Pakistan’s economy has probably attained a balance on the external account side at high interest rate.

But this is achieved by reducing government spending on development coupled with reduced spending from the private sector.

As a result of these and other measures, the total value of investment in new machinery, buildings, infrastructure etc for use in the production process, also known as gross capital formation (GCF), dropped to its lowest level in FY23.

These investments are critical for the production of goods to create alternatives for imported products and for increasing the capacity for export in the future.

Although the current account is in balance, the fiscal account of the government, on the contrary, is not in balance. Even before incorporating interest expenses, the government’s primary account is in deficit in FY23. Interestingly, the primary balance has remained negative in all the years since 2005.

The first task with the government is to bring the primary account balance in surplus. So far into the year FY24 this target is being achieved, however, we will need to wait to see if it maintains till the end of the year.

Some would argue that the federal government’s primary deficit is due to higher sharing of revenue with the provincial governments. However, just to clarify, the primary balance reported by the government is at the consolidated level in which the amount transferred by the federal government and received by the provincial governments is cancelled out against each other.

Therefore, the government transfers under NFC award are not a reason for consistent primary and fiscal deficits.

This points out to a deeper problem as the sum of revenues of federal and provincial governments is lower than the sum of their expenses (other than interest expense). Therefore, the revenue measures, if any, need to be taken at the federal as well as on the provincial level to bring the primary account in surplus.

At the fiscal account level, the interest rate and inflation environment has resulted in high Mark-up payments for the government.

But relying on reduced interest rates for solving the fiscal deficit problem is also not worthwhile. In the best-case scenario, the size of relief as a result of lower interest rate in FY25, will only be around 1% of GDP whereas the fiscal deficit was over 7.7% in FY23. i.e. a 500-basis point cut (on average) in interest rate in FY25 would only save government interest expense between Rs1 to 1.2 trillion.

High inflation is created due to reasons discussed in an earlier column.

Foreign currency requirement for taming inflation

In the near term, an inflow of foreign currency could reduce inflation, and the interest cost for the government. But on the contrary, lower interest rates will re-start the demand leading to some imbalance in external accounts. Though a limited imbalance in external account should not be a cause of concern, as more fully discussed in (Pakistan borrows growth from its future)

Pakistan ‘borrows’ growth from its future

There is no space with the federal government to increase expenditure on development, but demand from the private sector resumes quickly in case interest rate starts declining. This investment could revive some of the investments in GCF.

Slow growth of GDP should persist for few years, and interest rate should reduce only gradually, but the sustainability of growth will depend on internal and external factors. The creation of space for growth and optimum utilization of limited resources need an extensive plan for which the federal and provincial governments need to work collectively to steer out of the present economic situation.

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