistan, a trend that is likely to boost economic activity. Thirdly, China has recently given more than a trillion dollars in stimulus to an otherwise slowing economy, which is likely to increase spending sentiment, decrease the burden of debt domestically, and reverse deflationary trend.

All these three consequences that fall in level of conflict, looser monetary policy stance, and better economic growth prospects are likely to push up prices of oil – where already OPEC+ have not increased production – and this will have a significant positive impact on inflation, where one knows that rising oil prices mean increasing electricity tariffs as well, which in turn, is another contributor to inflationary build-up. Having said that, two more things need to be internalized – base effect, and sensitive price index (SPI) – whereby once the base effect of last years’ high level of inflation phases out, drastic falling rate will have a relatively moderating trend; other things not changing much though.

Secondly, an important determinant of inflation, and not a desirable way that this influence has shaped, is the negative impact on inflation coming from falling aggregate demand, given aggregate supply has not been impacted much both in terms of reduction in terms of supply-hurdling bottlenecks – including artificially-boosting-prices through hoarding, and because of rent-seeking role of middle-man or ‘aarthi’ contributing to suppressed prices for farmer, and inflated costs for wholesale-, and retail consumer – and increase in investment in the real sector; a glaring manifestation of which is the rise in stock market index, as financial investments find little incentive elsewhere.

Here, SPI, which gives a more accurate picture in terms of increase in prices of commodities of essential nature, and which has the most impact on everyday life of common man, SPI remained in double digits all through January to August – falling from the high of 36.2 percent in January to being at 10.8 percent in August – while since September it came in the single digit zone, and for November stood at more than CPI at 7.3 percent.

Having said that, since many of the commodities that influence daily-natured supply chain like agricultural commodities, which form the core of SPI, and given not much has improved in terms of improvement in governance-, and incentive structures (as indicated above), including lack of any significant increase in investment level here, not to mention likely upward change in income tax, and in one big increase in one go, likely to be implemented starting January as per agreement under the current IMF programme, may overall lead to negative shocks in aggregate supply, resulting in likely build-up of cost-push inflationary channel.

Hence, there are serious reform concerns in terms of poor performance to improve governance, and incentive structures in an overall lack of effort to move away from ‘market fundamentalism’ to, for instance, ‘dual-track’ pricing system as introduced by China primarily during the 1980s and 90s to enhance better price discovery, and greater incentivisation for farmers, and industries, especially for crops that form the core of food security, and manufacturing that has big say in employment, and important linkages for enhancing manufacturing, and exports in an overall sense.

Linking back to the initial argument for analysing inflation prospects for next year, weak outlook for supply side – especially in a fast-unfolding climate change catastrophe, raising unpredictability, as the current year is strongly tipped to be the hottest since records were first started to be kept – will not allow a dampening impact on inflation as correctly looser monetary policy stance boosts aggregate demand.

Moreover, notwithstanding the fall in inflation, the longevity, and the level of rise in price since the days of the Covid pandemic overall meant the cost of living continues to be very high, and given poor price discovery in the country, there should be a ‘price commission’ formulated to check this strong aberration from prices closer to the actual value goods and services hold.

Much better price discovery is also important for creating space for economic growth to outpace its current low-growth shackles, as reflected in the June forecast by World Bank’s flagship ‘Global Economic Prospects’ (GEP) report; according to which, growth was likely to show only a paltry increase from a very low expected growth rate for 2024 at 1.8 percent, to 2.3 percent forecasted for 2025, and 2.7 percent for 2026; where average of these growth rates being almost in balance with the population growth at 2.3 percent, and of course should be higher to have much-needed positive impact on real incomes, which have no where near increased as much as the drastic rise in price level over the recent years.

Similarly, International Monetary Fund (IMF) in its Article IV report for Pakistan, released in October also put the growth expectation for the country at 2.4 percent (2024), and 3.2 percent (2025), projections which are same as in October update of IMF’s World Economic Outlook (WEO), and only slightly better than those by World Bank.

