Promising developments and pressing challenges
The economic situation in Pakistan presents a mix of promising developments and pressing challenges. Expectations point towards a gradual easing of inflation alongside momentum in imports, exports, and remittances, contributing to maintaining a sustainable current account. Despite these positive indicators, fiscal management faces significant hurdles, with mounting expenditure pressures and widening fiscal deficits.
In Pakistan, the inflation rate hit a seven-month low of 1.39% in the week ending May 9, mainly due to a decrease in food prices, marking the fourth consecutive week of decline, as reported by the Pakistan Bureau of Statistics (PBS). The sustained deceleration in short-term inflation rates and related trends suggests that the monthly benchmark inflation, measured by the Consumer Price Index (CPI), could reach a low not seen in over two years, falling within the range of 13-15% in May. This underscores a pressing need for the central bank to take decisive action by aggressively reducing its key policy rate from the current record high of 22% at its upcoming meeting scheduled for June 10, 2024, or potentially even earlier through an emergency session.
Despite inflation dropping below the interest rate for the first time in years, registering at 21.7% in March, the bank opted to maintain the interest rate at the record high of 22% in its last monetary policy meeting held in late April 2024. This resulted in a positive real interest rate of 1.3% in March.
Based on the latest weekly inflation data from PBS, experts anticipate a year-on-year inflation decrease to 13% in May. This significant decline in inflation from 38% in May 2023 to around 15% in May 2024 is attributed to improved local crops and anticipated agricultural growth exceeding 5%, marking an 18-year high.
The central bank has kept the rate unchanged at its past seven meetings held over the previous 10 months from July 2023 to April 2024. According to PBS, the short-term inflation rate measured by the weekly Sensitive Price Indicator (SPI) dropped to a 23-month (100-week) low of 22.32% in the observed week compared to the same period the previous year. However, year-on-year short-term inflation remained in double digits.
In the observed week, out of 51 items, prices of 12 items (23.53%) increased, 13 items (25.49%) decreased, and 26 items (50.98%) remained unchanged compared to the previous week. Notably, there were significant year-on-year increases in gas charges for Q1, onions, tomatoes, and other commodities.
The Ministry of Finance has forecasted further easing of inflation in Pakistan, attributing it to the favorable base effect from the previous year and improvements in the domestic supply chain of essential goods. The ministry emphasized a moderate inflation outlook, with the government actively implementing strict administrative measures to reduce inflation. Despite the rise in international crude oil prices leading to an increase in domestic petrol prices, the government aims to counterbalance this by reducing wheat flour prices and implementing administrative measures.
Expectations are pointing towards a gradual easing of inflation further to a range of 17.5-18.5 percent in May. It is anticipated that imports will gain momentum, fostering economic activities, while exports will continue their upward trend. Remittances are projected to hover around $2.3-2.5 billion, contributing to maintaining the current account within sustainable limits.
The fiscal performance from July to February of FY2024 shows some positive developments amid various challenges. Revenue collection has notably increased, especially non-tax revenue, while tax collection has not only kept pace but exceeded targets from July to March of FY2024. This improved revenue performance reflects enhanced economic activity, effective tax administration, and compliance measures. The government is striving to sustain this momentum to achieve the FY2024 revenue target through an effective revenue mobilization strategy.
However, there are significant challenges stemming from mounting expenditure pressure, primarily driven by higher interest payments, leading to a widening fiscal deficit in the first eight months of the fiscal year. Nonetheless, the surplus in primary balance continues to improve, indicating the government’s capacity to cover its primary expenditures. To address these challenges, the government is committed to enhancing revenue collection, controlling expenditures, and maintaining fiscal discipline.
The first nine months of the current fiscal year show signs of moderate recovery in macroeconomic conditions, supported by growth in agriculture, easing inflationary pressures, and stability in external accounts.
According to available quarterly estimates, GDP growth in Q1 and Q2 of FY2024 is estimated at 2.5 percent and 1.0 percent, respectively. The positive momentum in the Large-Scale Manufacturing (LSM) sector since December 2023 is expected to continue due to increased agricultural production, rising export demand, improvement in the Composite Leading Indicator of Pakistan’s main export markets, and the anticipation of exchange rate stability.
While fiscal performance shows positive trends with significant revenue growth, the increasing pressure on expenditures, particularly due to higher interest payments, poses significant challenges for fiscal management. To achieve a stabilization path, fiscal consolidation is essential to pave the way for sustainable economic growth.
As Pakistan navigates through the complexities, sustaining economic recovery and fiscal stability requires concerted efforts and strategic interventions. While positive signs emerge from increased revenue collection and macroeconomic resilience, the burden of escalating expenditure and fiscal deficits looms large. To chart a path towards sustainable growth, fiscal consolidation is imperative, alongside efforts to enhance revenue mobilization and control expenditures. By addressing these challenges head-on, the country can lay the foundation for a resilient and prosperous economic future.