High inflation undermine growth

The Pakistani economy recovered solidly in FY21, supported by robust fiscal and monetary responses to the pandemic. The government implemented temporary fiscal measures, expanded the social safety net, reduced interest rates, provided soft loans and relief on loan servicing. Growth in economic activity gained momentum in the first half of 2021, and FY22 GDP could maintain a solid pace, backed by supportive fiscal measures announced in the FY2022 budget. However, the outlook remains clouded due to the uncertainty of the course of the pandemic, with less than majority of the population fully vaccinated as of early January 2022. Furthermore, strong inflationary pressures, driven partly by a weakening currency, may undermine private consumption (80% of GDP). A food subsidy program worth 120 billion rupee (0.9% of GDP), together with the 260 billion rupee Elsas social welfare program could offset some of the inflation impact. A sustained strong inflow of remittances (10% of FY21 GDP and majorly from Gulf countries like Saudi Arabia and UAE) would also support private consumption. The government has earmarked up to USD 6 billion for development spending in large infrastructure projects for FY21, which could boost public investment (3-4% of GDP). To control inflation amid sharp currency depreciation, the central bank raised its policy rate by 150 bps to 8.75% in November 2021 (+175 bps cumulatively over 2021) and increased the annual number of monetary policy meetings to eight.

Twin imbalances

Pakistan’s public finances improved in FY21. Revenue collection rose by 19.4%, driven by greater tax receipts, and, against a 4.5% increase in expenditure, helped shrink the fiscal deficit. Interest payment also rose at a far lower 2% in FY21, compared to the 78% surge in FY20. Pakistan’s qualification for the G20 Debt Service Suspension Initiative (DSSI) provided temporary debt payment relief of nearly 2% of GDP to the country. Lowering the budget deficit in FY22 will require greater revenue mobilization, which remains among the lowest in the world as a percentage of GDP (14.5%). Reform measures will include widening its tax base by reducing exemptions and preferential rates, and improving the national rate of tax compliance. On 21 November 2021, IMF and Pakistan reached a Staff-Level Agreement under IMF’s Extended Fund Facility, which would revive Pakistan’s “suspended” IMF program and make available about USD 1 billion in disbursement if the agreement is approved by the IMF Executive Board, which could bring additional financing from other multilateral organizations. In addition, Pakistan received a USD 3 billion loan from Saudi Arabia as part of an economic support package. Budget spending is problematic: 20% was allocated to defence, while 43% to the servicing of government debt. The FY21 federal deficit was financed mainly by domestic sources, such as the local banking system, with 24% provided by external sources. External debt represented 31.2% of gross public debt as of June 2021 (down from 32.5% in June 2020), and 36.1% of it was held by multilateral creditors.

 
The current account deficit narrowed in FY21, the smallest in a decade, driven by strong remittances growth, solid export receipts, and a smaller primary income deficit owing to reduced foreign interest payments after Pakistan joined the G20 DSSI. Workers’ remittances surged by 27% in FY21 to hit a record high of USD 29.4 billion. Exports (10% of GDP) benefitted from improved competitiveness linked to a weaker rupee, with major exports such as textile manufactures (59% of goods exports) increasing by over 30% in the first 10 months of 2021. Nevertheless, the trade deficit widened as the growth in import value was much higher than export because of rupee depreciation and higher global oil prices. The improvement is likely to reverse in FY22 as the primary income deficit should widen on the expiry of the DSSI (December 2021), and import value is set to rise further on improving domestic demand and higher international crude prices.

Government under pressure

Pakistan’s Prime Minister Imran Khan, elected in 2018, is under increasing pressure from main opposition parties, religious groups, and even political allies amid the Pakistan Tehreek-e-Insaf (PTI) government’s struggle to stabilize the economy. The PTI, which holds 45.6% of legislative seats, relies on junior coalition partners to hold a slim majority (51.8%) in the lower house. In its 70-year history, no prime minister has lasted a full five-year term, and the key to ensuring the longevity of Khan’s administration is the ability to keep the army’s support. The security situation in the country remains tenuous, with a significant increase in attacks targeting religious minorities. The recent developments in Afghanistan should see China and Pakistan, which already enjoyed long-standing ties, to further deepen their military and strategic partnership. Tensions with India over Kashmir remain volatile.