The State Bank of Pakistan’s latest Monetary Policy Report offers a cautiously optimistic assessment of economic activity, projecting a further improvement in growth during the current fiscal year. At the same time, however, the report identifies several external risks, including the continuing uncertainty created by the Middle East conflict, climate-related disruptions and changes in global tariff policies.
Pakistan’s leadership is already attempting to address some of these external challenges. The country’s leadership is engaged in efforts to facilitate dialogue between Iran and the United States, while the government is taking measures to mitigate the economic impact of climate change. It is also negotiating with US authorities to reduce tariffs affecting Pakistani exports. These efforts are important, but the SBP report points to another risk that lies much closer to home: delays in implementing structural reforms.
The central bank has warned that failure to advance the reform agenda being monitored under the International Monetary Fund programme could weaken exports, slow productivity growth and reduce the economy’s ability to sustain higher growth without generating renewed inflation and current-account pressures. This warning deserves considerably more attention than it has received.
Pakistan’s economic managers have repeatedly claimed that economic activity is recovering. The SBP has also relied on its surveys to support this assessment. Yet there are reasons to question whether the optimism reflected in these surveys accurately captures the condition of the broader economy. The first concern is the nature of the surveys themselves. Businesses participating in official surveys may have incentives to present a more positive assessment of their prospects than they privately feel. This does not necessarily invalidate the findings, but it does mean that survey-based optimism should be treated cautiously, particularly when independent assessments appear to paint a less encouraging picture.
A second concern is the relationship between sales, production and employment. Rising sales do not necessarily mean that domestic production is increasing. If inventories are being run down, particularly in sectors such as automobiles, companies can increase sales without producing more. At the same time, rising unemployment would suggest that the recovery is not translating into sufficient expansion of productive activity. This distinction is critical. An economy can appear more active because consumption and imports are increasing without experiencing a corresponding improvement in productive capacity.
There is also a broader contradiction in the current policy framework. Economic theory generally suggests that contractionary fiscal and monetary policies can restrain growth. Yet the IMF has insisted on higher taxation and relatively tight monetary conditions as part of its stabilisation programme. The rationale is not simply to suppress demand but to address deeper structural weaknesses, particularly the entrenched influence of powerful economic groups over taxation and access to credit.
The problem is that the tax structure has so far shown little evidence of fundamental transformation. Pakistan continues to rely heavily on indirect taxation, whose burden falls disproportionately on lower-income households. Indirect taxes account for almost 80 per cent of Federal Board of Revenue collections when withholding taxes imposed on goods are included. A substantial portion of these withholding taxes is ultimately passed on to consumers through prices.
This means that even measures presented as improvements in tax collection can have consequences for inflation and household purchasing power. The manner in which tax enforcement is being pursued also deserves scrutiny. The audit achievements frequently highlighted by the FBR chairman are often concentrated at the factory-gate level. In sectors such as sugar, for instance, additional taxation can ultimately be reflected in higher consumer prices. Revenue collection is essential, but the quality and incidence of taxation matter just as much as the amount collected.
Monetary policy presents another dilemma. The SBP policy rate currently stands at 11.5 per cent, considerably below the record 22 per cent reached during the previous tightening cycle. Yet it remains significantly higher than rates prevailing in several competing regional economies. This has naturally prompted renewed calls for further monetary easing. The challenge for the central bank is to balance the need to support economic activity against the risk of reigniting inflation and external imbalances. Lower interest rates may stimulate investment and credit, but if demand expands faster than domestic productive capacity, the result could be higher imports, renewed pressure on the current account and eventually another round of macroeconomic instability.
The government’s recently approved export subsidy and incentive package adds another layer of uncertainty. Reports of possible misuse of the scheme, including the Rs88 billion export refinance and related incentives, have already surfaced. It is also unclear whether the programme received the necessary approval from the IMF. If it did not, the issue could become a point of contention during the forthcoming fourth-quarter staff-level agreement review. The broader question is whether Pakistan’s export policy is delivering sufficient economic returns to justify the resources being committed.
Exports are conventionally treated as the principal engine of growth, and there are good reasons for that approach. Pakistan needs foreign exchange earnings and greater integration with international markets. But not every export generates the same economic benefit. Some export industries depend heavily on imported raw materials, energy and semi-finished goods, meaning that increased exports can also contribute significantly to import demand and reduce the net foreign-exchange gain.
At the same time, remittances have become an increasingly important source of external financing and have, in some periods, exceeded export earnings. This should prompt a more rigorous assessment of the country’s overall foreign-exchange strategy.
Rather than continuing to provide broad incentives to exporters simply because exports are assumed to be beneficial, the government should conduct a detailed cost-benefit analysis of individual export sectors. Policymakers need to know which industries generate the greatest net foreign exchange, create productive employment, increase domestic value addition, improve technology and contribute meaningfully to tax revenues. Such an assessment could help redirect scarce public resources towards sectors with the strongest long-term economic contribution.
The central issue, therefore, is not whether Pakistan should welcome signs of improving economic activity. It certainly should. The issue is whether policymakers are accurately diagnosing the sources and sustainability of that improvement.
Excessive optimism can be almost as damaging as excessive pessimism when it leads governments to delay corrective action. If the economy is genuinely recovering, policymakers should identify the factors driving the recovery and strengthen them. If growth is being supported primarily by imports, temporary inventory adjustments or consumption, they need to recognise those limitations before external pressures re-emerge.
Pakistan has repeatedly experienced cycles in which initial signs of stabilisation generate confidence, followed by renewed demand, rising imports, worsening external balances and another crisis. Breaking that pattern requires a much more honest assessment of economic performance. The SBP’s warning about delayed structural reforms should therefore be taken seriously. Economic stability cannot rest indefinitely on an IMF programme, temporary external financing or optimistic surveys. It must be supported by fundamental improvements in taxation, productivity, exports, investment, credit allocation and public-sector efficiency.
What Pakistan needs now is neither undue pessimism nor manufactured optimism. It needs an accurate reading of the economy. A realistic assessment may reveal uncomfortable weaknesses, but it also allows policymakers to act before those weaknesses become crises. Economic managers would be far better served by acknowledging the challenges early and making timely policy adjustments than by celebrating an anticipated recovery that may prove weaker, narrower or less sustainable than the headline numbers suggest.