Positive prospects for inflation, especially imported inflation as President-elect Donald Trump is reportedly going to heavily increase trade related tariffs as an overarching guiding direction for the country’s trade policy, and as consumption, and investment demand create upward push for growth, and also inflation, will ultimately mean pressure on domestic foreign exchange reserves, and the currency, with negative consequences for debt sustainability, when external debt obligations already are a big concern for Pakistan.

For instance, Table 3b of the same October published IMF’s Article IV report for Pakistan pointed out a very difficult debt obligations scenario, whereby during five fiscal years from 2024/25 to 2028/29, average annual external debt obligations stood at USD 18.1 billion; where debt obligations reached by subtracting current account deficit number from gross financing requirements– which in turn are significantly higher than external debt obligations – for a particular year.

Here, in addition to low growth in both exports, and foreign direct investment, and no breakthrough increase witnessed in remittances, weak multilateral spirit giving little hope for reduction in debt burden, through much-needed improvement in the global debt restructuring framework.

Moreover, pressure on debt is likely to rise with likely generation of greater needs as little is being promised by rich, advanced countries, both in terms of climate change related bilateral support, and in terms of push for greater issuance through multilateral platforms.

Hence, unlike developed countries meeting the annual climate finance needs of developing countries at USD 1.4 trillion, and instead only committing USD 300 billion, and that too as a target to be met by 2035, and also developed countries not reportedly putting their weight behind developing countries’ demand to IMF for issuing a meaningful amount of special drawing rights (SDRs) on an annual basis, all clearly spell out a weak multilateral spirit, which not only debilitates developing countries efforts to improve economic resilience, but also does not help them in lessening their debt burden; a significant portion of which was taking during the recession-causing Covid pandemic years.

A recently released report by World Bank titled ‘International Debt Report 2024’ has given important details with regard to a very external debt situation being face by the country, the build-up of which has gained a lot of momentum since the Covid pandemic, not to mention the climate change-related catastrophic floods witnessed by the country in 2022.

Here, while external debt stock has increased, and with it interest repayment needs, but increase in interest payments also reflect an (otherwise wrongly) over-board recourse to practice of austerity policies during the recent years in particular; in addition to an unnecessarily high economic growth sacrifice that these over-board consolidation/austerity/aggregate demand squeeze policies produced. Lack of economic growth resultantly also reduced debt sustainability.

Hence, as per the Report, external debt stock increased drastically from being at USD 110.2 billion in 2019 to USD 130.9 billion in 2023. Moreover, a big jump in external debt stock build-up during the last decade was also seen, whereby external debt before rising to USD 110.2 billion in 2019 (or 353.6 percent of exports), was less by USD 49.9 billion back in 2013, when it stood at USD 60.3 billion (or 197.4 percent of exports).

The Report also reveals the rapid rise in bilateral debt (mainly from China) as a proportion of long-term component of debt, from being at USD 19.9 billion (2013) to USD 39.4 billion (2019) to being USD 45.7 billion in 2023, while during the same time multilateral component of long-term debt increased from USD 24.1 billion (2013) to USD 30.1 billion (2019) to being at USD 38.6 billion in 2023; hence bilateral long-term debt increasing by almost double, that is during the decade (2013-2023) it increased by USD 25.8 billion, while during the same time period, multilateral long-term debt increased by USD 14.5 billion.

Hence, the significant build-up in debt during the decade (2013-2023) and a lack of improvement in debt sustainability, given it was already very weak to start with, as evident from rising external debt stock to export percentage, whereby in 2013 while it already stood at a weak level of 197.4 percent, it rose to 352.4 percent, and given foreign direct investment also did not show much increase during the same period, mean an increase in debt unsustainability in a very drastic way, and should raise alarm bells going into 2025, and over the medium-term at least, given overall high gross financing needs.

While the overall economic situation has shown some improvement, the outlook holds potential for serious headwinds, which can even turn the direction of this recovery, and calls for serious and urgent efforts to usher in meaningful economic reforms, especially on the supply side.

Copyright Business Recorder, 2024