The State Bank of Pakistan (SBP) said Pakistan’s macroeconomic conditions deteriorated during the first half of fiscal year 2022-23 (H1-FY23) despite policy-induced improvement in external current account and primary fiscal balance.

In its Half Year Report for FY23 on the ‘State of Pakistan’s Economy’ released on Friday, the SBP noted that adverse global economic conditions, uncertainty surrounding the completion of IMF program’s 9th review, insufficient external financing and low level of foreign exchange reserves remained major concerns during H1-FY23 which were exacerbated by the fallout of flash floods and political instability.

“Specifically, both agriculture production and large scale manufacturing (LSM) contracted whereas, headline inflation rose to multi-decade high level.”

The central bank raised the policy rate by 225 bps in H1-FY23 on top of the 675 bps increase during FY22 to address the challenges.

“Similarly, the government resorted to curtail federal expenditures on grants, subsidies and development,” the central bank said. “Furthermore, to contain pressures on external account the government and the SBP introduced various regulatory measures to restrict imports.”

Inflation remains persistent

Despite visible contraction in domestic demand, the report added that the inflation outturns remained stubbornly persistent since H2-FY22.

High global commodity prices along with elevated inflation expectations and a range of domestic factors pushed the national consumer price index (NCPI) inflation to 25% during H1-FY23 compared to 9.8% in the same period last year.

Higher food prices, on account of flood induced supply shortages, mainly drove overall inflation followed by non-food and non-energy (NFNE) and energy groups.

In addition, rupee depreciation along with the increase in power tariffs and energy prices provided further impetus to inflationary pressures.

The second round effect of these supply shocks to broader prices and wages along with rising inflation expectations pushed up core inflation, the report said.

Fiscal sector

The report highlighted the contraction in major non-interest current expenditure, particularly subsidies, grants and development spending, which contributed to improvement in primary surplus during H1-FY23.

However, fiscal deficit remained at last year’s level, in terms of GDP, because of a sharp expansion in interest payments.

“On the revenues side, tax administration efforts, inflation and higher return on deposits led to an expansion in FBR taxes. However, a sharp contraction in imports and an overall dip in economic activity constrained tax collection below the target for the first half of FY23.”

External sector

As per the report, the external sector, in general, and external financing, in particular, remained under significant pressure during H1-FY23 due to uncertainty regarding the resumption of IMF program, along with tight global financial conditions.

“Supply chain disruptions resulting from Russia-Ukraine conflict and China’s zero - Covid policy, hampered global demand, which also weighed on Pakistan’s export performance.”

On the supply side, flood-related disruptions led to lower crop outturns, which not only dented the food exports but also deteriorated the commodity import outlook.

Similarly, workers’ remittances also declined during H1-FY23.

“In addition to the global economic slowdown, increase in the use of informal channels also affected remittances flows to the country,” it said. “However, the decline in exports and remittances was more than offset by a much larger fall in imports during H1-FY23, leading to a notable decline in current account deficit (CAD).”

Despite this improvement in CAD, the report noted that the dearth of financial inflows led to decline in FX reserves during H1-FY23.

In addition to the delays in the disbursements of the IMF tranches and the political uncertainty in the country, higher net FX outflows on account of scheduled debt repayments and disinvestments added to external account pressures. The combined effect of these developments, in the backdrop of US dollar’s appreciation against a basket of global currencies, led to rupee depreciation during H1-FY23.