ISLAMABAD  -  The State Bank of Pakistan (SBP) has noted that Pakistan’s macroeconomic conditions improved, supported by stabilisation policies, successful engagement with the IMF, reduced uncertainty, and favourable global economic environment.

The latest data on high-frequency indicators points to further improvement in macroeconomic conditions in FY25. This, combined with the approval of the Extended Fund Facility (EFF) programme by the IMF Board in September 2024, is expected to boost investor confidence and further upgrade Pakistan’s credit rating. “These developments could make way for external inflows from multilateral creditors, as well as from private investors,” the central bank stated in its Annual Report on the State of Pakistan’s Economy for the fiscal year 2023-24.

Moreover, according to the report, global commodity prices are maintaining a downtrend while global growth is expected to remain steady, as per the IMF’s latest World Economic Outlook. These developments have improved Pakistan’s near term macroeconomic outlook. “However, inherent volatility in global energy prices may pose some risks to this outlook,” it warned.

Amid receding inflationary pressures, the SBP has already started to lower the policy rate, after maintaining the tight monetary policy stance for the longest period in recent past. Lower borrowing costs, combined with improving external position and fall in global commodity prices, are expected to support expansion in industry and services sectors during FY25. Meanwhile, the FY25 budget envisages a notable increase in development spending that may further boost economic activity. The high frequency demand indicators also continue to show signs of bottoming out, whereas LSM saw almost consistent improvement since December 2023. However, the latest information about kharif crops suggests that agriculture sector may not sustain its growth momentum into FY25. According to the preliminary estimates as of 1st September 2024, cotton arrivals reported a 59.7 percent decline compared to the same period last year. In view of these developments, the real GDP growth is expected in the range of 2.5 – 3.5 percent in FY25. Despite reduction in the policy rate, the real interest rates remain significantly positive. The tight monetary policy stance and continued fiscal consolidation, as envisaged in FY25 budget, are expected to keep inflation significantly contained during FY25. Moreover, the headline inflation has maintained a general downturn since June 2023, falling to 6.9 percent in September 2024, whereas core inflation has also declined considerably in recent months. In view of the recent outturns, the average inflation in FY25 may even fall below the earlier projected range of 11.5 – 13.5 percent. However, volatility in international oil prices, fiscal slippages and unplanned subsidies pose significant risks to this projection. The SBP projects a fiscal deficit in the range of 5.5 – 6.5 percent in FY25, compared to 6.8 percent of GDP in FY24. This improvement is expected to come from a sharp increase in both tax and nontax revenues. While direct taxes are expected to continue the uptrend witnessed since the last year, the continuing momentum in economic activity, which is anticipated to be led by industry and services sectors in FY25, and an uptick in imports are likely to further boost indirect taxes.

On the other hand, expenditures are also expected to continue to grow. The FY25 budget envisages notable increase in expenses for social protection. In addition, the government has announced an increase in salaries and pensions of government employees in view of the heightened inflation. Similarly, to give a boost to economic growth, the budget envisages substantial increase in development spending during FY25. In line with the moderate expansion in industry and services sectors, imports are likely to increase in FY25. Moreover, while there are upside risks to global commodity prices due to rising geo-political tensions, commodity prices continue to be low. On the other hand, both the exports and workers’ remittances are holding the trends observed in FY24. Incorporating these trends and expected future developments, the SBP expects the CAD to remain contained in the range of 0 – 1.0 percent of GDP in FY25. On the other hand, the approval of $7 billion EFF programme and the realisation of external inflows from multilateral and bilateral creditors are expected to further strengthen the external buffers.

The increase in domestic agricultural productivity also contributed to relatively better macroeconomic outcomes during the year, the report added. The real GDP registered a moderate agriculture-led recovery in FY24. A record harvest of wheat and rice, and a rebound in the production of cotton mainly provided a boost to agricultural output during FY24. The Report highlights that despite a recovery in real economic activity, the current account deficit further narrowed to a 13-year low as strong growth in remittances and exports more than offset a slight increase in imports. This, coupled with the Stand-By Agreement with the IMF that catalysed inflows from other multilateral and bilateral sources, helped in the build-up of FX reserves and calming sentiments in the foreign exchange market. The gradual exchange rate appreciation during the year, together with higher-than-envisaged fiscal consolidation, led to a notable decline in public debt to GDP ratio in FY24. The report notes that the SBP maintained a tight monetary policy stance by keeping the policy rate unchanged at 22 percent for almost the entire FY24. The SBP also introduced reforms in foreign exchange companies, following administrative actions by the government to bring order in foreign exchange and commodity markets. The government continued the fiscal consolidation, with the primary balance posting a surplus for the first time in 17 years. These, together with the decline in global commodity prices amid improved global economic activity and trade, had positive bearings on key macroeconomic indicators, the report highlighted. The inflation dropped from its peak of 38 percent in May 2023 to 12.6 percent in June 2024. It averaged at 23.4 percent during FY24, considerably lower than 29.2 percent in FY23. A consistent decline in headline and core inflation in the latter half of FY24, created room for the SBP to reduce the policy rate by 150 basis points to 20.5 percent in June 2024. Notwithstanding these positive developments, the report highlights that a host of structural impediments continue to pose challenges to sustaining macroeconomic stability. Falling investment amid low savings, unfavourable business environment, lack of research and development, and low productivity, alongside climate change risks continue to constrain the economy’s growth potential. In addition, longstanding inefficiencies in the energy sector have resulted in the accumulation of the circular debt. While the government has started to address energy sector challenges through substantial price adjustments, there is a need to broaden the scope of these efforts by introducing sectoral policy and regulatory reforms. These reforms are also necessary to address the issue of inefficiencies in the State-owned Enterprises (SOEs) that continue to be a drain on fiscal resources, which are already constrained by low tax-to-GDP ratio.