FeaturedNationalVOLUME 19 ISSUE # 16

Potential risks and uncertainties

The economic landscape in FY2024 has been characterized by both challenges and notable strides. In January, inflationary pressures persisted, yet hopes for a decline in the upcoming months remain.

The finance ministry, in its Fiscal Risk Statement FY2023-24, presented an overview of potential risks and uncertainties that could influence the country’s fiscal trajectory in the years ahead. In recent years, Pakistan’s economy has grappled with numerous challenges, impacting both economic growth and the fiscal deficit. To address these issues, the government has undertaken various economic reforms aimed at curbing the fiscal deficit and enhancing efficiency in key sectors, thereby attracting increased investment, it noted.

However, these measures have concurrently heightened inflationary pressures within the economy, notably impacting food prices, which have reached unprecedented levels in recent months. The ministry acknowledged the deteriorating inflation outlook, highlighting it as a significant macroeconomic challenge. It specifically identified the uncertainty surrounding the future adjustment path in energy prices as a key upside risk to the inflation outlook.

The report also underscored Pakistan’s debt situation as an additional risk factor. With external debt comprising 40.8% of the total public debt, the government’s fiscal position is deemed vulnerable in the face of high current account deficits, low foreign exchange reserves, and a weakening exchange rate. Ongoing fiscal deficits necessitate refinancing maturing debt, coupled with raising additional debt to address the fiscal shortfall. The prevalence of a substantial amount of short-term debt creates potential challenges during periods of sluggish economic growth, heightened fiscal deficits, and/or diminished investor confidence.

The report further cautioned that climate and natural hazard events could pose additional challenges to the government’s fiscal risk position. In response to these challenges, the ministry recommended a restrictive monetary policy through higher interest rates, with the dual objective of reducing inflation and addressing external imbalances. Additionally, it advocated for measures to enhance the business environment, fostering a fair and level playing field for organizations to promote increased investment and trade.

The Consumer Price Index (CPI) recorded a year-on-year inflation of 28.3%, driven by increased costs in various sectors. Despite these challenges, the government has implemented relief measures, such as the Ramazan Relief package, to support the economically vulnerable during the holy month of Ramazan in 2024. On the fiscal front, tax and non-tax collections saw substantial growth, contributing to an improved revenue scenario, although higher markup payments led to a fiscal deficit. Externally, trade balance improvements and increased foreign investments have positively impacted the current account balance.

As the new government assumes office following the general elections, there are expectations that a robust strategy and vision will contribute to the revitalization of the economy, building upon the gains achieved in the past six months. Measures taken in the recent months have restored market confidence and resulted in an upswing in economic activity. In Q1 FY2024, GDP growth accelerated to 2.1%, marking a positive shift after two consecutive quarters of negative growth. The growth was widespread, with the agriculture sector posting a 5% increase and manufacturing activity registering a 2.5% growth.

The removal of import bans and other restrictions has alleviated supply constraints, contributing to the increased economic activity. Data from Q2 FY2024 indicates a stronger performance in the manufacturing sector, with large-scale manufacturing experiencing an 8.2% increase over Q1. It is anticipated that Q2 FY2024 GDP growth will rise to around 3%, driven by enhanced manufacturing output and increased crop production, particularly in cotton, which has surged by 75% to 8.35 million bales.

To address challenges, the caretaker government implemented measures to reduce unproductive expenditures and boost both tax and non-tax income. During Jul-Dec FY2024, the government achieved a primary surplus of Rs 1.5 trillion (1.4% of GDP), surpassing the IMF SBA target of 0.5% of GDP. Unpopular measures, including a subsidy reduction on power and gas through timely quarterly tariff implementations, have improved the primary account. No supplementary grants were issued during this period, and Provincial Annual Development Plan (ADP) projects have been transferred to provincial ADPs. Simultaneously, funds for 9.3 million vulnerable households have been increased.

On the revenue side, the Federal Board of Revenue (FBR) tax collection grew by 30% to Rs 5.15 trillion during Jul-Jan FY2024, despite a slowdown in imports and a 0% GST on petroleum products. Overall growth in domestic taxes increased by 40%, reflecting the rebound in economic activity and rising profitability in various sectors. Import taxes posted a growth of 16%, aided by improvements in import valuation, yielding Rs 151 billion in collections, and an anti-smuggling drive witnessing almost 69% growth in FY2024.

The improvement in the fiscal position has enabled the government to reduce the accumulation of public debt. Net domestic borrowing decreased by 67% to Rs 1.9 trillion from Rs 5.8 trillion in the preceding period. Lower domestic borrowing costs, lower borrowing on margin (below the State Bank of Pakistan policy rate), and an extended maturity profile have contributed to the reduction in net domestic borrowing. The domestic debt profile improved to 3.1 years in Jan 2024, up from 2.7 months in Jun 2023. Additionally, the government successfully launched a 1-year Sukuk on the Pakistan Stock Exchange (PSX) in November 2023, raising lower-cost debt from non-bank and retail investors. Similarly, external net borrowing fell to $0.3 billion, compared to $3 billion in the preceding period.

Pakistan’s current economic challenges are rooted in the unsustainable public debt position, with the country breaching the Fiscal Responsibility & Debt Limitation Act (FRDL) since 2013. Weak tax collection, mounting losses of State-Owned Enterprises (SOEs), and the highest interest rates since 1972 have hindered the government’s ability to service public debt liabilities.

The improvement in the fiscal position and meeting other quantitative and structural benchmarks led to the successful first review of the IMF SBA in November 2023, resulting in the subsequent disbursement of $700 million in January 2024. The measures taken to conclude the IMF staff review included the annual rebasing of power tariffs, semi-annual gas tariff adjustments, and the implementation of the SOE Policy to enhance governance and improve financial performance.

As the first seven months of FY2024 unfold, economic indicators signal a cautiously optimistic outlook. The government’s responsive measures, including relief packages and fiscal management, have mitigated challenges. Noteworthy improvements in trade balance and foreign investments showcase resilience. While inflation remains a concern, the expected decline, coupled with sustained economic policies, positions the nation for further momentum in the last quarter of FY2024. As we navigate uncertainties, the focus on sound economic policies and reforms will be crucial for achieving growth targets and ensuring economic stability in the current fiscal year.