WB Country Director says inequitable and distortive tax system, reducing inefficient expenditures and untargeted subsidies, lessening large state presence in economy, reducing barriers to trade and investment and reducing losses in energy sector are potential factors.

ISLAMABAD  -  Pakistan’s economy has continued to stabilize from the recent economic crisis, with growth recovering to 2.5 percent in the fiscal year ending June 2024, says the World Bank in its latest country economic update.

Released yesterday, the Pakistan Development Update: The Dynamics of Power Sector Distribution Reform, finds that following recession in FY23, economic activity strengthened in FY24 reflecting strong agricultural output, lower inflation, prudent macroeconomic measures, and reduced political uncertainty. But this level of growth is not sufficient to bring down poverty rates, which increased from 40.2 percent in FY23 to 40.5 percent in FY24.

“Pakistan’s stabilizing economy is on a path of recovery. To sustain and strengthen that positive momentum, steady implementation of the Government’s structural reforms plan that aims to address long standing constraints to faster growth will be the key. These include reforming an inequitable and distortive tax system, reducing inefficient expenditures and untargeted subsidies, lessening the large state presence in the economy, reducing barriers to trade and investment, and reducing losses in the energy sector” said Najy Benhassine, World Bank Country Director for Pakistan. “Implementation of planned structural policy reforms supported by a strong national political consensus and increased private sector participation, is critical to mitigate risks, support stronger private-led growth and poverty reduction.”

As the economic stabilization continues, macroeconomic risks remain high reflecting high financing needs, modest foreign exchange reserves, high debt and debt servicing costs, financial sector vulnerabilities, and a loss-making power sector that continues to weigh on public finances.

“Pakistan’s recovery is expected to continue, with real GDP growth expected to reach 2.8 percent in FY25,” said Mukhtar ul Hasan, lead author of the report. “However, output growth is expected to remain below potential over the medium-term as tight macroeconomic policy, elevated inflation, and policy uncertainty are expected to continue to weigh on economic activity. Faster growth will be needed to support significant improvements in living standards.”  

Economic activity is expected to continue recovering, with real GDP growth estimated at 2.8 percent in FY25, as the economy benefits from the absence of import restrictions, easing domestic supply chain disruptions, and lower inflation. 

Business confidence is also expected to improve with credit rating upgrades and less political uncertainty. The agriculture sector is projected to grow at an average rate of 2.4 percent over FY25–26. The absence of import controls will enhance the availability of farm inputs for the agricultural sector, contributing to the industry’s recovery over the medium term.

Together, growth in the agricultural and industrial sectors will spill over to the services sector, which is anticipated to grow by 3.2 percent on average over FY25–26, led by recovery in the largest sub-sectors of wholesale and retail trade, and transport and storage amid the revival of imports and aggregate demand. However, output growth is expected to remain below potential at 3.2 percent in FY26 as tight macroeconomic policy, elevated inflation, and policy uncertainty continue to weigh on activity.

With high base effects, lower commodity prices, and continued tight macroeconomic policies, consumer price inflation is expected slow to an average of 11.1 percent in FY25 and further to 9.0 percent in FY26; but remain elevated in the short term due to higher domestic energy prices, increasing money supply through OMOs, and new taxation measures as fiscal consolidation efforts continue.

On the external front, the CAD is forecast to remain low at 0.6 percent of GDP in FY25 and inch up to 0.7 percent in FY26 as domestic demand continues to recover amid the continued absence of import restrictions. Inflows of critical imported inputs will also support major export-oriented sectors, including textiles. Growth in imports is expected to exceed growth in exports, leading to a wider trade deficit. Meanwhile, remittances are expected to slow marginally in part due to slower growth in host countries. Amid a lower CAD, gross reserves are expected to improve marginally over FY25–26, supported by new inflows under the IMF-EFF program.

The fiscal deficit is projected to increase to 7.6 percent of GDP in FY25 due to higher interest payments, but to gradually decrease with fiscal tightening and declining interest rates, narrowing to 7.3 percent in FY26. The primary balance is expected to record a surplus of 0.7 percent of GDP in FY25, primarily due to the projected windfall from the exceptionally high central bank dividends. These dividends represent one-time gains from elevated policy rates in FY24 and will be allocated to the Government as non-tax revenue in FY25. The primary balance is projected to turn into a deficit of 0.2 percent of GDP in FY26. Gross financing needs will remain sizeable throughout the projection period because of maturing short-term debt, multilateral and bilateral repayments, and Eurobond maturities. Public debt, including guaranteed debt, is expected to reach 73.8 percent of GDP in FY25 and increase further to 74.7 percent in FY26. A deeper fiscal consolidation over the medium term will be necessary to restore fiscal and debt sustainability.

Downside risks remain high: the outlook depends on the new IMF-EFF program remaining on track, continued fiscal restraint, and obtaining additional external financing. Significant risks stem from the heavy exposure of the banking sector to the Government and geopolitical instability. Potential policy slippages, reversals in reforms, and further political instability would lead to reduced confidence among businesses and increased external financing constraints and costs. Implementation of planned structural policy reforms, supported by a strong national political consensus, is critical to mitigate risks and support stronger medium-term growth and poverty reduction.

The Special Focus section highlights the challenges in Pakistan’s power sector, including the escalating CD, operational inefficiencies, and a lack of investment. These issues stem from outdated infrastructure and management practices, leading to high distribution losses and low collection rates. Despite improvements in generation capacity, the DISCOs continue to struggle, contributing to high electricity costs and financial instability. Private sector participation in the distribution sector offers the potential for improved management, increased efficiency, and new investment; but good outcomes are contingent on the establishment of a conducive broader policy and regulatory environment.