Stabilisation versus growth

The first six months of 2024-25 have revealed a mixed picture of the economy with some positive developments along with the persistence of various negative trends.

The start of 2024-25 was accompanied by a modest escalation of foreign exchange reserves to USD 9.4 billion by end-June 2024. This was facilitated by the one-year Stand-by Facility with the IMF. Pakistan has subsequently from September 2024 onwards entered into a three-year Extended Fund Facility with the IMF and total financing of USD 7 billion.

The Government which was inducted in February 2024 announced an ambitious budget for 2024-25, which envisages FBR revenue growth of 40 percent and a significant primary surplus of 2 percent of the GDP by the end of the year.

The presence of the EFF with the IMF has facilitated a further buildup of foreign exchange reserves. They stood at USD 11.7 billion in end-December, sufficient to provide import cover of up to two months.

The reduction in external financial vulnerability has motivated the new Government to claim that the economy of Pakistan has achieved ‘stability’.

The manifestation of stability is also on several other fronts. The exchange rate has remained, more or less, unchanged in nominal terms since March 2024 due to the buildup of reserves. This was facilitated by a positive current account balance in the balance of payments from July to December 2024.

The strongest impression of stability is conveyed by the quantum reduction in the rate of inflation. It averaged only 7 percent from July to December 2024 and was even lower at 4.1 percent in December 2024. The even more positive development in the even lower rate of inflation in food prices of only 2.5 percent in December 2024.

We come now to the persistence of a major negative trend. The biggest concern is that Pakistan has continued to witness a big plummeting of the GDP growth rate to a magnitude not seen before.

The last five years from 2018-19 to 2023-24 have seen a GDP growth rate of close to only 2.5 percent, implying no increase in real income over this period. Last year, the GDP growth rate was below 3 percent, despite the exceptional performance by the agricultural sector. Now, in the first quarter of 2024-25, PBS has estimated only 1 percent growth in the GDP.

Apparently, there is the likelihood that in the pursuit of stability, both on the external front for higher reserves and domestically to achieve a low single-digit rate of inflation, there has been a tradeoff with respect to growth. Inflation containment has been accompanied by a big rise in the rate of unemployment.

What factors explain, more or less, the complete loss of growth momentum by the economy? The first major reason is the big drop in investment, both public and private. It has sharply declined from 15.4 percent of the GDP in 2017-18 to 11.4 percent of the GDP in 2023-24. Consequently, without adequate expansion in production capacity it has been difficult to achieve a relatively high rate of growth.

Private investment has been restrained by very high interest rates in recent years and a big ‘crowding out’ from bank credit by big increase in borrowing by the government. Further, the profitability of industry and services has been reduced by the big escalation in electricity and gas tariffs.

The need to restrict the trade deficit has led to measures to curtail the imports of industrial inputs and machinery. The best example of the presence of such controls is in the automobiles industry, which has witnessed an over 30 percent decline in output.

There is a strong imperative for restoring the level of private investment by appropriate incentives including a further reduction in interest rates in the presence of the low rate of inflation. The rate of monetary expansion is negative and is helping the process of stabilization. As such, there is some scope for interest rate rationalization.

The tax burden on industry is very high and over three times the national average. The tax system will have to be reformed to reduce taxation on industry and increase it on property, incomes from agriculture and retail trade.

The Kharif outcome of crops in the first half of 2024-25 has also been negative. In particular, the cotton crop is likely to be lower by over 20 percent in relation to the level achieved last year. Further last year’s bumper crop of wheat led to a fall in the price received by farmers of over 30 percent. This is likely to have reduced the cultivation of wheat this year.

There are other indicators of the loss of growth momentum in the economy. These include the big decline of 11 percent in the first quarter of 2024-25 in the quantity of electricity sales and a small growth only in sales of petroleum products.

Overall, the time has come when the extent of the tradeoff between stabilisation of the economy and growth in the GDP must be reexamined. The people are somewhat relieved with the big decline in the rate of inflation, especially in food prices. However, the absence of significant growth in the economy has led to an unprecedented increase in the rate of unemployment. It is estimated currently at 13 percent, twice the rate five years ago in 2020-21. This is probably the highest ever rate.

The IMF first review of the EFF is due shortly. There is need to highlight that the GDP growth target of 3.2 percent in 2024-25 is very likely to be missed. Changes must be negotiated in the performance criteria and in the reform agenda to facilitate achievement of the GDP growth target in the Program for 2025-26 of 4 percent. This will require appropriate adjustment in interest rates, size of the federal PSDP and reduction in the tax burden on the large-scale manufacturing sector.

Copyright Business Recorder, 2025