FeaturedNationalVOLUME 19 ISSUE # 5

Between high inflation and modest growth

In its recent September outlook report, the Asian Development Bank sheds light on the economic dynamics of Pakistan, distinguishing it as an outlier in Asia. The country grapples with the unfortunate combination of the highest inflation rate and the fourth lowest economic growth rate among the 46 economies surveyed in the region.

The Asian Development Bank has maintained Pakistan’s economic growth forecast at 1.9%, citing a moderate level of confidence in the economy. However, it anticipates a slight alleviation in inflation, aligning with Islamabad’s expectations. According to the Asian Development Outlook update report released by the Manila-based lender, “Pakistan’s overall recovery is still constrained by moderate confidence and high inflation eroding purchasing power.”

Despite affirming the 1.9% economic growth forecast for Pakistan in the current fiscal year, the ADB has revised the growth projection for South Asia to 5.7% in 2023. This adjustment is primarily attributed to higher-than-expected growth in India for the July–September quarter. For 2024, growth forecasts for the sub-region remain at 6%, with no changes for other economies, despite downward revisions for Bangladesh and Maldives.

The report comes a day after the central bank maintained its policy rate at 22%, citing a tight external financing position. On the growth front, the State Bank of Pakistan (SBP) anticipates a moderate economic recovery throughout this fiscal year. In recent review talks, the International Monetary Fund (IMF) also reduced Pakistan’s growth forecast to 2%. In the previous month, Pakistan officially revised its growth estimates to a nominal contraction of 0.2%.

Contrary to government expectations, Fitch Ratings, a US-based credit rating agency, has kept Pakistan’s credit rating unchanged at CCC. The agency expressed skepticism about the ambitious external funding targets, noting challenges in arranging $1.5 billion in Eurobond and $4.5 billion in commercial bank borrowing. Fitch Ratings anticipates scheduled elections in February and a prompt negotiation of a follow-up IMF program after the SBA concludes in March 2024. However, there is still a risk of delays and uncertainty regarding Pakistan’s ability to achieve this.

In the first quarter GDP growth figures released by the federal government last month, the economy was estimated to have grown at a rate of 2.1% during the July-September quarter. The central bank highlighted the agriculture sector as the major driver of the growth, with the manufacturing sector also experiencing a moderate recovery, while growth in the services sector remained subdued compared to the commodity-producing sector.

The SBP projected that the GDP growth rate for the current financial year 2023-24 would range between 2 and 3 percent, falling short of the target of 3.5 percent. The SBP’s annual report on the state of Pakistan’s economy for the fiscal year 2022-23 indicates some early signs of improvement in the country’s economic situation. Securing a US$ 3.0 billion Stand-By Arrangement (SBA) from the IMF towards the end of FY23 helped alleviate near-term risks to the external sector. High-frequency indicators suggest a bottoming out of economic activity from July 2023. The withdrawal of guidance on import prioritization, coupled with a gradual easing in the foreign exchange (FX) position, is expected to somewhat improve the supply chain situation and boost growth in large-scale manufacturing (LSM) and exports. Additionally, an anticipated rebound in cotton and rice production is expected to support agriculture growth in FY24. Based on these considerations, the SBP anticipates real GDP growth in the range of 2 – 3 percent in FY24.

The SBP also projects the current account deficit to fall within the range of 0.5 – 1.5 percent of GDP in FY24. The report notes that the lagged impact of monetary tightening and other contractionary measures is expected to restrain domestic demand. Furthermore, prospects for an improvement in the supply situation, due to a likely increase in the production of essential crops and imports, are expected to contribute to lowering inflation in the range of 20.0 – 22.0 percent in FY24. Slightly improved global and domestic growth prospects are anticipated to bolster foreign exchange earnings from exports of goods and services. Although import volumes may increase, lower commodity prices are expected to prevent a significant expansion in the import bill during FY24. Accounting for these factors, the SBP projects the current account deficit to fall within the range of 0.5 – 1.5 % of GDP in FY24.

The report highlights that Pakistan’s economy faced multiple challenges during FY23, with long-standing structural weaknesses exacerbating the impact of successive domestic and global supply shocks of unprecedented nature. The macroeconomic situation began deteriorating in the second half of FY22 due to the Russia-Ukraine conflict, elevated global commodity prices, and an unplanned fiscal expansion. The situation worsened in FY23 due to floods, delays in the completion of the 9th review of the IMF’s Extended Fund Facility (EFF) program, continuing domestic uncertainty, and tightening global financial conditions.

In its September outlook report, the Asian Development Bank highlighted Pakistan’s economy as an outlier in Asia, characterized by the highest inflation rate and the fourth lowest economic growth rate among the 46 economies in the region. Regarding inflation, the ADB anticipates a slowdown in the inflation rate in the upcoming months. “Pakistan’s inflation rate averaged 28.5% over July–October but is expected to ease amid fiscal consolidation and monetary tightening, as well as the improved availability of food and key imported inputs.”

In comparison to its projection three months ago, the ADB has raised its inflation forecast for Pakistan to 25%, significantly higher than the initial projection of 15%. The ADB estimates that inflation accelerated to 29.2% in the last fiscal year (FY2023), surpassing the earlier forecast of 27.5% in April. While the inflation forecast for South Asia remains unchanged at 8.6% for 2023, it has been revised upward to 6.7% for 2024.

The central bank, in a statement the day before, noted that inflation expectations of both consumers and businesses, though showing some improvement in recent months, still remained at an elevated level. The bank expects headline inflation to decline significantly in the second half of the fiscal year, attributing it to contained aggregate demand, easing supply constraints, moderation in international commodity prices, and a favorable base effect. Following a substantial increase in gas prices, up to 520% in November, the government is reportedly in the process of further raising prices

As Pakistan stands at the crossroads of economic challenges, the Asian Development Bank’s projections paint a picture of resilience amid adversity. The anticipation of a slowdown in inflation over the coming months offers a glimmer of hope, albeit against a backdrop of fiscal consolidation and monetary tightening. The government’s strategic moves, such as increasing gas prices, indicate attempts to navigate the complex economic terrain. However, with inflation persisting at elevated levels and growth struggling to gain momentum, Pakistan faces a delicate balancing act in the pursuit of sustainable economic recovery.