The World Bank expects Pakistan’s fiscal deficit to decline to 3.5 per cent of the gross domestic product (GDP) by financial year 2017 in a latest report unveiled on Sunday, projecting a steady growth recovery-cum-low inflation in the next two years, supported by fiscal consolidation and an improving external position.

According to the twice-a-year South Asia Economic Focus report, investment is expected to rise due to operationalization of China Pakistan Economic Corridor (CPEC) and inflation is projected to remain low on the back of low commodity prices, exchange rate stability and a prudent fiscal policy.

“Fiscal consolidation is projected to continue over the medium term based on strong tax revenue efforts as well as gradual phasing-out of energy-related subsidies and of contingent liabilities on loss-making SOEs,” the report added.

Resultantly, the report said, the fiscal deficit is expected to decline to 3.5% of GDP by FY 2017.

The reduced need for deficit financing should facilitate provision of bank credit to the private sector, leading to increased economic activity.

The government of Prime Minister Nawaz Sharif inherited a record fiscal deficit of 8.8 percent in June, 2013. The deficit for the 2014-15 was provisionally projected at around 5 percent. The government is aiming 4.3 percent budget deficit target for the current fiscal year. The World Bank projected Pakistan’s economic growth to accelerate to 4.5% in FY 2016 and then further to 4.8% in FY 2017 supported by strong growth in industry and services.

Overall, South Asia is expected to maintain its lead as the fastest-growing region in the world, with economic growth forecasted to accelerate from 7 percent in 2015 to 7.4 percent in 2016.

The report said that macroeconomic stability in Pakistan has largely been restored and key external risks are lower. “The record increase in remittances and stable agricultural performance continues to support a steady growth outlook.”

Prospects for continued growth appear reasonably bright, supported by strong fiscal consolidation and improved external position, the report said but added that slowdown in China might affect this outlook.

“For sustained and inclusive growth, Pakistan needs to successfully implement reforms in energy and taxation, and increase investment.”

Noting the recent development, the report said that economic conditions have improved over the past year and a strengthened external position, continued fiscal consolidation efforts, and progress in achieving structural reforms have led to Pakistan’s outlook being raised to positive from stable by the main rating agencies.

Record high remittances offsetting a persistent trade deficit; subdued international oil prices curtailing the import bill; and improved inflows against Coalition Support Fund together contributed to a manageable current account deficit of 0.8% of GDP in FY 2015.

This, coupled with higher net inflows in capital and financial accounts, resulted in an overall external surplus for the second year in a row with a significant increase in international reserves, inducing stability in the foreign exchange market.

Despite weaker manufacturing performance, economic growth marginally picked-up in FY 2015 to 4.2%, compared to 4.0% in FY 2014, driven mainly by services and agriculture sectors.

On the demand side, government consumption, growing at 16%, contributed 1.9% to overall growth. Private consumption also contributed to overall growth, although growing at a much smaller rate. Inflation continued its single-digit trend for the third year in a row and recorded an 11- year low of 4.5%. Fiscal consolidation was on track due to healthy non-tax revenues and some rationalization in power subsidies, supported by decline in international oil prices. Total public debt is on a declining path, an outcome that coupled with improved import coverage has allowed Pakistan to qualify again for IBRD financing.

Investment in Pakistan is expected to increase to 15.4% of GDP by FY2017 on account of operationalization of China Pakistan Economic Corridor (CPEC)-related projects.

The current account deficit is projected to increase slightly to 1.0% of GDP by FY 2017 but will remain manageable.

Exports are projected to contract in the first year owing to tapered global demand and then grow marginally the following year.

Imports, however, are projected to post moderate growth due to CPEC-related investments and higher domestic demand.

The slowdown in China, if protracted, could have adverse effects on investment and trade, and Pakistan may not have the ability to absorb external shocks in the absence of strong buffers.

Furthermore, realization of tax revenue targets largely hinges on steady implementation of tax reform agenda.

For the economy to accelerate in the long run, key growth constraints like electricity shortages, cumbersome business climate, complex trade regime, low access to finance and security situation need to be addressed.